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    Clean Energy Incentives Manufacturers Should Consider

    Posted 5:15 PM by
    In a move to accelerate investments in industrial energy efficiency, and to reward states and business that engage in such investments, President Obama signed an executive order August 30, 2012: Accelerating Investment in Industrial Energy Efficiency.
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    State & Local Tax Update - 9/17/12

    Posted 12:00 PM by

    Reassessment for Indiana Real Property Taxes: Indiana counties are currently wrapping up their 2012 statewide reassessments. During a reassessment year, county and township assessors are required to inspect all properties and adjust all assessed values to properly reflect market value in use. Counties were last required to reassess property in 2002; therefore, some property owners should expect significant changes as a result of the 2012 reassessment.

    Property owners are encouraged to review their assessment notices (Form-11) as soon as they receive them to make sure the assessed value looks appropriate. The property owner has 45 days to file an appeal after the mailing of the first notice of assessment. When a property owner receives their tax bill, it is often too late to appeal the assessed value for that year. Some counties began mailing their assessment notices this month.

    Contact your KSM advisor, or KSM property tax leader Chad Miller, as soon as you receive your Form-11. We would be happy to review the reassessed value of your commercial property to help you consider whether an appeal should be filed.

     

    Alabama Issues New Rules on Sales Factor: Effective for tax years beginning after December 31, 2010, the Alabama Department of Revenue, has adopted Ala. Admin. Code § 810-27-1-4-.09.01 and 810-27-1-4-.17 regarding the apportionment factor. The adopted rules indicate that Alabama uses a double-weighted sales factor in the three-factor apportionment formula. The rules also provide that for taxpayers with a business interest in an unincorporated entity, the apportionment formula must include the pro rate share of the unincorporated entity's factor data. In addition, the rules address the new market-based sourcing methodology used to source sales other than sales of tangible personal to Alabama. Under the act, gross receipts from sales that do not involve tangible personal property are considered to be in Alabama if the taxpayer's market for the sale is in Alabama.

    Georgia Issues Guidance on Pass Through Entity Withholding: Effective September 2, 2012, the Georgia Department of Revenue has adopted amendments to Rule 560-7-8-.34 to conform the regulation with current state law and clarify provisions. Among other changes:

    • An entity is required to include guaranteed payments as part of its taxable income sourced to Georgia;
    • The term "entity" does not include a Subchapter "S" corporation that is treated as a "C" corporation for Georgia purposes;
    • Estimated tax payment dates for entities that file a composite return are made the same as for individuals;
    • A fiscal year entity is required to adjust its estimated payment dates and extension dates as if it were an individual filing a fiscal year return;
    • It is clarified that the 4% withholding is required with respect to the nonresident member's share of taxable income sourced to Georgia; and
    • The filing of estimated tax payments by the member does not relieve the entity from the responsibility of the withholding requirement.

    Michigan Tribunal Rules on Discharge of Single Business Tax Under Bankruptcy : A taxpayer's assessment for a company's unpaid single business tax (SBT) as a corporate officer was not dischargeable in bankruptcy because it was a non-dischargeable excise tax under 11 U.S.C. § 507(a)(8)(E). The SBTs at issue arose from the business activity of a limited liability company, of which the taxpayer was an manager or member. The return date for the taxes at issue was more than three years before the date of the filing of the taxpayer's petition in bankruptcy, which would mean the taxes would be dischargeable under 11 U.S.C. § 507(a)(8)(E) unless they were an excise tax on a transaction. The SBT is a tax upon the privilege of doing business that is measured by the "adjusted tax base" of persons with business activity in Michigan. The SBT cannot be substantially distinguished from the Texas franchise tax, which a federal bankruptcy court has held to be a privilege tax on a transaction. In addition, a federal district court in Michigan, Quiroz v. State , U.S. Dist. Ct., E.D. Mich., Dkt. No. 11-CV-12672, 03/27/2012 , has held that an officer liability assessment arising from a corporation's failure to pay SBT was a debt for a non-dischargeable excise tax on a transaction under 11 U.S.C. § 507(a)(8)(E). Although the Tribunal was asked to determine whether the taxpayer's officer liability fell within the scope of a federal bankruptcy discharge of 11 U.S.C. § 523(a) issued by the U.S. Bankruptcy Court for the Southern District of Florida, the Tribunal found that the Florida bankruptcy court would have come to the same conclusion as the court in Quiroz . In addition, while the taxpayer is not the "taxpayer" that initially incurred the tax liability, an officer is liable for payment of the tax under Mich. Comp. Laws Ann. § 211.27a(5), and so is a payer of tax (a taxpayer). The debt that the taxpayer in this case listed on his bankruptcy schedule is a debt for a tax, which the taxpayer became liable to pay by virtue of the officer liability statute. Paul A. Henderson v. Mich Department of Treasury

