On Dec. 22, 2017, the Pennsylvania Department of Revenue (DOR) issued Corporation Tax Bulletin 2017-02 concerning the disallowance and recovery of 100 percent depreciation under Internal Revenue Code (IRC) Section 168(k). The Bulletin disallows all depreciation on assets subject to 100 percent federal bonus depreciation placed in service between Sept. 28, 2017, and Dec. 31, 2022. Further, cost recovery equal to the full acquisition cost of the asset will be allowed only at the time the asset is sold or otherwise disposed of.
Discussion and Explanation
Overview of Federal Bonus Depreciation
Bonus depreciation is a method of accelerated depreciation, first dating back to Sept. 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. 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 Tax Cuts and Jobs Act of 2017 (Tax Act) has again expanded bonus depreciation to 100 percent for assets placed in service between Sept. 28, 2017, and Dec. 31, 2022. After Dec. 31, 2022, the bonus depreciation percentage is reduced 20 percent annually.
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 Section 168(k) to be added back when computing taxable income for corporate net income tax purposes. 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. The 3/7 formula was based on 30 percent bonus depreciation, and allowed for full cost recovery over the useful life of the asset for federal income tax purposes. In other words, Pennsylvania didn’t 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 DOR allowed this remaining depreciation to be claimed in the year in which the asset became fully depreciated for federal income tax purposes.1 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 DOR issued Corporation Tax Bulletin 2011-01. This provided the DOR’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 DOR allowed the recovery of 100 percent bonus depreciation in the last year of federal depreciation (e.g., also the year placed in service). In effect, Pennsylvania followed federal law and allowed corporate taxpayers to take 100 percent bonus depreciation on such assets.
Corporation Tax Bulletin 2017-02 and Its Implications for Corporate Net Income Taxpayers
Pennsylvania’s tax statute regarding bonus depreciation remains unchanged, while the Bulletin completely reverses the DOR’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 doesn’t affirmatively address whether DOR’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.
To date, Pennsylvania is the only state to disallow all depreciation on 100 percent bonus assets under the Tax Act. All Pennsylvania corporate net income taxpayers claiming 100 percent bonus depreciation under the Tax Act will be impacted the Bulletin, regardless of the location of such assets.
Since a deduction for cost recovery will ultimately be allowed, 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. The result for taxpayers will be increased Pennsylvania corporate net income tax liabilities until the assets are sold. Similarly, the Commonwealth’s corporate net income tax revenues will initially increase, followed by later reductions. The unknown timing of the sale of these assets will be exceedingly difficult to account for in the Commonwealth’s budget. In short, Pennsylvania is capitalizing on this position and shifting repayment to later budget years and administrations.