New Law allows Small businesses to expense rather then depreciate certain assets

Ten Forty + Quality Tax Preparation & Financial Services 281-397-7777 Fax 281-397-7443 Tax Tips Beginning in 2016 and retroactive to 2015 in select circumstances, the IRS created a new audit­proof option that you can use to improve your tax deductions. The new option allows you to avoid depreciating certain assets and instead simply write them off. For example, say you buy two $2,000 computers for your office. Under the old rules, you likely had to treat the computers as capital assets and either: 1. depreciate them using the five­year depreciation table, or 2. elect Section 179 to expense them immediately. (Note that if you used Section 179, you had to hold the computers for five years to avoid recapture of some expensed amounts.) And then, whether you depreciated the assets or expensed them, you had to carry them in your books of account and track them for your tax return. This was a pain. But now, because of some new rules, you can avoid the capitalization and recapture rules. And this new rule allows you to remove those expensed assets from your books of account and tax returns. And it’s easy. You simply need to · follow a few simple rules, · likely insert some magic language that we will give you for your expense policy, and · do this today (this is the “act fast” part). Silver Lining In 2013, the IRS issued its final tangible­property regulations.1 This is a tome containing more than 250 pages of detailed regulations that most tax pros, business owners, and rental property experts dreaded, particularly at first glance. The property regulations, also commonly referred to as the “repair regs,” explain new tax rules that generally require you to capitalize amounts paid to buy, produce, or improve tangible property but that also allow you to deduct certain amounts as business expenses. The silver lining in the new regulations that we discuss in this article is the “de minimis” safe harbor that, when implemented, requires you to immediately deduct as business expenses assets with a certain dollar amount that you select (within limits), and gives you a regulatory advance agreement from the IRS that it will not, in an audit, challenge your election to expense. Safe Harbors: One of Two Dollar Limits The new rules contain two safe harbors; one of the two applies to you. You either have or don’t have an “applicable financial statement” for your business. If you have a CPA audit or something similar done to your financial statements, you have an applicable financial statement (AFS). The difference between having an AFS and not having one is this: With an AFS, you can create tax­deductible $5,000 expensing per invoice or invoice item. Without an AFS, you can create tax­deductible $2,500 expensing per invoice or invoice item. How to Take Advantage of the Safe Harbor To benefit from the safe harbor, you need to take four steps. Step 1: Have—and Stick to—an Expense policy For safe harbor protection, you must have in place an accounting policy—at the beginning of the tax year—that requires expensing of amounts paid per invoice item of property costing $2,500 or less (less than $5,000 with an AFS), and amounts paid for items with economic useful lives of 12 months or less. And you must comply with this expense policy in your books and records. If you establish a policy to expense amounts paid for items costing $2,500 or less, for example, you must expense every such item in your books. You can’t expense some of those items and capitalize others. Greedy? You can set your expense policy threshold above the safe harbor threshold, but the safe harbor applies only to amounts that don’t exceed the $2,500 threshold. Suppose, for example, you require the expensing of amounts paid for items below $3,100. The safe harbor will apply only to invoices or items that don’t exceed $2,500. So why wouldn’t you always set your expense policy threshold to the maximum safe harbor? Because the threshold applies not only to your tax return but also to your financial statements, and you may have reason to look better to your shareholders than you look to the IRS. Step 2: Put the Expense Policy in Writing If you have an AFS, the IRS requires that you have your expense policy in writing.9 As a proprietorship or small corporation, you likely don’t have an AFS, and you likely don’t have your expense policy in writing. And it’s likely that your historical expensing amount will not prove a history of $2,500 as your expense policy. This is a problem. It’s compounded by the fact that the IRS does not require you, as a non­AFS taxpayer, to have your expense policy in writing. Why? Because, as the IRS says in the preamble to its expensing regulations, “the de minimis safe harbor is intended to provide recordkeeping simplicity to