On Friday, February 13, 2015, the IRS released an advance version of Rev. Proc. 2015-20, 2015-5 I.R.B. 450, that allows a “small business taxpayer” to make certain tangible property and dispositions changes in methods of accounting with an I.R.C. § 481(a) adjustment that takes into account only amounts paid or incurred, and dispositions, in tax years beginning on or after January 1, 2014.
Background. Effective January 1, 2014, the IRS issued final regulations at Treas. Reg. § 1.263(a)-1, -2, and -3 that completely changed the way taxpayers must evaluate certain expenditures in order to determine whether the costs represent immediately deductible repair expenses or capital improvements that must be depreciated over time. In addition, regulations issued at Reg. § 1.162-3 provide new guidance on when a taxpayer may deduct costs incurred to acquire “materials and supplies.” Collectively, these regulations are referred to as the “tangible property regulations” (TPRs).
Are the TPRs optional for small business taxpayers now? No, all taxpayers must still comply with the regulations. However, small business taxpayers may change their accounting method in accordance with the TPRs without examining expenses from years prior to 2014 and computing a § 481(a) adjustment.
What is a “small business taxpayer”? Rev. Proc. 2015-20 defines a “small business taxpayer” as a business with total assets of less than $10 million or average annual gross receipts of $10 million or less for the prior three tax years. These tests are applied to each separate and distinct trade or business of the taxpayer. In other words, a taxpayer with a Schedule C sole proprietorship with average annual gross receipts (AAGR) of $4 million, a Schedule E rental real estate business ($2 million in total assets), and a 100% interest in an S corporation ($5 million AAGR), will still qualify as a small business taxpayer.
Which accounting method changes may be made under the Rev. Proc.? Changes under the final tangible property regulations (section 10.11(3)(a) of Rev. Proc. 2015-14); certain permissible to permissible methods of accounting for depreciation of MACRS property in mass asset accounts (sections 6.37(3)(a)(iv), (v), (vii), and (viii) of Rev. Proc. 2015-14); disposition of a building or structural component (section 6.38 of Rev. Proc. 2015-14); and dispositions of tangible depreciable assets (section 6.39 of Rev. Proc. 2015-14).
3115 Change Numbers: 184, 185, 186, 187, 188, 189, 190, 191, 192, 193, 200, 205, and 206
Not included: 196
How do I make the changes under Rev. Proc. 2015-20?
(1) The IRS is waiving the requirement for a taxpayer’s first tax year after January 1, 2014 to complete and file a Form 3115 to make the above-listed accounting method changes.
(2) Further, the IRS is permitting small business taxpayers to make such changes with a § 481(a) adjustment that takes into account only amounts paid or incurred, and dispositions, in taxable years beginning on or after January 1, 2014. In effect small business taxpayers may elect to make these change on a cut-off basis, i.e. with a zero § 481(a) adjustment.
(3) There is no requirement to refer to Rev. Proc. 2015-20 in order to qualify for the relief provisions.
Thus, small business taxpayers adopt the TPRs simply by filing their return in conformance with the regulations.
Limitations on relief.
- Taxpayers filing under this procedure do not receive audit protection for tax years beginning prior to January 1, 2014.
- A taxpayer that chooses to use the procedures of Rev. Proc. 2015-20 for tangible property method changes must also use this procedure for its dispositions changes, and vice versa.
- A taxpayer that uses the method change relief in Rev. Proc. 2015-20 for any trade or business is not permitted to make a late partial disposition election for all trades or businesses.
Great news! I’ll just be tossing all these 3115s in the shredder now… Not so fast. The TPRs represented an opportunity as well as a burden, so some taxpayers may still be better off filing a Form 3115. Specifically:
- Any taxpayers wishing to make a late partial asset disposition election (partial asset dispositions for 2014 or future years may be made simply by filing the return with the proposed treatment);
- Taxpayers who tended to “overcapitalize”, i.e. capitalized expenses for repairs, maintenance, materials and supplies, in addition to improvement costs, because they will be able to accelerate deductions;
- Taxpayers concerned about tax treatment of expenses in prior open years who want audit protection.
Anything else? The revenue procedure also requests comment on whether the $500 safe-harbor threshold (the de minimis safe harbor) should be raised for businesses that choose to deduct, rather than capitalize, certain capital expenses, to an amount greater than $500, and, if so, what amount should be used and the justification for considering that amount appropriate. Considering the IRS’ apparent willingness to make last-minute changes, it is possible that the de minimis safe harbor threshold could be increased before April 15.
Daniel L. Mellor is an associate with the firm. He earned his J.D. at the George Mason University School of Law in Arlington, VA and his Master of Laws (LL.M.) in Taxation from the Temple University Beasley School of Law in Philadelphia, PA. Mr. Mellor’s particular areas of expertise include business transactions, estate planning and probate litigation.