Businesses typically have a policy of expensing (that is, currently deducting instead of depreciating) items that cost less than a threshold amount. It’s simply not worth the trouble of depreciating low-cost items over many years. The amount businesses establish as their expensing thresholds vary widely. Until now, the IRS provided no guidance on what the threshold should be, and it was always possible it could argue that a taxpayer’s threshold was too high. However, this has changed. New IRS regulations enshrine this threshold expensing practice into law by establishing a new de minimis safe harbor. (IRS Reg. §1.263(a)-1(f).) Also, for the first time, the IRS has created maximum dollar amounts that may be expensed as “de minimis” (Latin for minor or inconsequential). This safe harbor became available for all taxpayers on January 1, 2014. Moreover, the usefulness of the safe harbor has been greatly enhanced for most taxpayers because the IRS increased the amount that can be deducted by smaller taxpayers from $500 to $2,500.
Example: Alice purchases two computers for her business at $2,000 each for a total cost of $4,000 as shown by the invoice. By using the de minimis safe harbor, she can deduct the entire $4,000 expense in a single year provided that the requirements to use the safe harbor are satisfied.
The de minimis safe harbor is most often used to deduct the cost of tangible personal property items (units of property) you use in your business. Components acquired to maintain or repair a unit of tangible property—that is, spare parts—are also deducted under the de minimis safe harbor if within the de minimis limit. This category does not include components that are acquired as part of a unit of property—for example, the original engine in an automobile. Any item with an economic useful life of 12 months or less must be deducted under the de minimis safe harbor if the cost is within the de minimis limit.
This safe harbor can’t be used to deduct the cost of land or inventory (items held for sale to customers).
The maximum amount you can deduct under the de minimis safe harbor depends on whether your business has an “applicable financial statement” for the year. This includes a certified financial statement prepared by a CPA. It also includes a financial statement (other than a tax return) your business files with the SEC or other state or federal agency (not including the IRS)—for example, a Form 10-K or an Annual Statement to Shareholders. Only larger corporations or businesses that are publicly traded usually file such statements.
Certified financial statements by CPAs usually cost at least several thousand dollars, and few small businesses have them. If you don’t have such a financial statement, you may use the de minimis safe harbor only for property whose cost does not exceed $2,500 per invoice, or $2,500 per item as substantiated by the invoice. This amount was $500 in the original version of the regulation, but the IRS increased it to $2,500 effective 2016. In addition, the IRS says it won't challenge an earlier use of the $2,500 amount provided that the requirments are satsified.
If the cost exceeds $2,500 per invoice (or item), no part of the cost may be deducted by using the de minimis safe harbor. If you have an applicable financial statement, then you may increase the per item or per invoice amount up to $5,000.
Example: Alice from the above example purchased two computers for her business at $2,000 each for a total cost of $4,000 as indicated by the invoice. Alice has accounting procedures in place at the beginning of the year to expense amounts paid for property costing less than $2,500, and Alice treats the amounts paid for the computers as an expense on her books and records. The amounts paid for the computers meet the requirements for the de minimis safe harbor. Alice may currently deduct the entire amount as an ordinary and necessary business expense.
In determining whether the cost of an item exceeds the $2,500 or $5,000 threshold, you must include all additional costs that are on the same invoice with the tangible property—for example, delivery and/or installation fees. However, you are not required to include “additional costs of acquiring or producing” the property that “are not included in the same invoice as the tangible property.” The best strategy is to have such additional costs included on a separate invoice.
When you make this election, it applies to all expenses you incur that qualify for the de minimis safe harbor. You cannot pick and choose which items you want to include. You must also include items that would otherwise be deductible as materials and supplies.
To qualify for this de minimis expensing safe harbor, a taxpayer must:
If you have an “applicable financial statement” and wish to qualify to use the $5,000 de minimis limit, your accounting procedure must be in writing and signed before January 1 of the tax year. If you don’t have such a statement and qualify only for the $2,500 limit, you do not need to put your procedure in writing (although you still may do so). But it should still be in place before January1 of the tax year.
To take advantage of the de minimis safe harbor, you must file an election with your tax return each year.