Alert — Final Tangible Property Regulations Require Filing Application for Change in Accounting Method for 2014 Tax Year (Revised)
The following alert has been modified as a result of new guidance provided by the IRS. On February 13, 2015, the IRS released Rev. Proc. 2015-20, which provides a new simplified procedure for small businesses. Under this simplified method, a small business may adopt the final tangible property regulations on a prospective basis and Form 3115 is not required.
In September 2013, the IRS issued final tangible property regulations addressing the capitalization and depreciation of capital expenditures, treatment of materials and supplies, and disposition of tangible depreciable property. The regulations are applicable to tax years beginning on or after January 1, 2014, and to some extent may be applied retroactively to taxable years beginning on or after January 1, 2012.
Prior to Rev. Proc. 2015-20, most businesses with depreciable fixed assets, materials and supplies expenses, or repair expenses would have been required to file Form 3115 (Application for Change in Accounting Method) under the tangible property regulations in order to file a complete and accurate 2014 federal income tax return. However, Rev. Proc. 2015-20 provides relief for qualifying small businesses in the form of new simplified procedures. Businesses that qualify for the simplified procedures may adopt the final tangible property regulations on a prospective basis without filing Form 3115.
Under the revenue procedure, a small business is defined as a business with assets less than $10 million or average annual gross receipts of $10 million or less (averaged over the prior three years). The assets and gross receipts test is applied to each “separate and distinct trade or business” owned by the taxpayer (See Rev. Proc. 2015-20, Section 4).
Although this new guidance is welcome news for many taxpayers, tax practitioners still should consider whether their clients might benefit from filing Form 3115 and advise them accordingly. For example, benefits of filing include audit protection, deductibility of partial/prior asset dispositions, as well as other potential deductions obtained from “scrubbing” depreciation schedules. Any decision by a client not to engage the tax practitioner to perform work necessary to determine potential deductions should be documented.
Tax practitioners will need to determine a) which required accounting method changes apply for a given taxpayer; b) which optional accounting method changes could benefit the taxpayer; c) which safe harbor elections (i.e., de minimis, small building, and routine maintenance) might benefit the taxpayer, and d) whether the taxpayer qualifies for the new simplified method for small businesses.
For those clients that do not qualify for the simplified procedures and for those that do but choose to file Form 3115, tax practitioners will need to prepare and timely file Form(s) 3115 to change tax accounting methods, making the necessary 481(a) adjustments. However, because of the amount of additional time and expense involved, some taxpayers may choose not to file Form 3115 where required. Such non-filing situations could run afoul of Treasury Circular 230 and/or subject tax practitioners to preparer penalties. In addition, as part of the tangible property regulations, new section 1.1016-3 was released. Under this section, the taxpayer could lose tax deductions permanently under the “use it or lose it” rules should certain aspects of the regulations not be properly followed.
Section 10.34 of Circular 230 prohibits a preparer from willfully, recklessly, or through gross incompetence, signing a tax return or claim for refund containing a position that the practitioner knows, or reasonably should know, lacks a reasonable basis. Unreasonable tax positions taken on a tax return could also subject taxpayers and their preparers to penalties (e.g., IRC §§ 6662 and 6694).
Under the tangible property regulations, if an accounting method change is required and the taxpayer does not take the necessary steps to make the change (e.g., filing Form 3115 with the proper IRS National Office and also with their tax return), that position would presumptively lack a reasonable basis.
Since the impact of these regulations may be significant to your business clients (including trusts, 990Ts, and individuals with a business or rental property), CAMICO encourages tax practitioners to make their business clients aware of the implications of the new tangible property regulations to the 2014 tax filings. Your firm might choose to incorporate information on this issue in your engagement letters and/or other client communications (newsletters, blogs, etc.). For example, consider adding the following clause to your engagement letters or client notifications:
The IRS and U.S. Treasury have issued final tangible property regulations (TPRs) that govern when taxpayers must capitalize and when they can deduct expenditures for acquiring, producing or improving tangible property. These regulations are fully effective for tax years beginning on or after January 1, 2014. Under certain circumstances, however, these regulations may also be applied retroactively back to the start of 2012 and are required to be applied to items on the taxpayer’s tax depreciation schedule or that should be on the taxpayer’s depreciation schedule based upon the criteria on the final TPRs. The final regulations have created new annual elections, and while certain safe harbors and elections are implemented through filing statements or treatment of an item on a timely filed federal tax return, the IRS considers the remaining provisions to be a change in method of accounting, which may require a taxpayer to file Form 3115, Application for Change in Accounting Method.
