complying with the tangible property regulations: mission impossible?

22nd Annual Health Sciences Tax Conference Complying with the tangible property regulations Mission impossible? December 3, 2012

Complying with the tangible property regulations: Mission impossible?

Disclaimer

Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. For more information about our organization, please visit www.ey.com. This presentation is © 2012 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are not necessarily those of Ernst & Young LLP.


Presenters

► Scott Wilson Roche Diagnostics Corporation

► Brandon C. Carlton Ernst & Young LLP

Washington, DC + 1 202 327 6826 [email protected]

► Brendan Cox Ernst & Young LLP

Philadelphia, PA + 1 215 448 5049 [email protected]

► Daren Campbell Ernst & Young LLP Washington, DC + 1 202 327 6539

[email protected]


Agenda

► Level-set ► Procedural background and outlook ► High-level vision of the tangibles regulations

► Key implementation hotspots ► De minimis rule/materials and supplies ► Dispositions/general asset accounts ► Repairs versus improvements

► How to move forward ► Priority implementation issues ► Other considerations

Tangible property regulations Level-set


Procedural background and outlook

► Temporary regulations issued (December 2011) ► Final regulations anticipated in 2013

► Transition guidance issued (March 2012) ► Provides 19 new automatic method changes ► Scope limitations waived for 2012 and 2013 ► Compliance with Section 263A generally required

► Large Business & International (LB&I) Directive issued (March 2012) ► Stand-down order on most repairs and associated

dispositions issues ► Notice 2012-73 (November 2012)


Materials and supplies

Acquisitions Improvements Depreciation and dispositions

§ 1.162-3T § 1.263(a)-2T § 1.263(a)-3T §§ 1.168(i)-1T,-7T,-8T § 1.263(a)-1T

► Definition of materials and supplies

► Three categories of deductibility: ► Incidental ► Non-incidental ► Rotable spare parts

► Election to deduct under de minimis rule

► Election to capitalize and depreciate

► Capitalized costs include costs that facilitate acquisition of property ► Whether and which test

for real property ► May expense employee

comp. and overhead

► De minimis rule: follow applicable financial statement (AFS) expensing up to ceiling (applied to each regarded entity) ► Greater of:

► 0.1% of tax gross receipts, or

► 2.0% of book depreciation/ amortization

► Election to capitalize and depreciate

► Unit of property (UOP) is generally all functionally inter-dependent property except for: ► Buildings ► Plant property ► Leased property

► Improvement defined:

► Betterment ► Restoration ► New or different use

► Safe harbor for routine

maintenance on property other than buildings

► Safe harbor for certain regulated entities

► No plan of rehabilitation

► Dispositions ► General rules ► Required to recognize

disposition of structural components

► Reasonable identification methods

► Allowed vs allowable issue

► General asset accounts

► Flexibility to recognize (or not) dispositions of assets

► Annual election ► One-time retroactive

election

► Remember: coordination with Section 263A required for most changes; several “sleeper” elections.

High-level vision of the tangibles regulations


Notice 2012-73

Notice 2012-73 (issued 11/20/12) announced: ► Temporary regulations (currently effective for tax years beginning on or

after 1/1/12): ► Will be modified to be effective for tax years beginning on or after

1/1/14 ► May be optionally applied for tax years beginning on or after 1/1/12 ► Optional early application may be done piecemeal

► Final regulations: ► Are anticipated to be published in 2013 ► Will be effective for tax years beginning on or after 1/1/14 ► May be optionally applied for tax years beginning on or after 1/1/12 ► Will include modifications to de minimis rule, dispositions rules and

the routine maintenance safe harbor

Tangible property regulations Key implementation hotspots


De minimis rule/materials and supplies

Materials and supplies Treas. Reg. § 1.162-3T

► Incidental Deduct when paid

► Non-incidental Deduct when used

► Rotable and spare parts

Deduct when disposed or use optional method of accounting

► Elect to capitalize and depreciate

► Can follow book de minimis expense policy if: 1) Have applicable financial

statement 2) Have written book policy 3) Deduct pursuant to book

policy 4) Less than a ceiling (by

taxable entity) of the greater of: 0.1% of tax gross

receipts or

2.0% of book depreciation and amortization

► Elect to capitalize and depreciate

De minimis rule Treas. Reg. § 1.263(a)-2T(g)

Elect to deduct under de minimis rule

if ceiling allows


Example flowchart

Book capitalizes tangible property?

