Frequently Asked Questions Regarding the New Tangible Property Regulations: Why Do I Need to File Form 3115?
The new Tangible Property Regulations are the most dramatic changes in tax law to affect for profit businesses since the changes to the Internal Revenue Code in 1986. Final regulations were issued in 2013 and supporting tandem regulations were issued in 2014 requiring taxpayers to modify internal processes to comply with the new rules and file one or more application for accounting method change (IRS Form 3115.) Many taxpayers will need to file several Form 3115s.
Complying with the law will be burdensome for both the taxpayer and CPA firms. A Form 3115 will need to be filed for each separate entity or business. For example, if an individual owns separate rental entities, he will be required to file a separate 3115 (or maybe more than one) for each rental entity and attach the form to the 1040 for tax year 2014.
Adopting the new regulations will be a lot of work for taxpayers and CPAs. Below is a list of several frequently asked questions related to the new regulations.
Q. What are the tangible property regulations?
A. The final tangible property regulations took effect in 2014 provide guidance through IRS regulations, and revenue procedures regarding when and how an expenditure or improvements should be expensed, depreciated or capitalized. These rules, made final in 2014, set forth various tests, safe harbors, and elections for the tax treatment of fixed assets and expenditures such as repairs and maintenance. Most of the regulations require taxpayers owning assets to comply with these regulations by applying for a change in accounting method requiring consent of the Commissioner by filing a Form 3115. Depending on the taxpayer and the assets, multiple Form 3115s may be required to be filed with the 2014 tax returns.
Q. What do the tangible property regulations mean to business owners?
A. All taxpayers must comply with the final regulations. Company accounting policies must be in compliance with the new regulations. In addition, all businesses, either C or S corporations, Partnerships, LLCs, Schedule C and Schedule E filers, must file for a change in accounting method on Form 3115 with their 2014 tax return to change from an accounting method under the old guidance to adopting the rules under the new guidance.
Q. Will there be accounting fees for the additional Form 3115 to be included in the 2014 tax return?
A. Form 3115 must be filed before the 2014 tax return is filed, and a copy must be attached to the 2014 tax return. Preparation of the Form 3115 must be done under its own fee arrangement. Your tax professional can provide an estimate of the time involved to prepare this form for a particular business. As the property regulations are complex, different taxpayers will have different needs and require different levels of review of prior year assets, repairs and supplies.
Q. Why will a company be required to pay for an extra tax return to change my method of accounting if the method being used currently conforms to the new law?
A. Even if a Company’s basis of accounting is compliant with regulations, the method of accounting is based on what is historically reported in tax filings and record keeping. The new guidance may change how a business historically accounted for a particular item. As an example, in prior years, the IRS required most large repairs to be capitalized. The new regulations require “testing” of expenditures to determine if the expense is a betterment, adaptation, or restoration in order to determine if the item should be capitalized.
It is likely that a Company’s present method will not comply fully with the new rules and consent to switch to a new method of accounting must be obtained from the IRS Commissioner. The new regulations are extremely extensive and it is very unlikely that any taxpayer will currently comply using a present method. Consent from the Commissioner can be obtained automatically without a user fee in most cases by filing the correct method change on Form 3115.
Q. Can a Company apply the new regulations going forward on an asset-by-asset basis without filing Forms 3115?
A. The new regulations include a specific regulation for each method change. Any change in the treatment of an asset is a change in method of accounting. Further, any change to comply with the new sections is a change in method of accounting. Depreciation changes and capitalization of fixed assets must comply with the final regulations.
Adopting the new methods also requires that taxpayers catch up and report adjustments to make up the differences between the old and new methods. This adjustment is known as a section 481(a) adjustment and is recognized starting in 2014 and can be recouped over one to four years depending on the adjustments.
Q. Are there user fees associated with filing a Change of Accounting Method?
A. A $7,000 user fee applies to taxpayers seeking non-automatic consent for an accounting method change. If a Form 3115 is filed to comply with the new regulations, the changes will generally receive automatic consent without a user fee. However, after 2014 an automatic method change may not be available, and changing a method of accounting may require a fee.
