IRS guidance offers relief for small businesses on HRAs, Form 3115

Chris Gaetano
Published Date:
Mar 23, 2015

Amid warnings of severe processing delays at the IRS this tax season, the preparer community got a pleasant surprise in February, when the service released new guidance offering relief from two tax provisions that CPAs considered particularly onerous.

The first piece of guidance, Rev. Proc. 2015-20, allows small businesses to comply with the new tangible property regulations through a simplified procedure, in lieu of filing IRS Form 3115, Application for Change in Accounting Method. The tangible property regulations, which were approved in 2013, essentially govern what counts as either a repair or an improvement and, therefore, what can and cannot be depreciated over time. One significant aspect of the rules is a finer definition of what actually counts as a unit of property. Whereas the preparer would previously count the whole building as a unit, under the new rules, a building is divided into discrete units that include categories such as electricity; plumbing; or the heating, ventilating and air conditioning (HVAC) system.

Since much of what was outlined in the new regulations requires a change in accounting methods, the taxpayer would have needed to fill out Form 3115, which informs the IRS of such modifications, according to Jonathan M. Horn, chair of the NYSSCPA’s Relations with the IRS Committee.

The form, Horn noted, was initially intended to make the process easier, as the alternative to filling it out was to get direct approval from the IRS. However, he said, completing the document is actually “a huge amount of work.” The full form includes eight pages of complex questions that, if answered incorrectly, could create the impression that the taxpayer is trying to dupe the IRS. What’s more, Horn added, the process requires “looking back to all your depreciation and expense decisions from the beginning of time for all property you own and asking, ‘Did I do it right and, if not, what’s the adjustment value?’”
Daniel Gibson, a managing partner from Iselin, New Jersey, knows well the anxieties that come with completing the form. “When you even mention Form 3115 to an accountant, it’s a frightening experience, because you’re looking at [pages] of pure misery.”

To add insult to injury, Gibson noted that Form 3115 often won’t even communicate any significant economic changes unless the preparer plans to take a particularly aggressive tax position—the form doesn’t change enforcement or regulations, only how people comply with those regulations. Horn made a similar point, saying that the form demands a lot of work for what often becomes a minimal or nominal adjustment.

Stakeholders brought these concerns up with the IRS, and, in response, the service released Rev. Proc. 2015-20 on Feb. 13. Under this guidance, small businesses that are allowed to bypass Form 3115 are defined as those with total assets of less than $10 million or average annual gross receipts of $10 million or less for the prior three taxable years.

Still, both Gibson and Horn said that just because a small business isn’t required to file Form 3115, it doesn’t mean it can’t anyway. There could be cases where going through all the hassle would actually be worth it for a client. For example, the form can be useful if a client has “ghost assets,” that is, assets that may have been replaced or even disposed of, but are still on the fixed-asset schedule and are being depreciated.

“There’s a chance to do a partial disposition election to really clean up your depreciation schedules, but [you can’t proceed] if you take advantage of the relief and don’t file a 3115 for these accounting changes,” Horn said.

He added that the form can also allow a taxpayer to expense something that, in the past, had been depreciated and, in doing so, get a sizable deduction. For more information on the IRS’s simplified procedure for Form 3115, visit The Society has created a special toolkit that includes a 1-CPE-credit webcast about the updates.

HRAs gets temporary reprieve
The second piece of guidance, Notice 2015-17, concerns health reimbursement accounts (HRAs), which allow employers to set aside pretax dollars specifically for their employees to pay medical expenses or purchase individual health insurance. The guidance concerns both how S corporations interact with these plans, as well as businesses as a whole.

Under IRS rules, when S corporations (closely held corporate entities) utilized these types of accounts, those who were 2 percent-or-greater partners in the entity needed to count the value of the insurance, whether paid for by the company or reimbursed to the individual owner, on the W-2 form as income. This was required even though it was largely a wash, as the rules also allowed 2 percent-or-greater partners to deduct the value of the insurance on their Form 1040s.

With the passage of the Affordable Care Act (ACA), however, these sorts of accounts were no longer valid—under the ACA, HRAs were considered a group plan and, as such, were subject to the minimal essential coverage standard. Minimal essential coverage means that a plan must have certain qualities to be considered in compliance with the ACA, such as affordability, fair premiums and a minimum coverage value. Due to the nature of HRAs, they were not considered to be in compliance with the ACA and continuing to use them would invite significant penalties—specifically, a $100-per-employee-per-day excise tax.

“The big thing people forget is that this excise tax applies to everyone, not just large employers,” Horn said. “You can have two employees and still be subject to the excise tax.”

Employers thought they had a workaround, Horn said, by making the reimbursement additional taxable income, however, the federal government said that this still violates the ACA. Indeed, the IRS eventually released guidance that said it didn’t matter whether the reimbursement came before or after tax—it’s still reimbursement, and therefore out of bounds for the ACA. According to Horn, this meant that, suddenly, many businesses were facing the possibility of massive penalties.

In response to numerous concerns voiced to the IRS, the government released 2015-17 on Feb. 18. In that guidance, the service said that it stands by the original position that HRAs are not in compliance with the ACA but, because of the confusion and the time required to transition to a new system, no business under 50 employees will be penalized if it continues using HRAs through June of this year.

Essentially, “They said, ‘We’re standing by our guidance, HRAs don’t work and you’ve got until June to fix it,’” Horn said.

In addition to this measure for small businesses, S corporations got additional relief for their investors holding 2 percent or more shares. Like other business entities subject to this rule, the IRS relief allows S corporations to avoid the penalties for running an HRA, but unlike other stakeholders, their relief will last until the IRS comes out with additional guidance specifically pertaining to them, according to Scott M. Cheslowitz, a member of the NYSSCPA’s Closely Held and S Corporations Committee.

“The notice, with respect to S corporation arrangements, basically now says, ‘We’re not going to hit you with the penalty, Mr. or Ms. 2 percent-or-greater shareholder, through at least 2015,’” he said.
This also means that these same shareholders, basically employees, would still pick up income on their W-2 from the reimbursements, but would then be able to deduct it when filing their 1040s. Cheslowitz praised the release, saying the IRS made the right call.

“They heard the comments from the preparer community, and they acted responsibly,” he said.
Horn added, however, that it would be best for practitioners to encourage their clients to transition to a new type of plan, or even drop coverage and simply give everyone the money to buy something off the exchange.

Both Cheslowitz and Horn said that, as happy as they are about the new IRS guidance, they do wish the timing had been different.

“It was really refreshing to see, within three days, the IRS come out with two reasonable pieces of guidance that resolve, at least partially, huge filing season issues,” Horn said. “The bad news was they could have done this months ago and saved everyone a lot of agita.”

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