Analyze fixed assets for potential deductibility for tax

What is character (i.e., gain/loss account) for book expense?

M&S Can the property be classified as a tax expense such as Repair

1. UOP < $100 2. UOP with economic life < 12 months 3. Fuel, water lubricants consumed in < 12 months 4. Component to maintain, repair, improve a UOP 5. Other identified guidance

M&S

Capitalize M&S

Incidental (deduct when acquired)

Non-incidental (deduct when used/consumed)

Rotable or temporary parts (deduct when

disposed) Depreciate

Repair? UOP not improved

Deduct

Has AFS, follows written book policy, and deducts for book

Subject to a ceiling — the greater of: 0.1% of tax gross receipts or 2.0% of total book depreciation and amortization

De minimis rule?

Capitalize and depreciate Deduct up to ceiling

Yes No

Supply, repair, other

Yes — IF Options

No

Yes — IF

No total $ limitation

No total $ limitation

Yes — IF

Total $ limited to ceiling

Amounts above ceiling

► No ► Amounts above ceiling

No


Tackling implementation De minimis rule and materials and supplies

1. Calculate ceiling 2. Compare aggregate amount expensed under book policy 3. If overage, remove amounts deductible under other provisions 4. If overage remains, determine what to capitalize

De minimis ceiling

Expensed amount

A

B

Incidental M&S

Non-incidental M&S (used only)

Repairs costs Capitalize


Example — de minimis rule

► “A Corp.” historically deducts for tax all amounts it expenses for financial purposes. A Corp’s exam team has always agreed not to consider amounts under US$2,500 in its audit.

► Does A Corp. need to make a change to use the de minimis rule under the tangibles regulations?


Example — de minimis rule and materials and supplies ► A Corp. decides to make a method change to use the de

minimis rule under the tangibles regulations. It has a book policy of expensing amounts under US$2,500 and simply deducts the cost of most materials and supplies.

► How can A Corp. follow the new law but do the least amount of work?


Dispositions T.R. § 1.168(i)-1T and T.R. § 1.168(i)-8T

► Includes the sale, exchange, retirement, physical abandonment or destruction of an asset ► Now includes the retirement of structural components of

a building

► Must use a reasonable valuation method that is consistently applied

► Basis issues with respect to allowed or allowable depreciation


Dispositions/general asset accounts T.R. § 1.168(i)-1T and T.R. § 1.168(i)-7T

New default General asset account (GAA)

When a component is disposed of:

1. Stop depreciating the

component 2. Must recognize gain/loss 3. Use reasonable basis to

determine tax basis of disposed asset

If elected to include in a GAA:

1. Continue to depreciate asset as if still owned

2. Recognize ordinary gain on amount realized

or

3. Optionally recover basis: ► For qualifying dispositions,

or ► On disposing of last item in

GAA


Example — dispositions

► “B Corp.,” a manufacturer, owns buildings and production equipment. B Corp. does not currently track dispositions of structural components of buildings or of most components of its production equipment. However, occasionally, B Corp. does recognize a loss on the disposal of some production equipment parts.

► Should B Corp. make a general asset election? If so, what should it include? What are the pros and cons?


Improvements Step 1 — determine unit of property

► General rule ► Functional inter-dependence

► Exceptions ► Buildings — single unit, but analyze …

Building structure plus eight defined building systems ► Plant property

Discrete and major function within the functionally inter-dependent machinery or equipment

► Network assets Facts and circumstances or published guidance

► Leased property and leasehold improvements


Heating, ventilation and air conditioning (HVAC)

Plumbing

Electrical

Gas distribution

Fire protection

Security systems

Elevator systems

Escalator systems

Structure: ►Roof ►Walls ►Windows

Improvements Unit of property for buildings — T.R. § 1.263(a)-3T


Improvements Step 2 — apply improvement rules

Capitalize

Betterment? ► Correct pre-existing

material condition or defect

► Results in material addition

► Results in material increase in capacity, strength, quality or output

Yes No

Potentially otherwise deductible

Restoration? ► Replace component for which

loss claimed

► Repair damage related to claimed casualty loss

► Replace component for which basis adjusted in gain/loss

► Repair unit of property (UOP) to ordinarily efficient operating condition from state of disrepair

► Rebuild UOP to “like-new” condition at end of class life

► Replace major component or substantial structural part of UOP

New or different use?

