Background

In 2013 we blogged that the IRS issued long-awaited and wide-ranging final regulations concerning the proper method of accounting for the acquisition, maintenance, and improvement of tangible property. In 2014, the IRS issued additional final regulations regarding dispositions of tangible property.

The new regulations will require many taxpayers to change their accounting treatment for particular items of tangible property. However, to do so, taxpayers must first obtain IRS consent, which in turn ordinarily requires that they file Form 3115 and account for the items’ treatment in prior years. The requirement is designed to ensure that all income is accounted for and no deductions are duplicated.

After it had originally released the tangible property regulations, the IRS received numerous comments about the additional administrative burdens that they would place on small business owners.

New Guidance

The new rule provides that a qualifying “small business” may make changes to its method of accounting for amounts paid or incurred, and dispositions of tangible property in tax years beginning on or after January 1, 2014 on a “cutoff” basis — that is, without accounting for their treatment in prior years. In addition, for its first taxable year that begins on or after January 1, 2014, a qualifying small business may make the necessary accounting changes without filing Form 3115.

For purposes of the new rules, a “small business” has either (a) total assets of less than $10 million or (b) average annual gross receipts of $10 million or less for the prior three tax years. Moreover, these ‘small business’ rules also apply to taxpayers with qualifying Schedule C businesses or Schedule E rental properties reported on their individual returns.

Treatment of the tangible items on a “cutoff” basis will not provide audit protection for prior years and will preclude a taxpayer from recognizing the benefit of favorable adjustments from prior years. Small businesses may, however, choose to file Form 3115 to retain a clear record of a change in method of accounting and to report favorable adjustments from prior years as current deductions.