Repairs & Capitalization Guidelines from TaxSpeaker ™

& 3/4/14 & 11/4/14

Pre step: Pray that you don't get to Step 4!

Note: The IRS preamble to these Regulations estimates taxpayer compliance time at 1/2 hour TOTAL. I think they wrote the Regulations in Colorado right after the new Marijuana regulations were written!

Step 1: Adopt current year De Minimus Policy and attach to return each year starting with 2014 return)

Step 2: Apply De Minimus and safe harbor maintenance rules to materials, supplies, equipment and repairs as follows:

a. Expense supplies and maintenance items lasting < 12 months

b. Expense other supplies & maintenance items costing <$200

c. Expense repairs & acquisitions costing <$500 ($5,000 audited statements) per maintenance policy. If you have audited financial statements complete and file Form 3115 change in accounting method. (IRS estimates 23 hours and 48 minutes to complete this form per the 3115 instructions)

d. Expense items replaced or expected to be replaced more than once during asset life

Step 3: Apply safe harbor maintenance rules to buildings

a. Expense items replaced or expected to be replaced within a 10-year period,

b. Determine if qualified small business with revenues <$10,000,000

c. Determine if building original cost is < $1,000,000,

d. If both b and c are met determine if total maintenance costs including other current year expense items are less than $10,000 per building.

e. If d is met expense the amounts, otherwise life as you know it has ended and apply the capitalization rules below.

Step 4: Determine the Unit of property;

Step 5: Apply the 3 Betterment tests to each item whose individual cost is >$500 ($5,000 audited financials), if no betterment test applies go to Step 6, if any apply capitalize;

Step 6: Apply the 6 restoration tests to each item whose individual cost is >$500 ($5,000 audited financials), if no restoration test applies go to Step 7, if any apply capitalize;

Step 7: Apply the 2 adaptation tests to each item whose individual cost is >$500 ($5,000 audited financials), if no adaptation test applies go to Step 8, if any apply capitalize;

Step 8: Send this analysis to your elected representatives to show how ridiculous, time consuming, and unproductive with small business the IRS rules are for 2014.

REPAIR AND CAPITALIZATION POLICY

Powell & Powell Accounting, Inc. hereby adopts for book and Federal income tax purposes the following policy regarding capitalization expenses for the year beginning January 1, 2014. In accordance with Internal Revenue Code Sections 167 and 168 and related Regulations Powell & Powell Accounting, Inc. has determined that amounts whose individual cost (including tax, installation and delivery costs) does not exceed $500 will be deducted as incurred as an operating expense. Amounts exceeding this dollar limit will be examined individually to determine if their use or purpose requires capitalization under the betterment, adaptation or restoration rules used by the Internal Revenue Service and will be capitalized or expensed as incurred as a result of the application of those rules.

Or

Company Name

Address

City, State Zip

Employer Identification Number: ______

For the Tax Year Ending December 2014

RE: Section 1.263(a)-1(f) De Minimus Safe Harbor Election

The general capitalization policy for tax purposes is that all equipment and other fixed assets costing in excess of $500 per invoice (or per item as substantiated by the invoice) will be recorded as an asset. This policy will be in compliance of the IRS safe-harbor provisions described in Reg. 1-263(a)(1)(f). If a repair or improvement in excess of $500 is considered a betterment, adaptation or a restoration to a unit of property, such expenditure will need to be capitalized for tax purposes.

Form 3115 or Not? from TaxSpeaker ™

So here is what we need to do for tax years beginning on or after January 1, 2014.

We have never had a regulatory guide for minimal amounts that may be written off by a business as immaterial, or as repairs and maintenance. Although we have 40 years of judicial guidance, the IRS has decided through the new Regulations that we have three possible choices of immaterial (de minimums) amounts now. And the choice must be made annually and attached every year to the tax return.

Do nothing and your de minimums amount is zero, meaning the business owner or tax professional must individually examine every repair, supply and asset purchase costing more than $0 to determine if it meets one of the 15-20 possible capitalization requirements. We will see in 2015 that most self-prepared tax returns, and most returns done by the fly-by-night tax offices will choose this method through inaction. Because the ability to take Section 179 on an amended return ended for years beginning on or after 1/1/2014 we will not be able to fix this issue upon audit, and we will be required to file a 3115 change in accounting method for them to adopt the new amounts at some future year.

