Easier Tangible Property Regulation Compliance

In 2013, the IRS released final regulations on the tax treatment of expenditures related to tangible property. The regs provide guidance on how to comply with Internal Revenue Code Sections 162 and 263, which require the capitalization of amounts paid to acquire, produce or improve tangible property but allow amounts for incidental repairs and maintenance of property to be deducted. The regs explain how to distinguish between capital expenditures and deductible business expenses.

The regs generally apply to tax years beginning on or after Jan. 1, 2014. They affect all businesses that own or lease tangible property, including buildings, machinery, vehicles, furniture and equipment.

Many of the small businesses affected asked the IRS to make it simpler for them to begin applying the regs. The IRS has now granted some relief, available for 2014 tax returns. It released a new procedure that allows qualified small businesses to make certain changes in their method of accounting on a “cut-off” basis — with an adjustment under Sec. 481(a) that takes into account amounts paid or incurred, and dispositions, only in taxable years beginning on or after Jan. 1, 2014.

The Sec. 481(a) adjustment generally accounts for how a taxpayer treated the items being changed in prior years to avoid duplication of deductions or omission of income. Under the new procedure, amounts paid or incurred, and dispositions, before Jan. 1, 2014, continue to be accounted for under the former method and require no adjustment.

The simplified procedure generally is available to small businesses — including sole proprietors — with total assets of less than $10 million on the first day of the tax year for which the accounting method change is effective or average annual gross receipts of $10 million or less for the prior three tax years. These tests are applied at the trade or business level. For example, a C corporation holding company with three single-member limited liability companies (SMLLCs) must apply the tests at the SMLLC level.

The IRS has also waived the requirement to file Form 3115, “Application for Change in Accounting Method,” for small business taxpayers who opt to use the simplified procedure for 2014. Qualified taxpayers may therefore implement the regulations on their tax returns without the burdens associated with Form 3115, although some may nonetheless find it advisable to file the form.

A taxpayer who properly files Form 3115 typically receives prior-year “audit protection” for the item affected by the method change. In other words, the IRS cannot audit open tax years and charge the taxpayer interest and penalties for underpayments related to use of the previous method. Some small business taxpayers may want to file Form 3115 to ensure audit protection.

Be aware, too, that the waiver of the Form 3115 requirement applies only to accounting method changes related to the tangible property regulations. Changes associated with other items still require the filing of Form 3115.

What if you have already filed your 2014 return with a Form 3115? The IRS has created a transition rule that permits qualified small business taxpayers to withdraw their Form 3115 by filing an amended return on or before the due date of the taxpayer’s timely filed (including any extension) original federal income tax return for the requested year of change.

If you have questions about the tangible property regulations, their effect on your business, or the new simplified procedure outlined above, please feel free to contact our office at 865.523.7400.