As a follow up to various articles published in the past year, the IRS has announced that it is deferring the effective date of the new tangible property regulations. The regulations were issued in late December 2011 to provide guidance to taxpayers on how to account for amounts paid to acquire, produce, or improve tangible property. The regulations, which were originally expected to be effective for tax years beginning on or after January 1, 2012, have been delayed to tax years beginning on or after January 1, 2014. Even though the effective date has been delayed, early adoption of the temporary regulations is available. Certain taxpayers may benefit from the early adoption of either the entire regulations or select provisions. Below is a summary of the new guidance and potential planning opportunities.
Planning Opportunities Related to Early Adoption
Although the guidance permits taxpayers to delay the implementation of the final regulations until tax years beginning on or after January 1, 2014, it also provides taxpayers the opportunity to adopt either the temporary or final regulations for tax years beginning in 2012 or 2013. The guidance also generally allows taxpayers to adopt specific provisions from the regulations without becoming subject to the entire regulations. This flexibility provides taxpayers a unique opportunity to use the regulations to maximize their overall tax position, depending on their facts and circumstances and whether it is advantageous to accelerate or defer taxable income. This opportunity is particularly beneficial for the 2012 tax year due to the recent increases in marginal income tax rates for individuals as a result of the compromise on the "fiscal cliff".
Below are a few brief examples of situations where it may be advantageous to adopt portions of the regulations in 2012.
Pass-Through Entities — Accelerate Income to Be Taxed at Lower Rates
With the maximum individual tax rates increasing from 35 to 39.6 percent and to 43.4 percent for passive shareholders/partners, it may be advantageous to accelerate income into 2012. These tax increases impact individuals with income over $400,000 and families with income over $450,000.
As a result, taxpayers that desire to accelerate income into 2012 to take advantage of the lower rates may choose to adopt the materials and supplies portion of the regulations in 2012 to capitalize items that would otherwise be expensed. This strategy would permit taxpayers to recognize income in 2012 when the maximum rates are at 35 percent instead of waiting until 2014 when the maximum rate could be as high as 43.4 percent.
C Corporations — Accelerate Deductions
C corporations are generally motivated to accelerate deductions to the earliest possible year. These corporations may be able to adopt the disposal rules in 2012 to accelerate tax deductions. The early adoption of the disposal rules would be particularly advantageous for taxpayers that have capitalized roof repairs or other major components in recent years. These taxpayers may be able to record as a disposal the remaining net tax value of the original roof or other major component in 2012 versus delaying the deduction until 2014. The acceleration of deductions accelerates the tax benefit and could provide an even greater benefit if various proposals to lower the corporate tax rate in future years prove successful.
Revise Systems in Anticipation of Implementation
]Taxpayers who decide not to early adopt these regulations will also benefit from the delay. Many taxpayers are currently not tracking the information necessary to implement the regulations. The delay in the effective date of these regulations will provide taxpayers with additional time to modify their systems and record keeping procedures so that they can contemporaneously capture the detail that is ultimately necessary to appropriately implement the regulations when required. If procedures are not reviewed in advance of these new regulations being mandatory, taxpayers could face significant inefficiencies and may also face tax exposures if they cannot adequately substantiate their tax positions.
Below are some examples:
- For those in the construction industry, materials and supplies are generally required to be capitalized to the extent these items have not been used or consumed as of the end of the year. Taxpayer’s will need to identify the types of materials and supplies that are on hand and determine the dollar value of these items at the end of the taxable year. By identifying these items in 2012, the taxpayer may be able to isolate these items into a specific expense account for 2013 that will enable them to estimate the dollar amount on hand at the end of the year assuming they are not otherwise maintaining an inventory of these items.
- De Minimis Rule — To the extent that a taxpayer expenses items that are under its capitalization threshold amount for financial accounting purposes, these amounts may have to be capitalized if they exceed the de minimis threshold amount. Taxpayers usually do not track these items in a specific account, so there is no mechanism to quantify the amounts expensed. These taxpayers may be able to revise their systems to identify and track these amounts contemporaneously in order to avoid a less efficient analysis on a retroactive basis.
In light of these and other potential planning and implementation issues, taxpayers have the opportunity to early adopt either the entire regulations or select provisions depending on each taxpayer’s unique tax situation. Regardless of whether taxpayers decide to early adopt or wait until 2014, they should begin to analyze how they will be affected and start to develop the necessary systems to track the information needed for the eventual implementation of the final regulations.