What is the De Minimus Safe Harbor Election for small businesses?

The Revenue Code generally requires that taxpayers depreciate the costs of durable goods and equipment over the life of the item. Because it is a durable good, the IRS would say that a $10 electric pencil sharpener must have its cost deducted over a 3 year period. The cost of accounting for and reporting the depreciation on the pencil sharpener would likely exceed its price. This absurd result can be avoided under a recently expanded treasury regulation (a rule on how the tax code is interpreted) that sets forth guidance on how these types of items can be wholly expensed in the first year instead of being depreciated.

The De Minimus Safe Harbor establishes the requirements for a small business taxpayer to expense purchases of property that would otherwise have to be capitalized up to $2,500. A higher limit applies to more sophisticated businesses, but the benefit to small taxpayers can be very significant. This $2,500 limit applies per item of property, so even a very large invoice could be expensed if each item was $2,500 or less. By expensing the items in the first year, the tax reporting is much closer to the actual cash flows of the business and businesses can reduce their exposure to phantom income.

Here are the requirements to place a business within the safe harbor:

1. The taxpayer must adopt an accounting policy to treat the cost of the items as an expense.
2. The taxpayer must make the de minimus safe harbor election on the tax return. Your tax preparer will know the magic words to include with the return.
3. The taxpayer must actually account for the expense of the items in accordance with the accounting policy.

Now most taxpayers are already doing number 3, and their tax preparer is easily able to do number 2. The part that many taxpayers don’t have is the accounting policy. This is easily remedied: here is a very simplified sample accounting policy:

“This accounting policy, adopted for tax purposes on [date of adoption], establishes that all equipment or assets costing $2,500 or less shall be expensed in [name of your business]’s financial statements (or books). This policy will be in compliance with the IRS safe-harbor provisions described in Reg. 1-263(a)(1)(f).”

While that is only a sample, it does illustrate that the accounting plan does not have to be complicated and any business can comply with the safe harbor requirements to take advantage of the new treasury regulations.

If you have any questions about deductions, depreciation or implementing an accounting policy for your company, contact an attorney at Nielsen Law Group for help. You can schedule your initial consultation by calling (480) 888-7111 or submitting a web request here.