taxpayers by allowing them to follow an established financial accounting policy for federal tax purposes, and allowing retroactive application is inconsistent with such purpose.” Your prior established expense policy is likely far below $2,500. To increase your expensing to $2,500, you need your expense policy in place now. Don’t waste a minute. Here’s some language you can use: Company Name Effective: January 1, 2016 For both book and tax purposes, the company (a) expenses assets costing $2,500 or less on a per invoice or per invoice­listed item basis, and (b) expenses assets with an estimated economic useful life of 12 months or less. For added proof that this policy is real and in place, sign the policy as an owner, date it, add a witness’s signature, and consider having the statement notarized. Tax year before January 1, 2016? In Notice 2015­82, the IRS grants safe harbor to years before 2016, but only if you had established expensing policies in those years. This means you had either a written policy or a consistent application of your expensing dollar amount. Step 3: Save Your Invoices The safe harbor applies only to items documented by invoices.12 That’s good. Remember, the invoice proves the purchase, and the canceled check or credit card charge proves that you paid the money. You want both proof of purchase and proof of payment in your tax file. Itemized versus lump­sum invoices. To apply the safe harbor on a per­item basis, you want the invoice to identify the separate items. Say you buy 20 computers that cost $2,000 each. If the invoice lists each computer separately—or at least notes the number of computers and the per­unit cost—the safe harbor lets you deduct the entire $40,000. Step 4: Make the Election on Your Tax Return You must make the election in your tax return every year you want to use the safe harbor.13 To make the election, you attach a statement to your federal tax return and file it by the due date (including extensions).14 The statement must be titled “Section 1.263(a)­1(f) De Minimis Safe Harbor Election” and include your name, address, and Social Security number, plus a statement that you are making the de minimis safe harbor election under Reg. Section 1.263(a)­1(f). Here’s some language for the safe harbor election: Taxpayer Name Taxpayer Address Taxpayer Social Security Number Taxpayer hereby elects under Reg. Section 1.263(a)­1(f) de minimis safe harbor expensing of up to $2,500. Two things here. First, the election is an annual event. Second, you can change your accounting policy on expensing any year. But if you make a change, make sure you have that change noted in a new or amended beginning­of­the­year written expense policy. Takeaways Because you save tax dollars, you want to use the new expensing safe harbor when you can. Here’s why: 1. Safe harbor expensing is superior to Section 179 expensing because you don’t have the recapture period that can complicate your taxes. 2. Safe harbor expensing takes depreciation out of the equation. 3. Safe harbor expensing simplifies your tax and business records because you don’t have the assets cluttering your books. In summary to put safe harbor expensing in place: 1. Have an expense policy in place at the beginning of the year. 2. Put the expense policy in writing, and comply with it. 3. Keep the invoices. 4. Make the annual election to expense on your federal income tax return. Please call us if you have any questions. Tax season is here. Go to www.tenfortyplus.com and complete your online organizer (under forms and documents). Make your appointment using our online appointment system. Call 281-397-7777 and get a user id with password set up so you can send us all your information through our online secure portal and do your taxes from the comfort of your home or office or come see us at our office. 1040 + Quality Tax Preparation & Financial Services Joseph C Becker www.tenfortyplus.com 281-397-7777, Fax 281-397-7443 joeb@tenfortyplus.com Contact Us There are many events that occur during the year that can affect your tax situation. Preparation of your tax return involves summarizing transactions and events that occurred during the prior year. In most situations, treatment is firmly established at the time the transaction occurs. However, negative tax effects can be avoided by proper planning. Please contact us in advance if you have questions about the tax effects of a transaction or event, including the following: • Pension or IRA distributions. • Retirement. • Significant change in income or • Notice from IRS or other deductions. Revenue department. • Job change. • Divorce or separation. • Marriage. • Self-employment. • Attainment of age 59½ or 70½. • Charitable contributions • Sale or purchase of a business property in excess of $5,000. • Sale or purchase of a residence or other real estate.