CPA Firm Suggests Changes to De Minimis Safe Harbor Election

BKD, LLP respectfully submits comments on the de minimis safe harbor limit provided in Treasury Reg. § 1.263(a)-1(f)(1)(ii)(D) for taxpayers without an applicable financial statement (AFS) as requested in Rev. Proc. 2015-20. BKD, LLP is one of the largest CPA and advisory firms in the U.S., with 34 offices in 15 states and works with thousands of small businesses that do not have an AFS. We appreciate the opportunity to comment.

Increase in the De Minimis Safe Harbor Amount for Taxpayers Without an AFS

From discussions with our business clients that do not maintain an AFS (as defined in Treasury Reg. § 1.263(a)-1(f)(4)), we learned that many have capitalization policies in excess of $500. Historically, these clients rarely have been challenged under IRS examination of maintaining a policy that does not clearly reflect income. As such, a $500 safe harbor does not appear to be a practical solution for taxpayers without an AFS.

The distinction between a taxpayer with an AFS and those without does not take into consideration the complexity or size of the taxpayer or the sophistication of their accounting department. A large closely held business that does not have a financial statement audit could have an accounting department just as sophisticated as that of an SEC-registered company. However, this similarly situated taxpayer is limited to a capitalization threshold of $500 under the de minimis threshold, rather than the more generous $5,000 amount provided to taxpayers with an AFS.

Granted, a taxpayer without an AFS is not handcuffed by the $500 threshold so long as they can prove under examination that deducting items in excess of $500 is a clear reflection of income. Unfortunately, due to the subjective nature of the "clear reflection of income" determination, taxpayers fear that an IRS examining agent may have a different opinion as to whether or not the expenditures are a clear reflection of income, which could lead to lengthy and costly disputes at the examination and appeal level -- or even litigation -- over an item that is nothing more than a timing difference. Increasing the safe harbor amount for taxpayers without an AFS would reduce taxpayer anxiety and potential future conflicts under examination.

We suggest increasing the de minimis safe harbor threshold for taxpayers without an AFS. Potential alternatives include a general increase in the amount across all business types, different thresholds based upon industries or a threshold based upon a certain percentage of average gross receipts for the three preceding tax years. Regardless of the method selected to increase the de minimis safe harbor, the threshold for taxpayers with and without an AFS should be indexed for inflation.

Reviewed Financial Statements Included as an AFS

In the preamble of T.D. 9636, Treasury states that it does not believe reviewed financial statements as defined in the AICPA's Statement of Standards for Accounting and Review Services "provide sufficient assurance to the IRS that such policies are being followed and, accordingly, that the taxpayer is using a reasonable, consistent methodology that clearly reflects income" and should not qualify as an AFS.

A review includes primarily applying analytical procedures to management's financial data and making inquiries of company management. While a review is less in scope than an audit, the certified public accountant is performing analytical procedures to provide some assurance, even though it is limited, that they are not aware of any material modifications that should be made to the financial statements. Arguably, such assurance of no material modification supports the position that reviewed financials meet the AFS expectation that a taxpayer is using a reasonable, consistent methodology that clearly reflects income.

We respectfully request Treasury and the IRS reconsider its position and include reviewed financial statements as an AFS under Treasury Reg. § 1.263(a)-1(f)(4) for purposes of the de minimis safe harbor election.

If you have any questions on these comments or would like to discuss any of the points raised herein in more detail, please contact Scott Humphrey, Jesse Palmer, Robert Conner or Darrick Elliott at 417.831.7283.