Q. If a business was started in 2013 must a Form 3115 be filed?
A. If the return was filed considering the final regulations then a Form 3115 may not be required. If old guidance, such as capitalizing repairs or using assets from a prior business, was used in the preparation of the 2013 return, then a Form 3115 to comply with the final regulations will be required.
For 2014 filings (the new regulations could have been adopted as early as 2012, but 2014 is the final year to adopt now according to the final regulations) the key to gather and filter information is the 2013 tax depreciation details. By reviewing these details, the internal accounting department or the CPA can determine if:
- permissible methods are being used,
- if maintenance is properly expensed,
- if prior year repairs can be currently deducted,
- if removal costs can be expected or
- if a partial asset can be disposed, such as part of a roof.
Any of these computations will require a Section 481(a) adjustment and statements supporting the computation to be included with the Form 3115.
Q. What if a taxpayer does not file a Form 3115?
A. The IRS has stated it will scrutinize returns that did not include a Form 3115 with the 2014 tax return. The general presumption will be that every business with material and supplies or depreciation must adopt the final regulations. Chances of an audit will increase significantly if a Form 3115 is not filed.
In addition, a tax preparer must also comply with the regulations and should not sign a return that does not comply with the regulations. Those tax preparers who do not comply, risk penalty and disbarment. Signing an improper return is potentially deemed a violation of professional standards (Circular 230) and reckless disregard of the regulations.
Q. What is the risk of not filing a Form 3115?
A. Upon examination, non filers risk permanent loss of deductions and penalties. Any improperly capitalized or depreciated asset or repair could be permanently lost as a deduction. Those claiming too much depreciation could be subject one a 20% understatement penalty. Through 2014 only, the IRS is allowing a late partial asset disposition which permits taxpayers to write-off a replaced component, resulting in a permanent tax saving.
In addition, without filing a Form 3115, taxpayers will not be able to deduct repair and maintenance or material and supply costs that would otherwise be deductible if a method change was filed. Further, an opportunity to define unit of property will be missed and the taxpayer will not be able to take advantage of a partial asset disposition or expensing certain costs related to the unit of property.
As noted in the prior question, risk of audit is also increased if a Form 3115 is not filed. If audited, the IRS has the discretion to select a method of accounting that best reflects income, which would likely not be in favor of the taxpayer. For example, if a taxpayer expenses routine maintenance under the new rules without ever filing a Form 3115 to adopt the new rules, an auditor can mandate capitalization of those repairs.
Q. Why should a business file a Form 3115?
A. Taxpayers are compelled to file an annual tax return. The same rule applies to filing this “extra” Form 3115. Complying with a new law is a cost of doing business. Keep in mind, that many of the changes of accounting methods can result in a benefit by being able to write off items that were improperly depreciated based on the final regulations. Therefore, the cost of preparing the required Form 3115 may be small compared to a possible additional deduction in 2014.
Even if a benefit is obtained by filing Form 3115, such benefit is not the main point of a 3115 filings. A taxpayer must file a 3115 in order to change the method of accounting to comply with the new regulations.
Q. Taxpayers pay tax preparers and CPAs to prepare taxes in accordance with all rules and regulations and to be compliant with the law. Why should taxpayers pay to file another return?
A. The requirement to file a Form 3115 for these latest rules is a new and different requirement. It is not required because a tax preparer made a mistake. A Form 3115 filing is a new requirement. As noted above, there are penalties for noncompliance to both the preparer and taxpayer. New rules require Form 3115 be filed to change the method of accounting to the new final regulations.
Q. What if many taxpayers or accountants don’t prepare these returns? Will the IRS audit everyone?
A. The law requires compliance by filing a properly prepared and timely filed Form 3115. Non compliance may yield penalty liabilities. Accountants are ethically obligated to clients to follow the law. Accounting standards also state that tax preparers are professionally unable to sign returns without the proper Form 3115.