    New York Court Holds Metropolitan Commuter Transportation Mobility Tax Unconstitutional : On August 22, the Supreme Court for Nassau County, New York, held that the metropolitan commuter transportation mobility tax (MCTMT) is unconstitutional because the New York State Legislature did not follow proper procedures in enacting the law. In its decision, the Court held that the MCTMT was unconstitutionally passed by the legislature. Because the MCTMT was a special law that did not serve a substantial state interest, the law should have been passed with either a home rule message or by a message of necessity with a two-thirds vote of each house. Accordingly, the Court granted the municipalities' motion for summary judgment. However, the New York State Department of Taxation and Finance has announced that the litigation has not concluded and taxpayers that have been paying the MCTMT should continue to pay and file returns. See Mangano v. Silver, New York Supreme Court, Nassau County, No. 14444/10, Aug. 22, 2012 for details of the decision.

    Rhode Island Kicks off Amnesty Program : From September 2, 2012, to November 15, 2012, Rhode Island will offer an amnesty program for delinquent taxpayers. The amnesty program applies to the following taxes due on or before December 31, 2011: Corporate income tax, estate tax, fiduciary income tax, personal income tax, sales and use tax, cigarette and tobacco products taxes, and employer taxes. The amnesty includes 2011 Rhode Island personal income tax returns that were due April 17, 2012. In exchange for coming forward, taxpayers will pay the full amount of overdue taxes plus 75% of any interest due, without having to pay the remaining interest and any penalty amounts due and without being subject to any other civil or criminal penalties. Taxpayers who are eligible for tax amnesty may set up a payment plan; however, the full amount of the tax and 75% of any interest due must be paid no later than December 14, 2012. For details visit: http://www.taxamnesty.ri.gov/.

    Texas Issues Sales Tax Guidance on Cloud Computing : A company's information technology infrastructure services offered to customers in the form of web services are subject to sales and use taxes. The services, commonly referred to as "cloud computing" services include the ability for customers to store, retrieve and maintain content, data, applications and software on the company's servers; run applications, monitor computers and computer usage, send electronic communications, and host web domains; and copy information to sites within the company's network and route end user requests for customer data to the site that can deliver the information most quickly. The fees charged for these services, along with incidental usage fees, are taxable data processing services pursuant to Tex. Tax Code Ann. § 151.0035. Advanced email software services provided by the company are taxable as telecommunications services while a service that provides customers with access to data gathered from the internet is taxable as an information service. Local taxes due on the sales of data processing and information services sold by the company are sourced to the local taxing jurisdictions in effect at the customer's Texas location. See Policy Letter Ruling 201207533L for details.




     

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    The Times They Are a-Changin’: Sales Tax in a Technologically Advancing World

    Posted 12:00 PM by

    Cloud computing. Software as a service. Digital goods. Webhosted. Web-based. Web-enabled. Licenses. Subscriptions. Nowadays, most companies use a variety of these tools in the everyday operations of their businesses. With such advancements, it has become especially important for businesses to understand the tax ramifications that result from the buying, selling and use of these goods and services. Read more

    To read the full text of the State & Local Tax Advisor newsletter, go here.

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    Two Words Every Manufacturer Should Know: Production Deduction

    Posted 4:38 PM by
    You have heard the phrase, “What you don’t know can’t hurt you.” Unfortunately, in the tax world, such is not the case. What you don’t know can hurt you and your wallet. As a small business owner in the manufacturing industry if you don’t know the term "production deduction," then it’s time to call your tax advisor or find a new one!
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    Tax-Exempt or Taxable Financing? The Impact on Investment Recovery.