The IRS has simplified procedures that will allow small businesses (defined as businesses, including sole proprietors, with assets totaling less than $10 million or average annual gross receipts totaling $10 million or less) to change a method of accounting under the final tangible property regulations on a prospective basis for the first taxable year beginning on or after January 1, 2014. The IRS is also waiving the requirement to complete and file IRS Form 3115 for small business taxpayers that choose to use this simplified procedure for 2014.
In order to make an election on a timely filed federal tax return and/or to properly complete Form 3115 when required, our firm may need additional time to analyze your current and prior acquisitions and improvements. By your signature below, you accept ultimate responsibility for your capitalization analyses and decisions, and you agree to provide us with the information necessary to prepare the appropriate elections and/or method change IRS form(s). If you have any questions regarding the application of these new regulations to your company, or your company’s specific qualifications for one of the safe harbors or new method changes, please ask us for advice in that regard.
Note: For individual tax return letters, change the first sentence to read: If your individual return includes business activities or rental property, please note that the IRS and U.S. Treasury have issued final tangible property regulations (TPRs) that govern when taxpayers must capitalize and when they can deduct expenditures for acquiring, producing or improving tangible property.
Given Circular 230 requirements and the potential for preparer penalties, tax practitioners should:
- Have or obtain the knowledge necessary to correctly prepare and properly submit Form 3115 and determine which required and optional accounting method changes are applicable to each tax client;
- Perform additional work as part of their general tax preparation services in order to determine whether a change in accounting method is required and whether the change requires an adjustment (e.g., § 481);
- Estimate the additional time necessary to calculate, prepare and file the accounting method changes and advise their client of the estimated additional cost; and
- Be prepared to disengage from any clients who decline to prepare required filings.
CAMICO strongly encourages tax practitioners to consider each tax client’s tangible property regulations implications as soon as possible so that the client and you have ample time to comply and make informed tax decisions. CAMICO’s prior experience suggests that actions or recommendations alleged to be late are frequently preludes to tax claims. Don’t let this happen to you.
For a discussion of Rev. Proc. 2015-20 and Form 3115, see “The New Rules and Consequences of RP 2015-20” by Eric P. Wallace, CPA. The author also provides a tangible property regulation subscription service which is available at www.tprtoolsandtemplates.com.
For an informative blog that discusses issues related to Rev. Proc. 2015-20 and provides a list of Rev. Proc. 2015-20 method changes, see “IRS drops ‘Form 3115’ requirement for smaller taxpayers under tangible property rules.”
KPMG provides a website devoted to the Tangible Property Regulations, available at www.kpmg.com/us/repairregs.
See “Implementing the new tangible property regulations,” Journal of Accountancy (February 1, 2014) at www.journalofaccountancy.com/issues/2014/feb/20137725.html.
The final tangible property regulations generally refer to the following:
- Treas. Reg. § 1.162-3 provides rules for materials and supplies
- Treas. Reg. § 1.162-4 addresses repairs and maintenance
- Treas. Reg. § 1.263(a)-1 provides general rules for capital expenditures
- Treas. Reg. § 1.263(a)-2 provides rules for amounts paid for the acquisition or production of tangible property, and
- Treas. Reg. § 1.263(a)-3 provides rules for amounts paid for the improvement of tangible property
- Treas. Reg. § 1.1016-3 addresses the “use it or lose it” provisions (generally applicable to depreciation (class lives or bonus impermissibly applied) and/or repairs (prior, current, or future repairs capitalized that should have been written off))
The final MACRS disposition of tangible property regulations generally refer to the following:
- Treas. Reg. § 1.168-1(i) provides rules for general asset accounts
- Treas. Reg. § 1.168-8(i) provides rules for partial or prior asset MACRS asset dispositions
The following items may need to be referenced in order to complete Form(s) 3115:
- Instructions to Form 3115
- Revenue Procedure 2015-20 involves simplified procedure for small businesses
- Revenue Procedure 2014-16 involves method changes for amount paid to acquire, produce or improve tangible property
- Revenue Procedure 2014-17 involves method changes for depreciation
- Revenue Procedure 2014-54 involves method changes for depreciation and dispositions
- Revenue Procedure 2011-14 involves procedures to obtain an automatic consent change in method of accounting
- Revenue Procedure 2011-14 involves procedures to obtain an automatic consent change in method of accounting (and 2014-16 and 2014-54 are updates to this document)
- Revenue Procedures 2012-1 and 2015-1 involves additional procedures for accounting method changes
- Revenue Procedure 87-56 on the proper class lives of assets for various business activities
- IRS Cost Segregation Audit Technique Guide, September 23, 2010