Safe harbor expensing threshold increases for small businesses
Posted On: 12-8-2015 | Posted By: Katie Barthel, CPA
As we get into the 2016 calendar year, small businesses need to keep in mind one of the recent changes related to tangible property expenditures. The Internal Revenue Service recently increased the allowable expensing threshold from $500 to $2,500.
This change is effective beginning January 1, 2016. However, the IRS has also said they will provide audit protection for companies that use up to a $2,500 capitalization policy in prior years. In order to take advantage of this new, increased threshold, the business should ensure that there is a capitalization policy in place for the year.
The change came about in order to ease an administrative burden on small businesses when depreciating small-dollar tangible property. The IRS currently has a safe harbor in place for small businesses allowing them to deduct amounts spent to acquire, produce or improve tangible property costing less than $500 that would otherwise be considered capital expenditures. These assets are treated as everyday expenses and deducted immediately, rather than spread out over the life of the asset with annual depreciation deductions. For tax years beginning on or after January 1, 2016, this small-dollar threshold will increase from $500 per asset to $2,500 per asset.
This new de minimis threshold will apply to any small business that does not require the use of audited financial statements. For businesses utilizing audited financial statements, which the IRS calls “Applicable Financial Statements,” the small-dollar threshold will remain at $5,000 per asset.
The new $2,500 threshold applies to any item that is substantiated by an invoice. The threshold is applied on a per-item basis, so invoice detail may need to be looked at in determining whether the items on the overall invoice would qualify for the $2,500 threshold, even if the total invoice is more than $2,500. Small businesses will be able to immediately deduct many expenditures that would otherwise be spread over a period of years through annual depreciation deductions.
This safe harbor election was originally put in place to protect small businesses from the compliance burden of capitalizing these purchases. Annual depreciation deductions can be arduous for any taxpayer to calculate, and the IRS intended to remove this reporting impediment as much as possible for certain small businesses.
After receiving numerous comments from businesses and tax professionals earlier this year to raise the dollar limit, the IRS decided that the $500 de minimis limit was too low to effectively ease the administrative burden for these small taxpayers. Many everyday capital expenditures exceed $500, such as tablet computers and equipment parts, so the $500 threshold added little administrative burden relief for small businesses. Increasing the threshold to $2,500 will help businesses simplify the paperwork and recordkeeping requirements as originally intended.
In addition to raising the small-dollar threshold for certain small businesses, the IRS will provide audit protection to a company that utilizes the new $2,500 de minimis threshold for tax years beginning before 2016.
This safe harbor is an annual election the taxpayer must make on their tax return each year. A capitalization policy must also be in effect for the year.
If you have any questions about how this change will affect your small business, please contact your WK advisor at (573) 442-6171 or (573) 635-6196.