    Posted 8:43 PM by
    Competition remains fierce between communities to attract or retain business that drives employment, revenues and overall development. The offer of issuing bonds for project financing is frequently used by local governments or agencies to incentivize location in a particular area.
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    Have You Considered an Automatic Enrollment Feature for Your 401(k) Plan?

    Posted 12:00 PM by

    Do you want to offer a retirement plan that provides a high level of employee participation and makes it easy for you to withhold employee contributions and select the investments for those contributions? Do you currently have a plan that fails to meet its annual non-discrimination testing requirements? If so, then you may want to consider an automatic enrollment feature for your 401(k) plan.

    Approximately 30 percent of eligible employees do not participate in their employer's 401(k) plan. Many employees are intimidated by their employer’s 401(k) plan and all the decisions (contributions, investments, etc.) needed to participate. Whether you already have a 401(k) plan or are considering one, an automatic enrollment feature offers the following advantages:

    • Increased plan participation  
    • Allows for the certain investments if employees do not select their investments
    • Simplifies the selection of investments appropriate for long-term savings for participants
    • Helps employees begin saving for their future
    • Offers significant tax advantages (including deduction of employer contributions and deferred taxation on contributions and earnings until distribution)
    • Permits distributions to employees who opt out of participation in the plan within the first 90 days

    A basic automatic enrollment 401(k) plan must state that employees will be automatically enrolled in the plan, unless they elect otherwise, and must specify the percentage of an employee's wages that will be automatically deducted from each paycheck for contribution to the plan. The document must explain that employees have the right to elect not to have salary deferrals withheld or to elect a different percentage to be withheld.

    An eligible automatic contribution arrangement (EACA) is similar to the basic automatic enrollment plan, but has specific notice requirements. An EACA can allow automatically enrolled participants to withdraw their contributions within 30 to 90 days of the first contribution.

    A qualified automatic contribution arrangement (QACA) is a type of automatic enrollment 401(k) plan that automatically passes certain kinds of annual required testing. The plan must include certain required features, such as a fixed schedule of automatic employee contributions, employer contributions, a special vesting schedule, and specific notice requirements.

    Disclosure Requirements

    Employers must notify employees who are eligible to participate in the plan about certain benefits, rights and features. Employees must receive an initial notice prior to automatic enrollment in the plan and receive a similar notice annually. 

    The notice should include information about the automatic contribution process, including the opportunity to elect out of the plan. In addition, the notice must describe the default investment used by the plan, the participants' right to change investments, and where to obtain information about other investments offered by the plan.

    An annual notice must be provided to participants and all eligible employees at least 30 days, but not more than 90 days, prior to the beginning of each subsequent plan year.

    If the participant, after receiving the initial or annual notice, does not provide investment direction, the participant is considered to have decided to remain in a default investment.

    Participation

    Employees are automatically enrolled in the plan and a specific percentage will be deducted from each participant's salary unless the participant opts out or chooses a different percentage.

    Contributions

    Basic and Eligible Automatic Enrollment 401(k) Plans – As with any 401(k) plan, in addition to employee contributions, you decide on your business' contribution (if any) to participants' accounts in your plan. If employers decide to make contributions to an automatic enrollment 401(k) plan for employees, there are additional options. Employers can match the amount their employees decide to contribute (within certain limits), or contribute a percentage of each employee's compensation (called a nonelective contribution) – or both. Employers have the flexibility of changing the amount of matching and nonelective contributions each year, according to business conditions.

    Qualified Automatic Contribution Arrangements – If a plan is set up as a QACA with certain minimum levels of employee and employer contributions, it is exempt from the annual testing requirement that applies to a traditional 401(k) plan. The initial automatic employee contribution must be at least three percent of compensation. Contributions may have to automatically increase so that, by the fifth year, the automatic employee contribution is at least six percent of compensation.

    The automatic employee contributions cannot exceed 10 percent of compensation in any year. The employee is permitted to change the amount of his or her employee contributions or choose not to contribute, but must do so by making an affirmative election.