► New use inconsistent with intended use when originally placed in service

Capitalize

Yes No

Capitalize

Yes No


Improvements Routine maintenance safe harbor — T.R. § 1.263(a)-3T

► Must reasonably expect to perform the activity more than once during property’s class life

► Must be able to keep asset in its ordinary and efficient operating condition ► Replace parts with comparable and commercially available and

reasonable replacement parts

► Does not apply if: ► Taxpayer takes a loss on removed components, takes a casualty

loss or includes adjusted basis of removed component in gain, or loss on sale of component

► Put property into use from a state of disrepair

► Does not apply to buildings


Example — improvements

► “C Corp.” currently deducts all repair/maintenance activity costing less than US$5,000 on its manufacturing line. C Corp. would like to continue to follow this method for tax.

► Can C Corp. continue to deduct repair/maintenance costs pursuant to its book policy?

Tangible property regulations How to move forward


Priority implementation issues

► Financial reporting ► Consider possible method changes and timing

considerations ► Optional application of temp/final rules in 2012, 2013 or 2014

► Section 263A Uniform Capitalization (UNICAP) requirement

► The risks of doing nothing until the 2014 tax year


Other considerations

► Collateral federal tax effects ► Fixed assets/cost segregation ► Impact on Section 199 deduction ► Impact on earnings and profits from controlled

foreign corporations

► Impact on state and local tax ► Apportionment factors ► Personal property taxes

► Impact on systems and processes


Possible systems changes

► General fixed asset system changes ► Systems modifications may be needed depending on the capitalization

and depreciation rules created for the former regulations. ► Master data review of fixed assets could be beneficial to:

► Review bonus depreciation ► Incorporate topside adjustment schedules ► Eliminate side schedules ► Clean-up deferred tax reconciliation

► Materials and supplies ► Additional accounts may be added to the general ledger to clearly

separate material and supply expenditures from other expenditures. ► Analysis tools or queries may be developed to automate the process for

filtering material and supply expenditures to determine whether or not book expenses must be capitalized for tax.


Possible systems changes (cont.)

► Acquisitions ► Upstream systems may be configured to flag differences in

acquisition costs between book and tax.

► Improvements ► Assets may be divided into business systems. ► Upstream systems may be configured to flag deductible

repair expenditures. ► Special depreciation keys may need to be established to

appropriately record repair expenditures.

► Depreciation and dispositions ► Information fields may need to be established or populated to track

general asset accounts. ► Special transaction codes may need to be established to allow for

tax-only dispositions.

Appendix — method changes and elections


Rev. Proc. 2012-19 Materials and supplies

Description of method change

Appendix § change #

§ 481 vs cut-off Notes

Deducting incidental materials and supplies when paid or incurred

§ 3.13 #165

Cut-off in 2012; modified § 481 in future

Change to deduct incidental materials and supplies in the taxable year in which they are paid or incurred Notes A, B, C, D and E

Deducting non-incidental rotable and temporary spare parts when disposed

§ 3.14 #166


Change to deduct non-incidental rotable and temporary spare parts in the taxable year in which the taxpayer disposes of the parts Notes A, B, C, D, and E

Change to the optional method for rotable spare parts

§ 3.15 #167

§ 481 Change to use the optional method of accounting for rotable and temporary spare parts Notes A, B, C, D and E

Deducting non-incidental materials and supplies when used or consumed

§ 3.12 #164


Change to deduct non-incidental materials and supplies in the taxable year in which they are actually used or consumed Does not apply to rotable or temporary spare parts Notes A, B, C, D and E

