The Internal Revenue Code (IRC) allows business owners to deduct all the ordinary and necessary expenses incurred during the taxable year in carrying on their trade or business, including the costs of certain materials, supplies, repairs, and maintenance. However, the IRC also requires business owners to capitalize (and depreciate) the costs of acquiring, producing, and improving tangible property, regardless of the size or the cost incurred. These competing provisions of the IRC significantly burdened small business owners with the difficult task of determining whether to expense or capitalize each expenditure for tangible property.
Thankfully, everything changed when the IRS established the de minimus safe harbor election (effective January 1, 2014). Under the election, a business owner can expense the costs to acquire or produce tangible property, within certain dollar limits, even if the business owner would otherwise be required to capitalize such costs on their books and records. 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
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 meeting 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 even considering whether the property should be capitalized. This can save small business owners significant amounts of time when it comes to managing the books and records.
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 Taxlete'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.