    The employer must at least 1) make a matching contribution of 100 percent for salary deferrals up to one percent of compensation and a 50 percent match for all salary deferrals above one percent, but no more than six percent of compensation; or 2) make a nonelective contribution of three percent of compensation to all participants.

    Contribution Limits – Employees can make salary deferrals of up to $17,000 for 2012. This includes both pre-tax employee salary deferrals and after-tax designated Roth contributions (if permitted by the plan). An automatic enrollment 401(k) plan can allow catch-up contributions of $5,500 per year for 2012 for employees age 50 and over.

    Vesting

    Automatic employee contributions are immediately 100 percent vested.

    Employer contributions are vested according to the plan's vesting schedule. However, the required employer contributions under a QACA must be fully vested by the time an employee has completed two years of service.

    Nondiscrimination

    Basic automatic enrollment 401(k) plans and most EACAs are subject to annual testing to ensure the amount of contributions made on behalf of rank-and-file employees is proportional to contributions made on behalf of owners and managers. Automatic enrollment typically increases participation, thereby making it more likely that a plan will pass the test. Automatic enrollment 401(k) plans set up as QACAs are not subject to this annual testing.

    Investing the Contributions

    You can automatically invest employee contributions in certain default investments that generally offer high rates of return over the long term and provide a greater opportunity for employees to save enough money to take them through retirement. If carried out properly, employers can limit liability as plan fiduciary for any automatic enrollment 401(k) plan losses that are a result of investing participants' contributions in these default investments. Note that employers are still responsible for prudently selecting and closely monitoring these default investments. There are conditions to obtain this relief from liability:

    • Plan sponsors place the participant's contributions in certain types of investments.
    • Before his or her first contribution is deposited, the participant receives a notice describing the automatic enrollment process; a similar notice is sent annually thereafter.
    • The participant does not provide investment direction.
    • The plan passes along to the participant material related to the investment.
    • The participant is given the opportunity periodically to direct his or her investments from the default investment to a broad range of other options.

    Qualified Default Investment Alternatives – You can choose from four types of investment alternatives for employees' automatic contributions, called qualified default investment alternatives, or QDIAs. Three alternatives are diversified to minimize the risk of large losses and provide long-term growth. They are:

    • A product with an investment mix that changes asset allocation and risk based on the employee's age, projected retirement date, or life expectancy (for example, a lifecycle fund);
    • A product with an investment mix that takes into account a group of employees as a whole (for example, a balanced fund); and
    • An investment management service that spreads contributions among plan options to provide an asset mix that takes into account the individual's age, projected retirement date or life expectancy (for example, a professionally managed account).

    There is an alternative that allows plans to invest in capital preservation products, such as money market or stable value funds, but only for the first 120 days after the participant's first automatic contribution. This option can be used only in EACAs that permit employees to withdraw their automatic contributions and earnings between 30 and 90 days (as specified in the plan) after the participant's first automatic contribution. Before the end of the 120-day period, if you receive no direction, you must redirect the participant's contributions in the capital preservation product to one of the long-term investments mentioned above.

    Note that you do not have to select a QDIA for your plan. You may find that other default investment alternatives would be more appropriate for your employees.

    Distributing the Contributions

    Employees may not want to participate in the company retirement plan. If employers want to allow participants to withdraw their contributions within 30 to 90 days of the first contribution, your plan document must provide for this option and be set up as an EACA. Any distributed amounts, including earnings, are treated as taxable income in the year distributed. The distribution is reported on a Form 1099-R and are not subject to the 10 percent early withdrawal tax.

    If an employee decides to withdraw investments within 30 to 90 days of the first contribution, a plan cannot impose restrictions, fees or expenses beyond standard fees for services, such as investment management and account maintenance. Further, participants should not be subject to penalties, such as surrender charges, liquidation fees, or market value adjustments.

    For questions regarding your retirement plan, please contact any of the members of our Employee Benefit Plan Services Group.

