October 10, 2020

Capitalization Policies

By Joshua Bloom, Manager, Assurance Services

Capitalization Policies Tax & Business

Every organization should have a capitalization policy in its accounting policies and procedures. Such a policy removes individual judgment from the equation and thus ensures consistency as to when a piece of equipment should be capitalized.

The most important factor in adopting a capitalization policy is the minimum expenditure that should be considered. In practice, minimum expenditures for capitalization generally range from $500 to $5,000. In addition to ensuring that assets are capitalized consistently, establish a minimum range requires less time spent on recordkeeping since policy criteria will dictate when capitalization is appropriate.

Establishing a Threshold

When considering what thresholds to use for capitalization, it is also important to consider the tax ramifications. The Internal Revenue Service (IRS) has issued regulations that establish a de minimis safe harbor election that allows taxpayers who have a written capitalization policy in effect as of the beginning of the year comfort that the thresholds will not be challenged.

The threshold amounts will vary based on whether the entity has what the IRS refers to as “applicable financial statements” or AFS, which is defined as an audited set of financial statements accompanied by a report from a CPA firm, or a set of financial statements filed with the Securities and Exchange Commission or another government agency.

If the company has an AFS, the IRS will not challenge a safe harbor threshold of up to $5,000. If the company does not have an AFS that meets the above criteria, the IRS will not challenge a safe harbor threshold of up to $2,500.

Being able to use a higher threshold means that more expenditures can be recorded as expenses, which reduces net taxable income in the current year as opposed to spreading out the expenditures over a number of years as depreciation is taken for those entities not utilizing bonus depreciation or Section 179 expensing.

Establishing a Useful Life

Any asset being capitalized should have a useful life of greater than one year, but U.S. GAAP does not provide for a specific useful life in the same way that IRS regulations do for tax purposes. The company should establish guidelines for how long an expected asset class is going to be in use, which saves additional time during the recordkeeping process.

For tax purposes, the specific useful lives of the assets are defined by IRS regulations. Your Marcum tax professional can assist in the decision-making process.