The Internal Revenue Code (IRC) allows businesses to deduct all ordinary and necessary expenses incurred in connection with operating their trade or business. This includes the costs for certain materials, supplies, repairs, and maintenance. However, businesses are required to capitalize (rather than deduct) the costs of acquiring, producing, and improving certain business property, regardless of the size of the property or its cost. Under the IRC's capitalization rules, businesses must track each capitalized asset on their books and records, and then depreciate the asset's cost over a period of years. The deduction and capitalization provisions of the IRC have historically burdened small business owners with the difficult task of determining what business property should be expensed vs. capitalized.
Fortunately, everything changed in 2014 when the IRS established the de minimus safe harbor election. Under the election, a business owner may deduct the costs to acquire or produce all business property that meet certain dollar limits, even if the property would normally be capitalized. For example, a small business owner who purchases a $1,000 laptop and $500 printer for use in their trade or business can now immediately deduct the costs of both purchases. Traditionally, the owner would need to treat both items as capital assets and depreciate the costs over the lifetime of the assets, while keeping track of the accumulated depreciation year after year.
Expense Limits
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.
Taking the 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.
Specific Requirements
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 all this mean?
Basically, small businesses may 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 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.
About the Author
Attorney Jordan D. Howlette is the founder and managing attorney of JD Howlette Law, a civil litigation and business law firm focused on delivering high-quality legal services to individuals and businesses in a timely, cost-efficient manner. Prior to establishing his practice, Jordan worked as trial attorney in the Tax Division of the U.S. Department of Justice, where he successfully litigated dozens of civil tax cases on behalf of the United States in federal courts around the country, securing millions of dollars in favorable judgments while also advocating for equitable justice. He is intimately familiar with the procedures, strategies, and processes of litigating cases from start to finish in court and with resolving multi-faceted civil disputes involving high-dollar amounts, complex statutory and regulatory provisions, and diverse parties from different jurisdictions.
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