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    Tax Credits: An Opportunity (with a Price)

    Posted 8:53 PM by
    Federal and state tax credits offer business owners incentives for their business activity that, effectively, provide dollar-for-dollar reimbursements of qualified expenditures. Other incentives provide special deductions that accelerate the recovery of investment in assets.
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    State & Local Tax Update - 8/21/12

    Posted 12:00 PM by

    Reassessment for Indiana Real Property Taxes: Indiana counties are currently wrapping up their 2012 statewide reassessments. During a reassessment year, county and township assessors are required to inspect all properties and adjust all assessed values to properly reflect market value in use. Counties were last required to reassess property in 2002; therefore, some property owners should expect significant changes as a result of the 2012 reassessment.

    Property owners are encouraged to review their assessment notices (Form-11) as soon as they receive them to make sure the assessed value looks appropriate. The property owner has 45 days to file an appeal after the mailing of the first notice of assessment. When a property owner receives their tax bill, it is often too late to appeal the assessed value for that year. Some counties began mailing their assessment notices this month.

    Contact your KSM advisor, or KSM property tax leader Chad Miller, as soon as you receive your Form-11. We would be happy to review the reassessed value of your commercial property to help you consider whether an appeal should be filed.

     

    Indiana Supreme Court Rules on Sales Factor Sourcing: The Indiana Supreme Court has held that a brewery and malt beverage distribution company's sales to Indiana customers, who used common carriers to pick up merchandise in the company's Ohio facility for delivery to Indiana, are in fact Indiana sales; accordingly, these sales are subject to the state's adjusted gross income tax. The Court further held the Tax Court's determination that an example included in Ind. Admin. Code § 3.1-1-53 operated to exempt the company from Indiana tax on income from sales of goods delivered by common carrier to Indiana customers was erroneous since the example was not a rule and did not have the force of law. See Indiana Department of Revenue v. Miller Brewing Company for details of the decision.

    Alabama Issues Sales Tax Nexus Regulation: The Alabama Department of Revenue has adopted new rule 810-6-2-.90.01 , Seller's Responsibility to Collect and Pay State Sales Tax and Seller's Use Tax, effective July 31, 2012. The new rule makes clear that, under certain conditions, an out-of-state seller is engaged in-state in the business of selling tangible personal property at retail and is required to register with the Department for a sales tax license and collect /remit sales tax on all sales made within Alabama. The new rule tracks the language of Ala. Code § 40-23-190, which indicates that actions/activities of related parties can create substantial nexus for an out-of-state seller.

    California Gillette Decision Vacated: On Aug. 9, 2012, the California Court of Appeal has, "on its own motion and for good cause," vacated its previous decision in the Gillette case and ordered a rehearing to decide whether California can require multistate taxpayers to use the double-weighted sales factor formula to apportion their net business income for corporation income tax purposes only if California repeals its Multistate Tax Compact provision, which allows taxpayers an option to use the equally weighted UDITPA apportionment formula.

    Michigan Tax Tribunal Rules on Rolling Stock Exemption: The taxpayer was not entitled to a "rolling stock" exemption for parts that were affixed to its trucks or trailers after the date that the trucks or trailers were purchased. The taxpayer is an interstate motor carrier who purchased certain parts - auxiliary power units, bunk heaters, and GPS systems - that were not affixed to the trucks or trailers at the time the taxpayer purchased the trucks and trailers. The sales and use tax exemptions for rolling stock used in interstate commerce only exempt "parts" that are affixed to a truck or trailer. Under the sales tax exemption, a part that is affixed to a truck at the time of purchase is exempt; however, if a person purchases a part that is not affixed to a truck or trailer, it is taxable. Since the taxpayer affixed the parts after acquiring the trucks and trailers, the parts were not "affixed to" a truck or trailer at the time they were used or consumed in Michigan. Thus, the parts were taxable. See MLT, Inc. v. Michigan Department of Treasury for details of the decision.

    Utah Income Tax Nexus Regulation Amended: Utah Admin. R. R865-6F-6 has been amended to reflect current policy, as a result of case law and amendments to the Multistate Tax Commission rule, to indicate that delivery of goods in a seller's vehicle no longer creates nexus for corporation income or franchise tax purposes.