Note A: Must be in compliance with § 263A for the costs subject to the method change or file concurrent § 263A change Note B: Should be combined on one Form 3115 with §§ 1.162-3T, 1.162-4T, 1.263(a)-1T, 1.263(a)-2T and 1.263(a)-3T and, if

applicable, should be combined on one Form 3115 with concurrent change under § 263A Note C: Scope limitations in Section 4.02 of Rev. Proc. 2011-14 are waived for the first and second taxable year beginning after

December 31, 2011 Note D: Form 3115 filed with Ogden, UT in lieu of IRS National Office Note E: Addresses use of statistical sampling using Rev. Proc. 2011-42 to determine § 481 adjustment and to support items on

income tax returns


Rev. Proc. 2012-19 Sales costs




Deducting dealer expenses that facilitate the sale of property

§ 3.16 #168

§ 481

Change for a dealer in property to treat costs paid or incurred to facilitate the sale of tangible property as ordinary and necessary business expenses Notes A, B and C

Capitalizing non-dealer expense to facilitate the sale of property

§ 10.08 #172

§ 481 Change to capitalize costs to facilitate the sale of tangible property for taxpayers that are not dealers in such property Notes A, B and C

Note A: Should be combined on one Form 3115 with §§ 1.162-3T, 1.162-4T, 1.263(a)-1T, 1.263(a)-2T and 1.263(a)-3T and, if applicable, should be combined on one Form 3115 with concurrent change under § 263A

Note B: Scope limitations in Section 4.02 of Rev. Proc. 2011-14 are waived for the first and second taxable year beginning after December 31, 2011

Note C: Form 3115 filed with Ogden, UT in lieu of IRS National Office


Rev. Proc. 2012-19 Acquisition costs and de minimis rule




Deducting de minimis amounts

§ 3.17 #169


Change to apply the de minimis rule for amounts paid or incurred to acquire or produce property Does not apply to inventory, land or § 195 expenditures Notes A, B, C and D

Capitalizing acquisition or production costs

§ 10.09 #173

§ 481

Change to capitalize amounts paid or incurred to acquire or produce property, including costs described in § 1.263(a)-2T(e) and (f) and ,if applicable, depreciate such property Must complete Schedule E of Form 3115 Notes A, B, C, D and E

Deducting certain costs for investigating or pursuing the acquisition of real property

§ 3.18 #170


Change to deduct certain amounts paid or incurred in the process of investigating or otherwise pursuing the acquisition of real property or a change solely for employee compensation and overhead related to such investigatory costs Does not apply to § 195 expenditures Notes A,B, C and D




income tax returns


Rev. Proc. 2012-19 Improvements




Deducting repairs and maintenance costs

§ 3.10 #162

§ 481 Change from capitalizing to deducting repairs and maintenance costs; also includes change in units of property Does not include property subject to a repair allowance election for year in the election was made Notes A, B, C, D and E

Change to the regulatory accounting method

§ 3.11 #163

§ 481 Change for certain regulated taxpayers to follow regulatory method for determining whether amounts improve property Does not include property subject to a repair allowance election for year the election was made Addresses use of statistical sampling for § 481 adjustment only Notes A, B, C and D




income tax returns


Rev. Proc. 2012-19 Improvements



§ 481 vs cut-off

Notes

Change to the safe harbor for routine maintenance on property other than buildings

§ 3.19 #171

Modified § 481

Change to apply the routine maintenance safe harbor method, which does not apply to buildings Notes A, B, C, D and E

Capitalizing improvements to tangible property

§ 10.10 #174

§ 481 by Class life

Change to capitalize amounts paid or incurred for improvements to units of property, and, if applicable, depreciate such improvements Does not include property subject to a repair allowance election for year the election was made Must complete Schedule E of Form 3115 Notes A, B, C, D and E




income tax returns


Rev. Proc. 2012-20 Depreciation




Depreciation of leasehold improvements

§ 6.27 #175

§ 481 — option for one net adjustment or may have two adjustments by separating negative and positive

