University's Tax Center Suggests Changes for Small Businesses Under Proposed 'Repair' Regs

As a Professor of Taxation and Director of the Graduate Tax Program at the Kogod School of Business at American University, my remarks will represent the views of the Kogod Tax Center, where I serve as its Executive Director. The Kogod Tax Center is a research and educational institute that seeks to foster public awareness of tax issues affecting small business, entrepreneurs and the middle class. The Tax Center offers solutions to technical issues through balanced, non-partisan research designed to ease the compliance burdens upon individuals and small businesses.

The attached comments, which I hope to present on April 25, make suggestions for simplifying the record keeping of small businesses in connection with their expensing and capitalization of expenditures under the new regulations. I look forward to the opportunity to offer my remarks.

These regulations reflect the great care and concern of the IRS about the need to accurately distinguish expenditures that may be immediately expensed from those that should be capitalized in order to avoid a distortion of taxable income. But while the need for technical accuracy is important, the cost and simple inability of many small business persons to meet the degree of accuracy sought by the regulations may foster unintentional and even intentional noncompliance that will lead to an overall lack of respect for our income tax system. Therefore, in an effort to encourage respect for these rules from the small business community, we offer the following suggestions to ensure compliance with only a minimal loss of technical accuracy.

1. Materials and Supplies

While the regulations' authorization to the IRS to adjust the $100 limit for expensing property is laudable, it is puzzling why setting an absolute $500 limit indexed for inflation, as suggested by other commentators, would create inappropriate distortions of income. In addition, although small businesses may use the § 179 expense election for many items, the $100 limit directly impacts the ceiling amount under the de minimis rule. Therefore, we urge that the $100 limit be increased to $500.

2. De Minimis Rule

If the requirement for an AFS is based upon a need for assurance that a consistent methodology was employed in deciding what was expensed or capitalized, there are other, less expensive, alternatives. For example, a compliance review under the rules of the AICPA's Statement on Standards for Accounting and Review Services, can provide the sufficient level of assurance needed to avoid inappropriate distortions of income.

3. Unit of Property -- Buildings

The creation of specifically defined building systems for purposes of measuring whether an improvement to a component of a building can be expensed is understandable only for buildings and their building systems costing millions of dollars. Also, to identify fire protection and alarm systems and security systems as separate components will have a chilling effect on taxpayers who are considering improving the safety of the occupants of their properties. In any event, small businesses and individuals will not have the information or documentation to allocate costs to these systems under whatever allocation procedures the IRS ultimately adopts. Therefore, it is recommended that there be a $1,000,000 initial basis threshold for any building before the standards for determining if an improvement has been made are applied separately to defined building systems. This threshold will reflect the reality that taxpayers cannot, or frankly will not, comply with the new rules for relatively insignificant amounts of expenditures attributable to a building.

4. Betterments & Restorations

The numerous examples in the temporary regulations illustrating what constitutes a betterment or restoration to a building are very helpful to small business persons who may not fully grasp conceptual descriptions of such terms. Examples, however, do not provide the "bright line" test small business persons need to efficiently prepare their tax returns. The Kogod Tax Center appreciates why the temporary regulations deleted the 50 percent replacement cost and 50 percent physical structure standard that were in the 2008 proposed regulations and requests instead a simple annual dollar threshold (say $10,000) that will be presumed not to be a betterment or restoration when attributable to a building with an initial cost basis not exceeding $1,000,000. This safe harbor will afford the certainty to small business persons who are not sufficiently sophisticated to address the definitions of betterment and restoration in the temporary regulations.

5. Effective Date

Making the regulations effective for the 2012 tax year imposes an enormous burden on almost every business that will be filing a tax return this year. Especially onerous is that section 481 adjustments are required and that the procedures for obtaining consent for these adjustments, whether or not automatic, became available only a few weeks ago. It is highly unlikely that small businesses are aware of these regulations, let alone that they must soon adopt accounting method changes to conform to them. Therefore, to reduce the burden on taxpayers who do not have the resources and/or documentation to comply with section 481, we suggest that such computations only be required for adjustments over $1,000,000 and permit small businesses to adopt a cut-off effective for taxable years beginning in 2012.

In conclusion, the Kogod Tax Center thanks you for taking our suggestions into consideration and welcomes the opportunity to respond to your questions.