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    Property Tax Reassessment: Property Owners Beware

    Posted 12:00 PM by

    2012 is a real estate tax reassessment year for Indiana real property taxes. This means that every parcel of property in the state will be examined by a county assessor to determine if the assessed value of the property should be increased. Considering the last Indiana property tax reassessment took place 10 years ago (in 2002), the Indiana assessment of property on thousands of parcels of commercial property across the state are expected to increase by the time reassessment is complete.

    With this in mind, the first thing a property owner should do when they receive the Form 11 notice of assessment is to look at the assessed value and ask, "Could I sell my property for this price?" If the answer is "no," then it is possible that the property may be over-assessed. In this case, KSM's property tax calculator will estimate the amount of property taxes you may save by filing an appeal.

    KSM's property tax leader Chad Miller has more than 12 years of experience in dealing with Indiana's difficult assessment system. Prior to joining KSM, Chad worked as the lead commercial assessor for one of the largest business corridors in the state. As a result, Chad has witnessed firsthand just about every argument an assessor or taxpayer can make for or against an Indiana property tax appeal. Since coming to KSM, Chad and his team have used this experience to lower the Indiana real property taxes for our clients, reducing their assessed value by more than $204,000,000. And that is just in the first six months in 2012.

    If you are interested in a free review of your property's assessed value to determine if an appeal makes sense, please contact Chad at 317.580.2058 or cmmiller@ksmcpa.com.

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    IRS Issues New Rules Under 263(a)

    Posted 12:00 PM by

    On Jan. 1, 2012 new rules became effective regarding when to deduct or capitalize amounts paid to acquire, produce or improve tangible property. These new rules will affect all taxpayers that acquire, produce or improve tangible property.

    The question of when to deduct or capitalize amounts paid to acquire, produce or improve tangible property is frequently a point of disagreement between taxpayers and the Internal Revenue Service (IRS). Since 2004 the IRS has been developing guidance intended to reduce controversy related to this question. After issuing and withdrawing proposed regulations under §1.263(a) in 2006 and 2008, the IRS in December 2011 issued yet another round of temporary and proposed regulations, with §1.263(a)-1T providing general rules for capital expenditures, §1.263(a)-2T providing rules for amounts paid for the acquisition or production of tangible property, and §1.263(a)-3T providing rules for amounts paid for the improvement of tangible property. Also affected are guidelines under Regulations §1.162-3 regarding materials and supplies and other regulations indirectly affected by changes to Regulations §1.263(a). These regulations are effective on Jan. 1, 2012 and will expire on Dec. 23, 2014 if not made final.

    §1.162-4T of the temporary regulations states that a taxpayer may deduct amounts paid for repairs and maintenance to tangible property if the amounts paid are not otherwise required to be capitalized. §1.263(a)-1T provides that no deduction is allowed for (1) any amount paid for new buildings or for permanent improvements or betterments made to increase the value of any property or estate, or (2) any amount paid in restoring property or in making good the exhaustion thereof for which an allowance is or has been made. The ongoing dilemma for taxpayers has been the application of these rules to business activity. What constitutes an “incidental” repair? What is “maintenance”? How does one discern when an asset has increased in value or had its useful life extended?

    The temporary regulations generally divide asset types into (1) buildings and structural components thereof, and (2) assets other than buildings and structural components thereof (i.e., everything else). The temporary regulations further categorize expenditures into (1) amounts paid to produce or acquire tangible property and (2) amounts paid to improve tangible property. Underlying any analysis of whether to deduct or capitalize an expenditure is the concept of the “unit of property” (UOP). 

    In the case of property other than buildings, the UOP for real and personal property includes all functionally interdependent components of the property. Components are functionally interdependent if placing one component in service depends upon placing the other component in service. For example, a tractor trailer in its entirety (inclusive of all components such as the motor, the cab, the transmission, the tires, etc.) is the unit of property. In the case of buildings, the UOP concept is clarified and expanded to separately consider important functional systems of a building. 