Changes comply with § 1.167(a)-4T for leasehold improvements in which the taxpayer has a depreciable interest at the beginning of the year of change Section 4.02(5) of RP 2011-14 does not apply Special rules for public utility property Note A, B, C and D

Permissible to permissible method of accounting for depreciation of MACRS property

6.28 #176

Some changes are modified cut-off; some cut-off; some § 481

Change from permissible to permissible depreciation methods under § 168 for certain assets owned by the taxpayer at the beginning of the year of change Must be combined on one Form 3115 with #177 Must complete Schedule E of Form 3115 Statistical sampling for § 481 adjustment Section 4.02(5) of RP 2011-14 does not apply Notes A, C and D

Note A: Must be in compliance with § 263A for the costs subject to the method change or file concurrent § 263A change Note B: Should be combined on one Form 3115 with concurrent change under § 263A Note C: Scope limitations in Section 4.02 of Rev. Proc. 2011-14 are waived for the first and second taxable year beginning after


income tax returns


Rev. Proc. 2012-20 Dispositions




Disposition of a building or structural component

§ 6.29 #177

§ 481 — option for one net adjustment or may have two adjustments by separating negative and positive

Change to the appropriate asset for dispositions of buildings and structural components Must be combined on one Form with certain 176 Must complete Schedule E of Form 3115 Statistical sampling for § 481 adjustment No ruling on asset Section 4.02(5) of RP 2011-14 does not apply Notes A, B, C and D

Dispositions of tangible depreciable assets (other than a building or its structural components)

§ 6.30 #178

§ 481—option for one net adjustment or may have two adjustments by separating negative and positive

Change to the appropriate asset for disposition of § 1245 property or a depreciable land improvement No ruling on asset Notes A, B, C and D

Note A: Must be in compliance with § 263A for the costs subject to the method change or file concurrent § 263A change Note B: Should be combined on one Form 3115 with concurrent change under § 263A Note C: Scope limitations in Section 4.02 of Rev. Proc. 2011-14 are waived for the first and second taxable year beginning after


income tax returns


Rev. Proc. 2012-20 Dispositions and general asset accounts




Dispositions of tangible depreciable assets in a general asset account

§ 6.31 #179

§ 481 Change to the appropriate asset disposed of or the method of identifying which assets have been disposed of for assets for which the taxpayer made a valid general asset account election; special rules for making the change including description of the assets Notes A, B, C and D

General asset account elections

§ 6.32 #180

§ 481 with modified cut-off in certain situations

Change to make a late general asset account election, a late election to recognize gain or loss upon the disposition of all the assets or the last asset in a general asset account, or a late election to recognize gain or loss upon the disposition of an asset for which the taxpayer made a valid general asset account election. This change only applies for the taxpayer’s first or second taxable year beginning after December 31, 2011; after that, the making of a late election will not be considered a change in method of accounting Notes C, D

Note A: Must be in compliance with § 263A for the costs subject to the method change or file concurrent § 263A 3115 Note B: Should be combined on one Form 3115 with concurrent change under § 263A Note C: Scope limitations in Section 4.02 of Rev. Proc. 2011-14 are waived for the first and second taxable year beginning after


income tax return


Tangibles regulations elections to be made on the 2012 tax return

Election Asset by asset

or overall? How election made Revocation, if

allowed Capitalize and depreciate materials and supplies

Asset by asset No statement required; treatment on timely filed original return constitutes election

Private letter ruling showing good cause

Deduct materials and supplies under de minimis rule in Treas. Reg. §1.263(a)-2T(g)



Capitalize and depreciate, rather than deduct under de minimis rule in Treas. Reg. §1.263(a)-2T(g)



Capitalize employee compensation and overhead as amounts that facilitate an acquisition transaction



General asset account Asset by asset Form 4562 on timely filed original return Irrevocable

Optional termination of a general asset account

Overall No statement required; treatment on timely filed original return constitutes election


Optional determination of the amount of gain, loss or other deduction for disposition from general asset account



complying with the tangible property regulations: mission impossible?

Economy & Finance

disclaimerernst young

young llpwashington

dependent property

property annual election

final regulations

unit of property uop

outlook temporary regulations

t definition of materials