At the end of 2013, the tangible property “repair” regulations were finalized by the IRS, followed by the finalization of the disposition of tangible property regulations in 2014. Collectively, both sets of regulations are effective for the 2014 taxable year and apply to all taxpayers who acquire, produce, improve, or dispose of tangible property.
These interrelated and complex regulations pose many questions for practitioners, particularly in regards to how to comply with the multiple annual tax elections and tax accounting method changes. There are non-tax implications to the regulations, as well, including the effect on the provision for income taxes, deferred income taxes, and liabilities for uncertain tax benefits (i.e., ASC 740-10).
With the 2014 tax-compliance season right around the corner, prudent businesses and practitioners are wise to keep the following five actions top of mind:
1. Education: The American Institute of CPAs has a wealth of content on the regulations, including their full text, supplementary guidance, tools, resources, and additional webcasts. Other resources on the regulations include the BDO Online CPE Network and the Wolters Kluwer Learning Center.
2. Assessment: Review the business’ current capitalization practices relative to the new guidelines and determine what changes to those capitalization practices need to be made, which elections will be made, and which accounting method changes are necessary.
3. Taxable income affect: Certain elections will require changes when an item is deductible for tax and financial accounting, which in some cases may be the current or future tax year. Certain accounting method changes, although implemented in the current year, require a retroactive application of the rules to prior years. Estimate the potential impact to taxable income as a result of making elections and accounting method changes.
4. Financial statement impact: Although the regulations primarily apply to tax, there are certain new rules that require financial and tax accounting conformity. In some cases, businesses may wish to change their capitalization processes for tax purposes, which will affect financial accounting results. In addition, accounting method changes and changes to the determination of taxable income can affect the amount of current tax provision, classification of deferred income taxes, liabilities for uncertain tax benefits, and, in certain situations, the effective tax rate. More information on financial statement implications is provided here.
5. Tax compliance: There are several avenues through which the regulations can be adopted, including “automatic accounting method changes,” formal election statements, and adopting a tax position on a federal income tax return. The manner of adoption is specifically identified in the regulations and in Revenue Procedures 2014-16 and 2014-54. As an automatic change, Form 3115, Application for Change in Accounting Method, must be attached to the timely filed (including extensions) federal tax return for the taxable year of change, and a copy of the Form 3115 must be filed with the IRS office in Ogden, Utah, on or before the filing date of that return. There is no IRS user fee associated with an automatic Form 3115.
A properly filed accounting method change includes a calculation of a section 481(a) adjustment. Failure to include a properly calculated section 481(a) adjustment exposes the taxpayer to potential disallowance of the accounting method change upon IRS examination, as well as penalties and interest on the IRS-computed section 481(a) adjustment. Certain accounting method changes are implemented on a modified cut-off basis (i.e., no section 481(a) adjustment for method changes implemented in the 2014 taxable year).
At a minimum, taxpayers should reasonably estimate and document a section 481(a) adjustment where required.
Where an accounting method change is required or appropriate but a request for accounting method change is not filed, determine the necessity of disclosing the position on Form 8275-R, Regulation Disclosure Statement. For businesses subject to ASC 740-10 (i.e., FIN 48), professionals should consider the impact to FIN 48 in the subsequent year of filing Form 8275-R.
Be advised that professionals must give consideration to the capital intensive nature of the business. Businesses with significant investments in property and equipment are likely to see a more material effect as a result of compliance than a business with less tangible property.
There may be situations when a business believes it already is following the regulations, or that adoption does not result in a current change to the timing of deductions. The IRS has stated that the rules for units of property and the routine maintenance safe harbor, for example, did not previously exist, and it is therefore not possible for taxpayers to comply with these rules without obtaining IRS consent via a Form 3115. Additionally, one requirement of an accounting method is consistency; even though there may not be a current change to the timing of deductions, an accounting method change is still required if it affects the past or future timing of deductions for such an item.
These complex regulations should not be underestimated. Conversely, thoughtful planning by practitioners and businesses to adopt these regulations is what's necessary to mitigate potential tax risk exposure. By taking steps to identify and remedy areas of noncompliance, you may be closer to thwarting any major tax and financial reporting gaffes that could result from the regulations.
About the author:
Nathan Clark is a senior director at BDO USA LLP.