Small Business Tax Rules
The IRS allows business owners to deduct the ordinary and necessary expenses of operating a business each year. However, business owners also are required to capitalize the costs associated with acquiring, producing, and improving tangible property used in their businesses (such as equipment, supplies, buildings, etc.). Because these two rules had often proved difficult to reconcile, the IRS issued new final regulations in 2013 clarifying how the rules apply. Though these regulations are extensive and complex, small business owners should be aware of some of the opportunities they provide.
The regulations delineate when you may deduct and when you must capitalize amounts paid to acquire, produce, or improve tangible property. Generally, amounts paid to improve a unit of property must be capitalized, while amounts paid for repairs and maintenance, as well as for materials and supplies consumed during the year, may be deducted.
Safe Harbor for De Minimis Expenditures
Qualifying businesses may elect to use a de minimis safe harbor that allows them to deduct costs incurred to acquire or produce tangible property in amounts of up to either $5,000 or $500 per item or invoice. The higher limit is available for taxpayers with an applicable financial statement (AFS). An AFS can be a certified audited financial statement used for nontax purposes, such as for obtaining credit. If you don’t have an AFS, you may still qualify for the $500 safe harbor if you expense amounts in accordance with a consistent accounting procedure in place at the beginning of the tax year.
Use of the safe harbor does not limit the ability to otherwise deduct amounts paid for incidental materials and supplies or for repairs and maintenance. Rather, it is an administrative convenience to allow expensing of smaller items without analyzing each one under the relevant rules.
Safe Harbor for Routine Maintenance
You may deduct amounts paid for recurring activities that keep your business property in its ordinarily efficient operating condition. For buildings and their systems, you must reasonably expect to perform the maintenance more than once during the 10-year period beginning at the time the property is placed in service. For other property, you must expect to perform the maintenance more than once during the property’s class life used for depreciation purposes.
Safe Harbor for Small Taxpayers
Qualifying small businesses may also deduct the costs of work performed on a building with an unadjusted basis of less than $1 million. To qualify for the safe harbor, the business must have average annual gross receipts of less than $10 million. Additionally, the total amount paid during the taxable year for the building’s repairs, maintenance, and/or improvements may not exceed the lesser of $10,000 or 2% of the unadjusted basis of the eligible building property. The building may be owned or leased.
Additional restrictions may apply for you to qualify for these safe harbors. Contact us if we can help you determine how the final regulations apply to you.
If you would like to become more aggressive on lowering your taxes and worry less about trying to manage this yourself, call 410-466-3779 and ask for Steven Graber.
Graber & Associates is a Baltimore CPA Accounting firm that has operated since 1993. We provide two convenient office locations, International Drive in the Inner Harbor area and Park Heights Avenue near Pimlico, to better serve our clients throughout the broader Baltimore metro.