    Under the new regulations, the building UOP consists of (1) the building and structural components; (2) heating, ventilation and air conditioning systems; (3) plumbing systems; (4) electrical systems; (5) all escalators; (6) all elevators; (7) fire protection and alarm systems; (8) security systems; (9) gas distribution system, and; (10) any other system defined in published guidance. This is a significant change compared to previously issued proposed regulations, given that under prior guidance taxpayers treated the entire building, inclusive of the now separately identified systems, as a single unit of property. For example, under prior guidance an expenditure related to heating, ventilation, and air conditioning (HVAC) systems may have been deducted based on the analysis that the UOP, the building, was not improved. Now, the analysis must look at only the HVAC system as the UOP, in which case the position for deducting or capitalizing the expenditure may change.

    Temporary regulations under §1.263(a)-2T regarding the acquisition or production of property retain most generally understood rules regarding capitalization of expenditures. Expenditures directly or indirectly incurred that result in the production or acquisition of a UOP must be capitalized. Amounts paid to move and reinstall a UOP already placed in service by the taxpayer are generally not amounts paid to acquire or produce a unit of property. All work performed on a UOP prior to the date placed in service is required to be capitalized. In general, all expenditures that facilitate the acquisition or production of real or personal property, such as permitting or title searches, must be capitalized.

    The temporary regulations continue to provide a de minimis rule regarding the amounts paid to acquire or produce tangible property (e.g., deducting amounts paid under $500). However, the general rule prohibiting a distortion of income is replaced with a bright-line ceiling rule. Taxpayers may not deduct otherwise capital expenditures in excess of the lesser of 0.1 percent of the taxpayer’s gross receipts for the tax year, or 2 percent of the taxpayer’s total depreciation and amortization for the tax year. Additionally, taxpayers are eligible to use a de minimis rule only if they have an “applicable financial statement” (i.e., an audited financial statement).

    Acquired materials and supplies are discussed under the temporary regulations. Materials and supplies that are incidental (for which no inventories or records of consumption are maintained) are deductible in the year purchased. Materials and supplies that are non-incidental are not deductible until the year in which they are used or consumed. In general, materials and supplies include property acquired to maintain, repair, or improve a unit of tangible property owned, leased or serviced by the taxpayer and that are not acquired as part of any single unit of property. Examples might include air filters for use in a building’s HVAC system, or brake pads for use on a tractor trailer. The proposed regulations add descriptions of material and supplies to include fuel, lubricants, water and similar items reasonably expected to be consumed in 12 months or less, beginning when used in the taxpayer’s operations.

    Proposed regulations under §1.263(a)-3T address amounts paid to improve tangible property. In general, amount paid related to a UOP already in service that (1) result in a betterment to the UOP; (2) restores the UOP; or (3) adapts the UOP to a new or different use must be capitalized. The application of these standards to amounts paid will likely remain a source of contention between taxpayers and the IRS, but the temporary regulations provide numerous examples of typical transactions and their treatment under the new rules. Of particular note are changes to regulations that specifically allow the disposition of structural components of a building or building systems. This will allow the adjusted basis of the retired component (e.g., an old roof) to be recovered when replaced. 

    The temporary regulations will dispense of the plan of rehabilitation doctrine, which required that otherwise deductible repairs or maintenance be capitalized if performed in conjunction with a larger remodeling or construction project. Retailers and other taxpayers whose buildings or other physical premises are subject to periodic refreshing are given guidance, via examples, on when such costs may be deducted. Taxpayers will still lack bright-line tests that provide clear guidance in such circumstances, so the facts and circumstances of each project must be analyzed. Any expenditure incurred to improve a material condition or defect in property that existed prior to acquisition, or which arose during production, must be capitalized regardless of whether the taxpayer was aware of the problem.

    The temporary regulations provide a routine maintenance safe harbor for tangible property other than buildings or building systems. Routine maintenance is a recurring activity and expenditure related to a UOP that a taxpayer expects to perform as a result of the taxpayer’s use of the property. The activity must keep (rather than put) the UOP in its ordinarily efficient operating condition. An activity is considered routine only if the taxpayer reasonable expects to perform the activities more than once during the class life of the UOP.

    The temporary regulations under §1.263(a) are far reaching and the discussion above serves to touch on many, but not all, key points that taxpayers should understand when determining whether to capitalize or deduct an expenditure. Taxpayers determining whether to deduct or capitalize expenditures should refer to these temporary regulations, the examples provided, and their KSM advisor.

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