Large businesses that have “applicable financial statements” may adopt a policy of expensing the first $5,000 of items. These folks have the burden of both adopting a policy and changing methods of accounting with Form 3115. An “applicable financial statement” (AFS) is one filed with the SEC; a certified audited financial statement; or a financial statement required to be provided to the federal or state government or any federal or state agency other than the SEC or IRS. (Reg. 1.263(a)-1(f)(4)(i)). These folks will need to use Revenue Procedure 2014-16 to help prepare the 3115.

Now what about businesses without “applicable financial statements”? First, they need to adopt a $500 de minimums policy. We have example policies included in our 1040 manuals and our business manuals but we fully expect all of the major software companies to also include the policies as part of this year’s tax software, and the adoption should merely be checking some box in the software to adopt the policy.

Second we need to see who these businesses are, since they have been ignored by every IRS employee, national CPA firm, financial press and everyone else. These businesses include, according to the SBA website, companies that provide 48% of the GDP in the United States, the bulk of new hiring in the last 20 years, and a large portion of employment. They include every sole proprietor, farmer, small S or C Corporation, LLC or partnership, every rental property owner, every employee that uses Form 2106 to write off business mileage or supplies and every employee that uses Schedule A to write off other business related repairs, supplies or small tools. Wait a minute are you telling me that nearly every tax return in America will require that we attach this “de minimums” election? Well, yes that is what I am saying, because if you do not, you adopt zero as your de minimums amount! Ridiculous, huh? But the fun doesn’t stop there.

Every IRS employee, large CPA firm and advisor is also telling us that every one of these same Schedule A filer, Schedule C filer, Schedule E filer, Schedule F filer and corporate or partnership return filer must also file Form 3115 to change their method of accounting to comply with the new Regulations. Have you read the instructions to Form 3115, the part that says it takes 23 hours and 48 minutes to complete? Are you telling me that Grandma Jones, that rents an apartment in her basement for $200 monthly has to make a de minimums election and file a Form 3115? The Schedule C body shop guy making $30,000 annually has to file the de minimums election and a 3115? The small S corp that runs a Subway restaurant making $50,000 has to file these forms? If you believe everything you read, yes. One simple question to all of these pundits, particularly the IRS-who is going to pay us to prepare these Forms 3115? Is Grandma Jones going to pay me an additional $750 to fill out this form? No, neither she nor any small business in America will do that.

Here is where we point out the issue. Every one of these advisers refers to the requirement to file a 3115 to change methods of accounting for the taxpayer’s books to comply with these new Regulations. Every single author, speaker and advisor in the country has jumped on that bandwagon, and even refers to the wording at the Regs that seem to require a 3115, in particular 1.162-3(i) which states “… a change to comply with this section is a change in method of accounting..”

Companies that have applicable financial statements, reviewed financial statements, or any other system that has had them adopt a repairs and capitalization policy will need to file the 3115 because they are changing methods of accounting. I agree with the pundits on that statement. However I believe there is a basic flaw in their advice to everyone else, and it is born out in something stronger than the IRS Regulations, it is established by Congress as United States law in Internal Revenue Code Section 446(a) which states “Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.”

And here is what the experts are missing. Grandma Jones does not have a set of books and has never adopted a method of accounting for repairs, supplies or small tools because she never had a need, nor an option. Similarly the small S corporation or partnership or LLC without formal financial statements does not have a set of books or if they do have also never adopted a method of accounting for repairs, supplies or small tools. Therefore they are not “changing” a method of accounting, for which a Form 3115 is required, they are initially adopting a method of accounting in the first year that such adoption is allowed as an option. No 3115 is required to “adopt” a method of accounting, just to change an existing method!

In summary we believe an election and a Form 3115 is required for businesses that have adopted a repairs or capitalization policy for their books, particularly those with formal financial statements and footnotes. For the bulk of small businesses that have never adopted a previous repairs and capitalization policy such as nearly every Schedule A,C,E,F filer in America as well as the vast majority of S corporations and LLC’s we believe that they need to adopt a de minimums policy for 2014, but we do not believe they are required, and we will not file a 3115 “Change in Accounting Method” form when no change is occurring, just an initial adoption.

Clearly this is an opinion which you may not share, in which case do two things: read Code Section 446 and the related Regulation cited above and read the word “change” in context; and then decide. Filing form 3115 is your decision to file based on your own interpretation of the law, combined with the need to balance the benefits of filing a form that we do not believe is required for many small businesses with the cost of preparing such a form. If your opinion differs, file the Form. We will not be filing Form 3115 except for those clients that have in the past adopted a repairs and capitalization policy and who are changing to comply with this new policy.