Impact #103 - Consequences of Not Filing the Required Tangible Property Regulation 3115s by Tax Year 2014
What are the issues or consequences to the taxpayer and the tax return preparer if a taxpayer does not comply with the new tangible property regulations (TPRs), i.e., file the required 3115(s)?
- It puts the client at risk for significant adverse consequences, such as:
- Permanent differences in deduction for repair and maintenance costs that were previously capitalized but should have been expensed under the TPRs through future depreciation disallowance (method 184 with a citation to 1.162-4).
- Permanent differences in denied depreciation deductions for improper employment of either class lives or bonus calculations, which cannot be fixed after notification of an IRS audit due to new TPR 1.1016-3 (method 7).
- Inability to deduct repair and maintenance costs that that would otherwise be deductible under the TPRs with a method change filing (method 184 with a citation to 1.162-4).
- Inability to deduct up to $200 per unit of property for either incidental or non-incidental materials and supplies costs that would otherwise be deductible under the new regulations with a method change filing (method 186 (non-incidental) and/or 187 (incidental)).
- Inability to employ the new TPR rules for non-incidental and incidental material and supplies (method 186 and/or 187)
- Missed opportunity to define the unit of property under 1.263(a)-3(e), either as required (if the taxpayer has multiple buildings as one unit of property, it will not be able to employ the TPR capitalization criteria nor take partial asset dispositions) or as optional (the larger the taxpayer can define the unit of property, the greater the opportunity for the expenditure to be deducted) (method 184 with a citation to 1.263(a)-3(e)).
- Inability to properly capitalize and depreciate amounts paid to acquire or produce tangible property (method 192).
- Inability to employ the new routine maintenance safe harbor of 1.263(a)-3(i) (method 184 with a citation to 1.263(a)-3(i)).
- Incurring an advance consent filing fee (currently $7,000) to file a non-automatic method change request for each method change related to the TPRs not filed by tax year 2014 (TPRs are almost universally automatic changes with no filing fees, but only through the 2014 tax year).
- A potential increase in audit risk as the IRS is expecting Forms 3115 for taxpayers with depreciable property, repairs and maintenance costs and materials and supplies costs.
- Provides the IRS with the ability to potentially dictate whether expenditures are to be capitalized and depreciated or expensed.
- Beyond the required TPR method filings, the client will miss out on the following optional TPR opportunities:
- The ability to deduct the net remaining tax basis of either prior partial asset or whole asset dispositions (these are only permitted through tax year 2014 under a 196 and/or a 205/206 method filings. The applicable method number required to be filed depends on the taxpayer situation).
- The ability to deduct and not capitalize removal/demolition/moving costs incurred during an asset improvement (method 21).
- It puts the client at risk for potentially significant taxpayer penalties:
- Taxpayer accuracy penalty (if understatement with negligence or disregard of rules or regulations) - 20% of the amount of the understatement.
- It puts the firm at risk for potentially significant preparer penalties:
- Unreasonable return position (if position results in an understatement and the preparer knowingly signed a return with a position lacking substantial legal authority) - per return, greater of $1,000 or 50% of fees charged to prepare the return.
- Willful or reckless conduct (if position results in an understatement and the preparer intentionally disregarded the rules or regulations) - per return, greater of $5,000 or 50% of fees charged to prepare the return.
Willfully failing to comply with the tangible property regulations would seem to fall squarely within the definition of willful or reckless conduct, making mitigation of this penalty, were it to be assessed, extremely difficult. Since the preparer penalties provide no minimum understatement for the penalty regime to apply (i.e. a $5,000 penalty could be triggered by a $1 understatement), the penalty risk from willfully choosing not to apply these regulations is unacceptable, no matter how insignificant they may seem on a particular return.
In addition to the above preparer penalties, the firm may be compelled to compensate clients for the above taxpayer penalties and adverse tax consequences.
- It creates a potential Circular 230 issue
- A practitioner must exercise due diligence
- In preparing or assisting in the preparation of, approving, and filing tax returns, documents, affidavits, and other papers relating to Internal Revenue Service matters;
- In determining the correctness of oral or written representations made by the practitioner to the Department of the Treasury; and
- In determining the correctness of oral or written representations made by the practitioner to clients with reference to any matter administered by the Internal Revenue Service.)
- A practitioner may not willfully, recklessly, or through gross incompetence sign a tax return with the intentional disregard of the rules or regulations.
Copyright © 2014, Eric P. Wallace and Boyer & Ritter LLC