TO EXPENSE OR NOT TO EXPENSEBy
Recent IRS regulations provide a safe harbor for small companies to expense relatively inexpensive items. But the maximum value of items depends on whether the company has an acceptable financial statement.
In September 2013, the Internal Revenue Service (IRS) issued final regulations regarding the treatment of getting, repairing, and improving physical property, known as the “repair regulations.” In August 2014, regulations detailing the treatment of dispositions of tangible property were issued. Tangible property must generally be capitalized, but a safe harbor was provided that allowed for items either below a certain value or with a life of 12 months or less to be expensed. Both the repair regulations and tangible property regulations were effective for all fiscal years beginning on or after January 1, 2014.
The IRS followed these up in January and September 2014 with revenue procedures that provided the steps necessary for the accounting method changes required to comply with the new regulations. Two additional sets of procedures dealing with related changes in accounting methods were issued in January 2015.
The reaction to these regulations and procedures was widespread. More than 40 state accounting societies and the American Institute of Certified Public Accountants (AICPA) protested the changes, particularly as they applied to small and medium-sized entities (SMEs). The rules insisted that all companies file Form 3115, “Application for Changes in Accounting Methods,” and a §481A adjustment and that these documents couldn’t be filed on a prospective basis.
Revenue Procedure 2015-20, issued in February 2015, simplified the process for “small business taxpayers,” which were defined as firms that either (1) had assets of $10 million or less or (2) averaged revenue of $10 million or less during the last three years. This should include most companies, as it has been reported in recent years that only about 0.2% of businesses by assets and about 0.1% of businesses by amount of receipts exceeded the threshold level of $10 million. Smaller firms don’t currently have to file either the §481A adjustment or Form 3115 for 2014. They were also allowed to file methods changes prospectively during the first year of the effect of the regulations (2014). These elements of relief affected most firms and were greatly appreciated by the community.
But Rev. Proc. 2015-20 left one large issue unresolved. The rules further divided firms into those that had an acceptable financial statement (AFS) and those that did not. An acceptable financial statement is defined as one that is (in descending priority) either:
- A financial statement required to be filed with the Securities & Exchange Commission (SEC);
- A certified audited financial statement that is accompanied by an independent CPA’s report that’s used for credit purposes; for reporting to shareholders, partners, or similar persons; or for any other substantial nontax purpose; or
- A financial statement (other than a tax return) required to be provided to the federal or a state government or any federal or state agency other than the SEC or IRS.
Those companies that have an acceptable financial statement were given a safe harbor for expensing, instead of capitalizing, relatively inexpensive (de minimis) items. With an acceptable financial statement, a company could automatically expense any single invoice item of $5,000 or less. Without such a statement, expensing could only be automatic for invoice items of $500 or less. This safe harbor applies regardless of the expected lifetime of the item in question.
Most firms, particularly smaller ones, don’t have audited financial statements. Most also don’t report results to the SEC, using either their tax forms or a review or compilation to show their results to stakeholders.
Reaction to this provision had been substantial. The Advocacy Office of the United States Small Business Administration (SBA) held focus groups to determine the perceived impact of this distinction between firms based on financial reporting. Opinions were very much in favor of increasing the de minimis amount for firms without acceptable financial statements. Suggestions were to raise the limit from $500 and ranged from $1,000 to $5,000 for all of those firms without acceptable financial statements. One reaction was that even as simple a thing as a broken window could cost more than the $500 limit. Organizations such as IMA® (Institute of Management Accountants), the AICPA, and the Advocacy Office of the SBA submitted comment letters regarding the revenue procedure. Each of those organizations named urged the Treasury to increase the de minimis amount of $500. Indexing of the amounts involved was also recommended.
The use of either the $500 or the $5,000 safe harbor isn’t automatic. An election specifying that the company will use the safe harbor must accompany the timely (with extensions) filed tax return for the year in which the expenses are made. In addition, those firms that have acceptable financial statements must also have written policies in place regarding the use of the de minimis amount. These policies must be dated prior to the beginning of the tax year in question. Firms without the proper financial statements don’t need a written policy in place. The safe harbor isn’t a method of accounting and isn’t connected to the filing of Form 3115.
The deadline for public comments on the safe harbor amounts was April 21, 2015. A response to the comments submitted hasn’t been promulgated as of this writing. It’s possible that responses will be put forth by the time of publication of this analysis, but the likelihood of that is unknown. If and until this issue is settled otherwise, the $500 and $5,000 limits have the force of the law of the land.