The IRS’s New Repair Regulations
When Your Client Should, But Won’t, File Form 3115
By Ralph G. Picardi, Esq.
Now that the era of the IRS’s new “repair regulations” is upon us, the question arises: What should you do when confronted with a client that does not want to incur the expense of having you prepare one or more Form 3115s? It is certainly the client’s prerogative not to file the Form this year, especially if the client qualifies as a “small business taxpayer”. But, there are reasons why some small business taxpayers would benefit from filing Form 3115, and you may be concerned that the client may blame you some day for the loss of such benefits, even though it was you urging the client to file.
In such a case, you could:
- Decide to not incur the risk and disengage. Although that is the safest course, from a risk management perspective, I am not convinced that you need to take such a drastic step. It would be perfectly reasonable to remain engaged, but to protect yourself through use of documentation.
- Have your client sign an indemnity/hold-harmless agreement whereby the client acknowledges the advice you have given, takes ownership of the contrary decision, releases you from any future claim arising out of that decision, and indemnifies you against any harm you may suffer as a result of any third-party action. However, many clients will refuse to sign such an agreement, and there is no guarantee it would be enforceable if they did.
So, if you aren’t prepared to walk away from the client who refuses to sign the agreement, the next best thing is a well-written letter or email to the client documenting
- your efforts to educate the client on the repair regulations and the available options,
- your advice to the client,
- the client’s decision to go in a different direction,
- and the client’s acknowledgement of its responsibility
A communication of this sort may not prevent the client from having selective memory and asserting a claim, although there is a good chance it will (plaintiffs’ lawyers will be less likely to take the case in the face of such a document), but it will most assuredly make the claim that is asserted more defensible. I suggest language along these lines:
Thank you for your time during our meeting [telephone conversation] of today [date]. As we discussed, last year the IRS finalized regulations that are commonly referred to as the “repair regulations”. Generally speaking, these regulations provide comprehensive standards for determining whether a particular expenditure may be deducted on your tax return as a repair expense or must be capitalized and depreciated. Other important subjects are also covered, such as the proper treatment of materials and supplies and the treatment of the costs of acquiring tangible property such as real estate. Applying the repair regulations to years prior to 2014 and making the necessary adjustments constitutes a change in accounting method and requires the filing of one or more Forms 3115 (Application for Change in Accounting Method).
In order for us to prepare one or more Forms 3115 and adopt the repair regulations it would be necessary for us to review all of your expenditures in all tax years that began prior to 2014 and determine whether those expenditures were properly accounted for as repair expenses or as capital expenditures on earlier tax returns, by applying the principles of the finalized repair regulations. As we discussed with you, such a review process is potentially a lengthy and expensive process.
The IRS has recently, however, granted some relief for “small business taxpayers”. This relief allows a small business taxpayer to adopt all or most parts of the repair regulations without filing a Form 3115. You are considered a small business taxpayer if your trade or business has either less than $10 million in assets on the first day of the 2014 tax year or the business has average annual gross receipts of less than $10 million over the three preceding tax years. If either test is satisfied, you may choose to adopt the repair regulations without filing the Form 3115.
Even if you are a qualifying “small business taxpayer” you may still want to file Form 3115 in order to take advantage of a “late partial disposition election.” This election is a one-time opportunity available only in 2014 to treat prior-year retirements of structural components of buildings (such as a replaced roof) as a disposition that generates a retirement loss deduction. If you previously retired a structural component, you are likely still depreciating the cost allocable to the component. The partial disposition election allows you to claim a loss for the remaining undepreciated cost in 2014. In addition, if in the past you have aggressively written off as “repair” expenses expenditures that maybe should have been capitalized, you may also want to file Form 3115 to eliminate or reduce the risk of the IRS auditing the issue for prior years.
If you choose to adopt the repair regulations without filing Form 3115 under the “small business taxpayer” exception, no deduction may be claimed in 2014 for amounts that you capitalized prior to 2014 but which are deductible under the final repair regulations. You must continue to capitalize and depreciate those amounts. This consideration, however, is offset by the fact that if a review of your prior expenditures reveals amounts that were claimed as repair deductions, and those amounts are required to be capitalized under the repair regulations you must include the prior deductions in income in 2014.
Please also note that in either event, you are required to adopt these regulations prospectively.
During our meeting [telephone discussion] you acknowledged that you understand that as the taxpayer, you need to make the decision whether or not to file Form 3115 on a case-by-case basis by carefully weighing the expected costs and inconvenience of filing (including the review of all prior asset capitalization and expenditures necessary to properly file Form 3115) against the value of any potential benefits of doing so. You also informed us that we had adequately explained the repair regulations and Form 3115, that you had given the matter careful consideration, and that you had decided to adopt the “small business taxpayer” relief (and therefore chose not to file Form 3115 to formally adopt the repair regulations on a retroactive basis). You stated, however, that you will adopt the repair regulation prospectively; we will provide [have provided] you with guidance in doing so.
If the above summary does not accurately reflect the discussion we had with you regarding the repair regulations and Form 3115, please respond to this message immediately and explain any inaccuracies that you find. Thank you, and we look forward to working with you this year.
© March 2015, PICARDI LLC