Under the Internal Revenue Code (IRC), business owners are entitled to deduct all ordinary and necessary expenses incurred in connection with operating their trade or business. This includes costs for certain materials, supplies, repairs, and maintenance. However, the IRC requires businesses to capitalize (rather than immediately deduct) the costs of acquiring, producing, and improving certain business property, regardless of the size of the property or the cost incurred. Under the capitalization rules, businesses must track each capitalized asset on their books and records, and then depreciate its cost over a period of years. These competing provisions of the IRC have historically burdened small business owners with the difficult task of deciding whether each purchase of business property should be expensed vs. capitalized.
Fortunately, everything changed when the IRS established the de minimus safe harbor election (effective January 1, 2014). Under the election, a business owner may immediately expense the costs to acquire or produce all business property that meet certain dollar limits, regardless of whether the property should otherwise be capitalized. For example, a small business owner who purchases a $1,000 laptop and $500 printer for use in his or her business can now immediately the deduct the costs of both purchases on the business's books and records. Traditionally, the owner would have been required to capitalize and depreciate the costs for both purchases, and track the accumulated depreciation year after year for each item.
So what are the dollar limits under the de minimus safe harbor election? Small business owners with audited financials may expense amounts up to $5,000 per invoice or item. Those without audited financials may expense amounts up to $2,500 per invoice or item.
Making the de minimus safe harbor election
Importantly, you must file a statement with your federal tax return if you wish to take advantage of the de minimis safe harbor election. According to the IRS, the statement should be titled "Section 1.263(a)-1(f) de minimis safe harbor election" and include your name, address, and Taxpayer Identification Number. The statement should also clearly note that you are making the de minimis safe harbor election.
Under the election, you must apply the de minimis safe harbor to all expenditures that satisfy the criteria for the election in the taxable year, including costs for materials and supplies.
Under the de minimus safe harbor election, a taxpayer must:
Establish before the first day of the tax year (January 1st for calendar year taxpayers) an accounting procedure requiring it to expense amounts paid for property costing less than a certain dollar amount; and
Actually treat such amounts as currently deductible expenses on its books and records.
If you have an audited financial statement and wish to utilize the $5,000 de minimis limit, your accounting procedure must be in writing and signed before January 1st of the applicable tax year. If you do not have an audited financial statement and qualify only for the $2,500 limit, you do not need to put your accounting procedure in writing (but it is still recommended that you do), but the procedure should still be in place before January 1st of the tax year.
So what does this all mean?
Basically, small business taxpayers may now elect to immediately deduct certain amounts paid for tangible personal property without ever considering whether the property should be capitalized. This exception can save small business owners significant amounts of time and resources when it comes to managing the books and records for the business.
Note, amounts paid for inventory or land cannot be expensed under the de minimis safe harbor election. However, small business taxpayers may be able to treat inventory items as non-incidental materials and supplies under a separate exception. See MyTaxRights's article entitled Treating inventories as non-incidental materials & supplies: an election worth understanding.
For more information, see the IRS's Tangible Property Regulations - Frequently Asked Questions page.