One of the more complex matters facing state budgets is how best to deal with the largess of the federal government’s business incentives included in federal tax legislation. There is probably no area of the federal tax law where this issue is more costly for states than the capital expenditure initiatives included in several recent tax bills.
The most current federal tax legislation, the Tax Cuts and Jobs Act (TCJA), signed into law by President Trump on December 22, 2017, is exceptional in that the law includes provisions allowing for the expensing of one 100% of the cost of capital assets acquired prior to January 1, 2023.
It is not difficult to understand the strain such a policy creates for those states that compute taxable income based on the business’s federal taxable income. In most instances, states attempt to “decouple” from the federal legislation and invoke different tax depreciation rules for state income tax applications.
Upon the passage of the TCJA in December, the Commonwealth of Pennsylvania issued Corporation Tax Bulletin 2017-02, which basically said that all federal income tax depreciation taken under the “bonus” depreciation rules included in the TCJA “must be added back to Pennsylvania taxable income for corporate income tax purposes.” Making matters worse, that Bulletin noted that Pennsylvania tax law “provides no additional mechanism for cost recovery with respect to qualified property.”
Bulletin 2017-02 did allow that “the taxpayer may take an additional deduction when the qualified property is sold or otherwise disposed of during a taxable year to the extent the amount of depreciation claimed has not been fully recovered.”
Thus, with this Bulletin, Pennsylvania effectively took the position that corporations in the Commonwealth that take advantage of federal “bonus” depreciation will be entitled to zero state depreciation until the property is no longer with that company.
Short on perspective, such a position is unduly harsh for capital-intensive industries within the State. Immediately upon the release of the Bulletin, legislators went to work to remedy the situation. The effort has now resulted in a more tenable, and competitive, tax position within the Commonwealth of Pennsylvania.
On June 28, 2018, Governor Tom Wolf signed into law Act 72 of 2018 (formerly SB1056), which decouples the state’s corporate net income tax law from the bonus depreciation provided in the federal TCJA and allows taxpayers to take additional deductions on qualified property for which a 100% bonus deduction is claimed for federal purposes. The provisions of the bill will go into effect immediately, and are applicable to tax years beginning on or after January 1, 2017.
Act 72 of 2018 disallows the federal bonus depreciation deduction from taxable income provided in Section 168(k) of the IRC (the provision of that bill providing for 100% “bonus” depreciation), and, importantly, provides an additional deduction equal to the depreciation as determined in accordance with Internal Revenue Code Section 167 (which addresses depreciation) and Internal Revenue Code Section 168 (Accelerated Cost Recovery System). The newly enacted legislation formally reverses the Pennsylvania Department of Revenue (DOR) policy previously set out in Bulletin 2017-02.
Though the new legislation leaves the add-back requirement for the federal bonus depreciation in place, the corporate net income tax rules are amended to allow an additional deduction equal to the regular Modified Accelerated Cost Recovery System (MACRS) depreciation that would have applied to the qualified property absent the application of bonus depreciation rules.
The provisions apply to qualified property placed in service after September 27, 2017, for which the taxpayer elected to take bonus depreciation. This dating matches the effective date for the federal bonus depreciation provision. Note that it remains unclear how these provisions will apply to qualified property for which a federal bonus deduction of less than 100% is claimed.
The Act also codifies an earlier DOR policy, provided under Corporation Tax Bulletin 2011-01,which allows for an additional deduction of any unrecovered 168(k) deductions in the earlier of the taxable year in which qualified property is fully depreciated or is sold or otherwise disposed by the taxpayer with respect to property placed in service prior to September 27, 2017.
Act 72 of 2018 provides a reasonable, and tenable, balance of maintaining Pennsylvania’s competitive business environment as a pro-business state, while still ensuring that the budget is not fully overwhelmed by federal legislation benefiting corporations.