The Tangible Personal Property Regulations: Opportunities in Materials and Supplies

Late last year, the Internal Revenue Service finally released the highly anticipated final regulations regarding tangible personal property.  The final regulations provide a myriad of new rules for many taxpayers that became effective Jan. 1 of this year. The IRS provided guidance on what constitutes materials and supplies.  The regulations also introduced the de minimis safe harbor, where companies can now expense certain expenditures immediately versus depreciating over an asset’s useful life.

What are Materials and Supplies?

The IRS defines materials and supplies as a component that is acquired to maintain, repair or improve a unit of tangible property with an acquisition or production cost of less than $200 and with an economic useful life of 12 months or less. Materials and supplies (other than inventory) that are used to perform routine maintenance can be expensed and deducted if they meet the above criteria. Materials and supplies can also include items such as fuels, lubricants, and water that are reasonably expected to be consumed in 12 months or less.

Timing of Deduction for Materials and Supplies

Under the final regulations, materials and supplies are divided into three categories to determine the accounting treatment:

• Incidental supplies are deductible when paid or incurred.  These are often carried on hand for which no record of consumption is kept. The items are not included in physical inventory, such as cleaning supplies, etc.
• Non-incidental supplies are generally deductible in the tax year when the materials and supplies are first used or consumed in the taxpayer’s operations such as fuel, motor oil and small engine parts.
• Rotatable and temporary spare parts are deducted upon disposal.

De Minimis Safe Harbor Election

The de minimis safe harbor election allows businesses to directly expense lower cost assets needed to run a business instead of capitalizing and depreciating the property. The safe harbor is probably the most useful and most widely applicable break for businesses in the final regulations.

If a taxpayer makes the de minimis safe harbor election, any amount paid to acquire or produce a unit of property or for a material or supply that falls within the safe harbor rules, generally, is deducted in the year paid as an ordinary business expense.

Applicable Financial Statements

In order to take advantage of de minimis safe harbor in the final regulations, all taxpayers will need to adopt or update a written capitalization policy for non-tax purposes.  The final regulations provide guidance on what type of policies need to be put in place based on whether or not the taxpayer issues applicable financial statements (AFS).  Applicable financial statements are certified audit financial statements or a financial statement required to be filed with the federal government, state agency, or Securities Exchange Commission.

Taxpayers with applicable financial statements can:

• Expense amounts paid for a unit of property costing $5,000 or less per invoice, providing that
• A written book capitalization policy is in place at the beginning of the year (based on a specific amount or useful life of 12 months or less) , and
• Amounts are expensed in the AFS in accordance with the policy

Taxpayers without applicable financial statements can:

• Expense amounts paid for a unit of property costing $500 or less per invoice, providing that
• A written book capitalization policy is in place at the beginning of the year (based on a specific amount or useful life of 12 months or less) , and
• Amounts are expensed in the AFS in accordance with the policy

Application

The de minimis expensing rule applies to amounts paid or incurred in the taxable year beginning on or after January 1, 2014. For example, ABC Company has a capitalization policy in place to expense amounts less than $5,000.  During Year 1, it pays $6,250,000 to buy 1,250 computers at $5,000 each.  The company receives an invoice from the supplier indicating the total of $6,250,000 and itemizes the computers. Each computer qualifies as a separate unit of property and the amounts paid to meet the requirements for the de minimis safe harbor.  The company can deduct the entire $6,250,000 in the tax year acquired, provided the amounts otherwise constitute deductible ordinary business expenses.

The safe harbor is elected annually by including a statement with the taxpayer’s tax return for the year.  The election will apply to all qualifying expenses including materials and supplies that meet the qualification and the election cannot exclude any qualifying expenses.  Once the election is made, it is irrevocable for that particular year.

For the first year of implementation, a taxpayer will likely have to complete a formal method change using Form 3115 – Application for Change in Accounting Method in order to implement these new rules. For small taxpayers, the government has provided some simplification through the use of an abbreviated Form 3115, which alleviates some of the burdens to the taxpayer.

The Next Steps

To  be sure your company is taking advantage of the de minimis election and the expensing of certain materials and supplies, you should review your company’s accounting policies and determine if there is a written policy regarding expenditures and capitalization. To get in compliance with the new regulations in this area,  you would need to perform a detailed review of general ledger accounts related to tangible personal property to see if any changes need to be made for how expenditures are accounted for and tracked. Additionally, your team will need to determine what new policies need to be implemented or changed. You should note that there may be costs that have been previously capitalized that can now be expensed under the final regulations.  Every taxpayer’s situation is unique to their facts and circumstances.

For our clients, we will be contacting you in the summer months to begin the compliance process and determine a timeline to implement a plan.

The tangible personal property regulations are detailed and complex.  Please look for our next alert in our Tangible Property Regulations Series.