It’s no revelation to hear that the federal tax laws are very complicated. There are many reefs and rocky shoals. But the IRS has created a number of safe harbors that taxpayers can rely upon to secure their intended tax results with greater certainty.
Here is a listing of some key safe harbors for small businesses. It’s boring stuff that can save your business significant taxes.
Building improvements safe harbor
It’s often difficult to determine whether an expenditure for a building is a repair, which is currently deductible, or an improvement, which must be capitalized and is usually recovered through depreciation. But if a business has average annual gross receipts for the three prior years of no more than $10 million and the building’s unadjusted basis is no greater than $1 million, then you can rely on a safe harbor. This allows you to deduct the cost of improvements immediately as long as the cost of repairs, maintenance, and improvements for the year do not exceed the lesser of $10,000 or 2% of the unadjusted basis of the building.
De minimis safe harbor for repairs
Instead of capitalizing the cost of certain tangible personal property (deducting the cost through first-year expensing, bonus depreciation, or regular depreciation and keeping records for years), you can use a safe harbor to immediately deduct the cost up to $2,500 per item or invoice. Doing so means you don’t add the item to your balance sheet. Under this safe harbor, you treat the cost as non-incidental materials and supplies, which are currently deductible.
Meals furnished for your convenience
Meals provided to your employees on your premises for your convenience are tax free to them and exempt from employment taxes. Under safe harbor, if more than half of your employees who are furnished meals on your business premises are furnished the meals for your convenience, you can treat all meals you furnish to employees on your business premises as furnished for your convenience (i.e., none are taxable to employees or subject to employment taxes).
Depreciating business vehicles
If you buy a new car, light truck, or van, you can depreciate the cost, including some bonus depreciation for the first year ($10,100 for vehicles bought and placed in service in 2019). But technically, claiming this additional first-year write-off means no further depreciation until after the end of the vehicle’s recovery period. The IRS created a safe harbor to allow depreciation in the second and subsequent years for vehicles bought and placed in service in 2018 and later years.
Employer mandate
Employers with 50 or more full-time and full-time equivalent employees must offer minimum affordable health coverage or pay a penalty (“the employer mandate”). Because an employer can’t know what’s affordable (the employee doesn’t disclose his or her household income), there are 3 safe harbors that can be used to determine whether coverage is affordable.
401(k) plans
These plans must meet certain nondiscrimination tests to ensure they don’t improperly favor owners and managers. The Qualified Automatic Contribution Arrangement (QACA), which is an automatic enrollment 401(k) that has a fixed deferral percentage for employees’ elective salary contributions, has a safe harbor that exempts the plan from nondiscrimination testing. Follow the rules and the plan is treated as nondiscriminatory.
Real estate for the QBI deduction
Only activities that constitute a trade or business can entitle an owner of a pass-through entity to claim the qualified business income (QBI) deduction on his or her personal return. The IRS has created a safe harbor that owners of rental real estate can use to establish their activities as a trade or business for this purpose.
Routine maintenance safe harbor
The cost of routine maintenance is currently deductible, even if it could be viewed as a capital improvement, as long as it is done to keep property in its ordinarily efficient operating condition. This maintenance safe harbor rule applies to buildings as long as the owner expects to perform the maintenance more than once over a 10-year period. The safe harbor applies to property other than buildings if expected to be done more than once during the class life (essentially, the recovery period for depreciation purposes) of the unit of property.
Safe harbor for employment taxes for misclassified workers
This safe harbor, called Section 530 relief, was created by the Revenue Act of 1978 and not by the IRS. It allows you to avoid penalties on employment taxes that you didn’t pay because you classified your workers as independent contractors. If the IRS successfully reclassifies your workers as employees, you must pay back employment taxes but won’t be penalized.
Final thoughts
The good news about many of these safe harbors is that they effectively act as post-year end elections to achieve a desired tax result (you can see your tax results for the year and then decide whether to use them). The bad news is that you usually have to attach a statement and take other required action in order to use the safe harbor (rules vary greatly from one safe harbor to another). Work with your CPA or other tax advisor to learn which of these safe harbors may be a benefit to you.
