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Priya D. Nair
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On December 22, 2017, the Pennsylvania Department of Revenue issued administrative guidance, Corporation Tax Bulletin 2017-02 (Bulletin), concerning the disallowance and recovery of bonus depreciation under Internal Revenue Code (IRC) Section 168(k). 1
The Bulletin disallows all depreciation on assets subject to 100 percent federal bonus depreciation placed in service between September 28, 2017 and December 31, 2022. Further, cost recovery equal to the full acquisition cost of the asset is allowed only at the time the asset is sold or otherwise disposed of. This currently makes Pennsylvania the only state to fully disallow depreciation on certain assets, though proposed legislation may change this treatment if enacted.
Overview of Federal Bonus Depreciation
Bonus depreciation is a method of accelerated depreciation, first dating back to September 11, 2001, allowing corporations to immediately deduct an additional percentage of the purchase price of eligible business assets in the year in which the assets are placed in service. 2
This was offered to encourage corporations to invest in additional capital assets. Originally, bonus depreciation was set at 30 percent, then later increased to 50 percent. From September 2010 to December 2011, bonus depreciation was temporarily increased to 100 percent before returning again to 50 percent.
The recent federal tax reform legislation has again expanded bonus depreciation to 100 percent for assets placed in service between September 28, 2017 and December 31, 2022. After December 31, 2022, 3
the bonus depreciation percentage is reduced by 20 percent increments annually, until it is completely phased out for the 2027 tax year and beyond.
Bonus depreciation is claimed as a deduction in the year the eligible assets are placed in service, with the remaining (non-bonus) portion of the assets being depreciated under IRC Section 167 until the basis of the asset is reduced to zero, or the asset is sold or otherwise disposed of.
History of Pennsylvania’s Treatment of Bonus Depreciation
Pennsylvania began decoupling from 30 percent bonus depreciation with its inception in 2001, and required all bonus depreciation claimed under IRC Section 168(k) to be added back when computing taxable income for corporate net income tax purposes. 4
However, to allow taxpayers to fully depreciate these assets for Pennsylvania purposes, an additional Pennsylvania deduction equal to 3/7 of the annual IRC Section 167 depreciation was allowed until the amount of the disallowed bonus depreciation was recovered. 5
The 3/7 formula was based on the 30 percent bonus depreciation rule originally in effect under IRC Section 168(k), and allowed for full cost recovery over the useful life of the asset for federal income tax purposes. In other words, Pennsylvania did not allow the initial deduction for bonus depreciation, but granted an additional deduction each year that the asset was depreciated over the same number of years as allowed for federal income tax purposes.
When the federal bonus percentage was increased to 50 percent, Pennsylvania did not change its 3/7 formula. Mathematically, this resulted in a significant portion (nearly 30 percent) of the cost of an asset not being depreciated for Pennsylvania purposes by the time it was fully depreciated for federal income tax purposes. Through administrative guidance, the Department allowed this remaining depreciation to be claimed in the year in which the asset became fully depreciated for federal income tax purposes. 6
While this approach deferred nearly 30 percent of the cost recovery to the end of the asset’s depreciable life, it did not require a sale or other disposition of the asset to recover this amount.
In response to federal 100 percent bonus depreciation in 2010, the Department issued Corporation Tax Bulletin 2011-01. 7
This provided the Department’s position that corporate net income taxpayers were not required to adjust Pennsylvania taxable income for 100 percent bonus depreciation. Consistent with its earlier administrative guidance regarding 50 percent bonus depreciation, the Department allowed the recovery of 100 percent bonus depreciation in the last year of federal depreciation, which meant such recovery occurred in the year the property was placed in service. Pennsylvania effectively followed federal law when the 100 percent bonus depreciation rule was applicable under IRC Section 168(k), and allowed corporate taxpayers to take 100 percent bonus depreciation on such assets.
Implications of Recent Bulletin for Corporate Net Income Taxpayers 8
While Pennsylvania’s tax statute relating to its distinctive treatment of bonus depreciation 9
remains unchanged, Corporation Tax Bulletin 2017-02 completely reverses the Department’s prior administrative position regarding 50 percent and 100 percent bonus depreciation. As a result, taxpayers will not be allowed any cost recovery on these assets until they are sold or otherwise disposed of. The Bulletin does not affirmatively address whether the Department’s change in interpretation will impact the ability to recover any remaining 50 percent bonus depreciation in the final year of federal deprecation, or if recovery is delayed until the asset is sold or otherwise disposed of.
The Department’s policy as stated in the Bulletin makes Pennsylvania the only state to currently disallow all depreciation on 100 percent bonus depreciation assets under the federal tax reform legislation without a mechanism to recapture the disallowed amounts on property that may be held indefinitely. All Pennsylvania corporate net income taxpayers claiming 100 percent bonus depreciation for federal income tax purposes will be impacted by the Bulletin, regardless of the location of such assets.
Since a deduction for cost recovery will ultimately be allowed when the asset is sold or otherwise disposed of by the taxpayer, this is a significant timing issue for both taxpayers and the Commonwealth. If allowed to remain unadjusted, cost recovery on these assets will be deferred indefinitely, based on their future disposition dates. Based on this treatment, impacted taxpayers generally will be subject to additional Pennsylvania corporate net income tax liability until the assets are sold. While the Commonwealth may initially receive additional corporate net income tax revenues, such amounts may fall over time in an unpredictable manner, making it exceedingly difficult for the Commonwealth to know the amount of revenue it will have in a particular budget year.
As a result of Corporation Tax Bulletin 2017-02, Pennsylvania currently is the only state to fully disallow depreciation on certain assets. Even though the policy in this Bulletin contrasts with the Department’s 2011 treatment of a similar change, and a legislative change by Pennsylvania to correct the situation is possible in the future, the policy stated in the Bulletin should be considered immediately.
A remedy may be provided for the Bulletin if the Department decides to revisit the issue. The Department could reconsider the basis for changing its administrative policy and adopt a position consistent with its prior treatment of 100 percent and 50 percent bonus depreciation. Alternatively, or in conjunction with a change in the Department’s policy, the General Assembly could amend the corporate net income tax statute to allow depreciation on the 100 percent bonus assets under the Tax Act. 10
The General Assembly is free to allow 100 percent bonus depreciation, depreciation consistent with IRC Section 167, or any other reasonable method providing a full measure of cost recovery over the asset’s depreciable life. Any such remedy would address the timing and budget considerations, as well as moving Pennsylvania back in line with most other states that allow depreciation of these assets.
Note that the treatment of bonus depreciation is projected to have an effect on Pennsylvania’s tax revenue. The Pennsylvania Independent Fiscal Office (“IFO”) estimates conformity to 100 percent bonus depreciation would reduce the Commonwealth’s tax collections by a total of $500 million to $600 million for the fiscal years ending June 30, 2018 (“FY18”) and June 30, 2019 (“FY19”). 11
The IFO report estimates Corporation Tax Bulletin 2017-02 would increase tax collections by $50 million and $160 million for FY18 and FY19, respectively. 12
Since depreciation is a timing issue, these impacts should in theory eventually reverse.
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