IRS Large Business Division “Standing Down” from Prior-Year Exam Activity of Capitalization Issues, Official Says

The IRS’s Large Business and International (LB&I) Division will cease audits of repair versus capitalization issues for tax years beginning before January 1, 2012, an IRS official said March 15. This policy is reflected in an LB&I directive to its field examiners issued March 15.

Similar to the LB&I directive involving the electric utility safe harbor under Rev. Proc. 2011-43, I.R.B. 2011-37, 326 (TAXDAY, 2011/08/22, I.4), the IRS is “standing down from prior-year exam activity,” Scott Dinwiddie, special counsel to the Associate Chief Counsel, Income Tax and Accounting (IT&A), said. Instead, LB&I is reserving examinations for issues that arise under the new capitalization regulations, Dinwiddie said.

The IRS issued comprehensive temporary and proposed regulations on the capitalization of costs relating to tangible property (T.D. 9564, NPRM REG-168745-03, TAXDAY, 2011/12/28, I.2). The temporary regulations apply to tax years beginning on or after January 1, 2012. The IRS also rescheduled a hearing on the regulations for May 9, 2012.

Dinwiddie noted that this is the third round of proposed regulations on this topic. At this point, the IRS is comfortable with the structure and direction of the regulation package, he said. Although the disposition regulations are new, the IRS was comfortable enough with them to include them in the temporary regulations.

The IRS has requested public comments and is most interested in comments on the details of the regulations, he indicated. These types of comments are more likely to have an impact.

Dinwiddie also mentioned the IRS’s Industry Issue Resolution (IIR) Program for addressing specific industries. He said the program is quite active and a number of IIRs are either in process or under request.

Dinwiddie and Kathleen Reed, a branch chief in the associate chief counsel (IT&A), spoke at a program sponsored by BNA Bloomberg Tax Management, held at the law offices of Buchanan, Ingersoll & Rooney PC, and hosted by Richard Marshall of the firm. Alexa Claybon from the Treasury Office of Tax Legislative Counsel also participated in the discussion. Reed told CCH that her branch primarily handled the depreciation portion of the new regulations.

Dinwiddie said the ceiling included in the de minimis rule is an important part of the rule. Reliance on the financial statement requirement might not be sufficient to ensure that a taxpayer’s accounting clearly reflected income. He said that the ceiling is “fairly generous” and that the IRS thought that most taxpayers would be under the ceiling.

Practitioners asked whether the rule would still apply if the taxpayer exceeded the ceiling, or would only amounts above the ceiling have to be capitalized. Dinwiddie said that the way the rule is written, it appears to disallow all deductions if the taxpayer exceeds the ceiling. Dinwiddie told CCH that “the issue is ripe for clarification,” and that its purpose is not to catch “foot faults.”

Asked about applying a higher amount than $100 to the definition of materials and supplies, Dinwiddie said that the area is appropriate for comments. One commentor suggested a level of $500, but Dinwiddie thought this would have “the potential to gut the rule.” However, a practitioner said that a $100 amount is “quite low.” Dinwiddie and Reed both said that it would be helpful if taxpayers submitted “hard data” to frame the discussion.

Another practitioner asked whether the IRS would issue informal guidance, such as Frequently Asked Questions, to clarify issues under the regulations. Dinwiddie told CCH that the operating divisions (LB&I and Small Business/Self-Employed) are interested in providing more information, but that Chief Counsel itself does not write FAQs.

The regulations permit statistical sampling of pre-2012 items when taxpayers change their accounting method and have to make a Code Sec. 481 adjustment. Dinwiddie confirmed that the regulations do not permit extrapolation as part of the calculation process. He said that extrapolation is not part of statistical sampling and that it is a new concept for the IRS. The IRS allowed it in Rev. Proc. 2011-43. Dinwiddie told CCH that whether to expand the use of extrapolation is an issue under consideration.

By Brant Goldwyn, CCH News Staff

Large Business & International Directive for Taxpayers Who Adopted a Method of Accounting Relating to the Conversion of Capitalized Assets to Repair Expense Under I.R.C. Section 263(a)

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