Consequences of Not Filing the Required Tangible Property Regulation 3115s
What are the issues or consequences to the taxpayer and the tax return preparer if a taxpayer does not comply with the tangible property regulations (TPRs), i.e. file the required or needed 3115(s)?
- It puts the client at risk for significant adverse consequences, such as:
- Permanent differences in deduction for repair and maintenance costs that were previously capitalized but should have been expensed under the TPRs through future depreciation disallowance (method 184 with a citation to 1.162-4)).
- Permanent differences in denied depreciation deductions for improper employment of bonus calculations, which cannot be fixed after notification of an IRS audit due to new TPR 1.1016-3 (method 7). [Note: RP 2015-13, section 8.02(e) removed the permanent differences threat of the “use it or lose it” rule for class lives employed incorrectly where the taxpayer took less depreciation than it was entitled to. Now under the provisions of RP 2015-13 if the 481(a) adjustment would result in a negative 481(a) that for item for the year under audit and the 481(a) adjustment would be negative for every other tax year under examination. If so, the taxpayer can then file a method #7, even though it is under audit, and obtain the proper negative 481(a)s it is entitled to. This new IRS rule still does not help taxpayers who have employed improper bonus calculations as it does not meet the criteria to have negative 481(a)s for all tax years under audit. Additionally, a 3115 filed under this new section of RP 2015-13 will not help a taxpayer if the taxpayer has positive 481(a) resulting from the employment of impermissible depreciation methods. If the taxpayer files a #7 3115 change request before being notified of an IRS audit, it can obtain a four year spread of any positive resultant 481(a)s. If the #7 method change filing is filed after audit notification however, those positive 481(a)s will require an immediate increase in income. Therefore, there still exist strong reasons for filing an impermissible to permissible depreciation method change, if applicable.]
- Inability to deduct repair and maintenance costs that that would otherwise be deductible under the TPRs with a method change filing (method 184 with a citation to 1.162-4). [Note this concern is overcome by Qualified taxpayers, i.e. under the $10M thresholds that adopt the TPRs via the employment of RP 2015-20.]
- Inability to deduct up to $200 per unit of property for either incidental or non-incidental materials and supplies costs that would otherwise be deductible under the new regulations with a method change filing (method 186 (non-incidental) and/or 187 (incidental)). [Note this concern is overcome by Qualified taxpayers, i.e. under the $10M thresholds that adopt the TPRs via the employment of RP 2015-20.]
- Inability to employ the new TPR rules for non-incidental and incidental material and supplies (method 186 and/or 187) [Note this concern is overcome by Qualified taxpayers, i.e. under the $10M thresholds that adopt the TPRs via the employment of RP 2015-20.]
- Missed opportunity to define the unit of property under 1.263(a)-3(e), either as required (if the taxpayer has multiple buildings as one unit of property it will not be able to employ the TPR capitalization criteria nor take partial asset dispositions) or as optional (the larger the taxpayer can define the unit of property the greater the opportunity for the expenditure to be deducted). (method 184 with a citation to 1.263(a)-3(e))
- Inability to properly capitalize and depreciate amounts paid to acquire or produce tangible property (method 192) or Inability to employ the new routine maintenance safe harbor of 1.263(a)-3(i) (method 184 with a citation to 1.263(a)-3(i)). [Note this concern is overcome by Qualified taxpayers, i.e. under the $10M thresholds that adopt the TPRs via the employment of RP 2015-20.]
- Incurring an advance consent filing fee (currently $8,600) to file a non-automatic method change request for each method change related to the TPRs not filed by tax year 2014 (TPRs are almost universally automatic changes with no filing fees, but only through the 2014 tax year. After that time period, they may be non-automatic or completely not available for several years due to the eligibility rules of RP 2015-13 (previously known as the scope limitations)). Note: taxpayer’s who did not file any TPR forms for tax year 2014 generally have the ability to file these as automatic method filings for tax year 2015. The taxpayer would is required to meet the eligibility rules and DCN 196 on partial asset dispositions is no longer able to be filed for any taxpayer, post 2014.
- A potential increase in audit risk as the IRS is expecting Forms 3115 for taxpayers with depreciable property, repairs and maintenance costs and materials and supplies costs.
- Provides the IRS with the ability to potentially dictate whether expenditures are to be capitalized and depreciated or expensed. Note this concern is overcome by Qualified taxpayers, i.e. under the $10M thresholds that adopt the TPRs via the employment of RP 2015-20.]
- Beyond the required TPR method filings, the client will miss out on the following optional TPR opportunity:
- The ability to deduct and not capitalize removal/demolition/moving costs incurred during an asset improvement (method 21).
- It puts the client at risk for potentially significant taxpayer penalties:
- Taxpayer accuracy penalty (if understatement with negligence or disregard of rules or regulations) – 20% of the amount of the understatement.
- It puts the Firm at risk for potentially significant preparer penalties:
- Unreasonable return position (if position results in an understatement and the preparer knowingly signed a return with a position lacking substantial legal authority) – Per return, greater of $1,000 or 50% of fees charged to prepare the return.
- Willful or reckless conduct (if position results in an understatement and the preparer intentionally disregarded the rules or regulations) – Per return, greater of $5,000 or 50% of fees charged to prepare the return.
NOTE: Willfully failing to comply with the tangible property regulations would seem to fall squarely within the definition of willful or reckless conduct, making mitigation of this penalty, were it to be assessed, extremely difficult.
NOTE: Since the preparer penalties provide no minimum understatement for the penalty regime to apply (i.e. a $5,000 penalty could be triggered by a $1 understatement), the penalty risk from willfully choosing not to apply these regulations is unacceptable, no matter how insignificant they may seem on a particular return.
NOTE: In addition to the above preparer penalties, the firm may be compelled to compensate clients for the above taxpayer penalties and adverse tax consequences.
- It creates a potential Circular 230 issue
- A practitioner must exercise due diligence
- In preparing or assisting in the preparation of, approving, and filing tax returns, documents, affidavits, and other papers relating to Internal Revenue Service matters;
- In determining the correctness of oral or written representations made by the practitioner to the Department of the Treasury; and
- In determining the correctness of oral or written representations made by the practitioner to clients with reference to any matter administered by the Internal Revenue Service. )
- A practitioner may not willfully, recklessly, or through gross incompetence
- Sign a tax return with the intentional disregard of the rules or regulations.
- A practitioner must exercise due diligence
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