By: Jackie Laberer
What is safe harbor?
A safe harbor is a provision in a law or regulation that protects a taxpayer from liability or penalty under specific situations or under certain conditions. An example of safe harbor is expensing business tangible personal property for the small business taxpayer.
What are the rules of de minimis safe harbor?
IRS first introduced the concept of expensing safe harbor tangible personal property on January 1, 2014. The law was to help small business taxpayers finally determine whether certain business expenses were deductible or must be capitalized. When the de minimis safe harbor rule was established, the threshold was $500. Per Section 162 of the Internal Revenue Code, the limits were increased to expense or take a tax deduction for tangible personal property, including the costs of certain materials and supplies and repairs and maintenance, in the year of purchase. This is helpful because it allows small businesses to write off greater amounts as expense deductions. The previous law required “applicable financial statements” (certified audited financial statements) to be used to prove any deduction was valid. However, effective for taxable years beginning on or after January 1, 2016, taxpayers without “applicable financial statements” may now deduct up to $2,500 per invoice or item. (Taxpayers with “applicable financial statements” may deduct up to $5,000 per invoice or item). These items may include purchases such as tablet computers, smartphones, machinery and equipment parts. Even though the new threshold limits take effect January 1, 2016, IRS will provide audit protection to eligible taxpayers by not challenging the use of the new higher threshold in tax years prior to 2016.
Careful consideration must be made in considering which expenses in these categories should be expensed or which should be capitalized. The decision to expense or capitalize an item is sometimes just a matter of timing. However, under Section 263, the taxpayer must capitalize amounts paid to acquire, produce or improve tangible personal property. These include improvements that (1) add to the value or substantially prolong the useful life of the property, or (2) adapt the property to a new or different use. The election cannot include amounts paid for inventory, land, rotatable, temporary and standby emergency spare parts that are elected to be capitalized and set up for depreciation over time.
In general, under Section 162, when you elect de minimis safe harbor expensing, materials and supplies and repairs and maintenance costs that also qualify under this category should be treated as such and not as normal repairs and maintenance costs. Taxpayers may not elect to treat repairs and maintenance costs paid during the year if they were amounts used for betterments. The election does apply to restorations that would otherwise be known as improvements to personal property, including when they pay amounts to replace a major component or part of the property. Normal repairs and maintenance costs should be deducted accordingly.
What are the requirements of de minimis safe harbor?
Taxpayers, however, are not required to capitalize improvement costs, and therefore may be permitted to deduct the costs of work performed on owned or leased buildings instead. The requirements of de minimis safe harbor election for small business taxpayers are: (1) average annual gross receipts of $10 million or less, (2) owns or leases the building property with an unadjusted basis of $1 million or less, and (3) the total amount paid for repairs, maintenance, improvements or similar activities on the property doesn’t exceed the lesser of (a) 2% of the unadjusted basis of the property or (b) $10,000.
What must be done to elect de minimis safe harbor?
A statement titled “IRS Section 1.263(a)-1(f) de minimis safe harbor election” should be attached to the taxpayer’s timely filed original federal tax return, including extensions, for the taxable year in which the de minimis safe harbor election is taken. The statement should include the taxpayer’s name, address and federal identification number. It should also include in the statement that the election is being made. This statement must be attached each year that an election is taken under the de minimis safe harbor rule.
Why take advantage of de minimis safe harbor?
It’s easier than ever before for qualifying small business taxpayers to take advantage of deducting tangible personal property costs under the de minimis safe harbor rule. Why not take advantage of it? Doing so could result in potential tax savings opportunities.