Q&A with the Pennsylvania Department of Revenue

Scenario: Company A is a federal S corporation whose shareholders elected out of PA S treatment 7 years ago

Sep 30, 2013
Company A is a federal S corporation whose shareholders elected out of PA S treatment 7 years ago. The shareholders of this Pennsylvania “C Corporation” now (as of 8/15/13) want S treatment in PA.Since more than 5 years have transpired, it can now elect PA S treatment (i.e., revoke the election out) effective 1/1/14.

As a PA C Corporation, this company has been adding back federal bonus depreciation (30% and 50%) and has been recovering such depreciation via the 3/7 mechanism as a subtraction modification. When this company becomes a PA S Corporation, may it continue to recover such added back depreciation on the old assets under the 3/7 mechanism, subtraction modification, while subtracting current year depreciation for new asset acquisitions calculated according to GAAP? Alternatively, does the company need to recalculate the GAAP basis of the old assets and depreciate those old assets under GAAP with the new asset acquisitions under GAAP (i.e., utilize one, GAAP depreciation figure)?

A:

The company is not permitted to continue the add back of the 3/7 mechanism for bonus depreciation.  To calculate the depreciation for PA S corporation purposes when there is a conversion from C Corporation to S Corporation status and bonus depreciation was claimed on assets that still have basis or have not been fully depreciated:

If the using either the 50% or 30% bonus depreciation method, use the remaining federal net book value of the asset, (original cost less bonus depreciation less accumulated depreciation), add the remaining balance of the bonus depreciation adjustment for PA not added back to depreciation expense as of the conversion date/tax year and use the straight-line depreciation method over the remaining life of the asset based upon its original life to determine the depreciation.  For example, if 50% bonus depreciation was taken for federal purposes on a 7 year life asset (with half-year convention) that originally cost $100,000 and after 3 years of taking depreciation on it as a C corporation, the asset has a remaining PA depreciable basis of $59,807 (100,000-50,000-28,135+37,942) on which 4.5 years or 54 months (due to ½ year convention) of straight line depreciation can be claimed in Year 1 (after the conversion) in the amount of $13,290.  See the example below for calculations.  

C Corporation

 

Depreciation

 

Bonus

Depreciable

 

Property

Life

method

cost

depreciation

basis

 

Equipment

7 yrs

MACRS 1/2 yr.

100,000

50,000

50,000

 

 

 

 

MACRS

Accumulated

PA bonus

adjustment

 

 

 

depreciation

depreciation

adjustment

balance

Year 1 depreciation and bonus depreciation adjustment

7,145

7,145

3,062

46,938

Year 2 depreciation and bonus depreciation adjustment

12,245

19,390

5,248

41,690

Year 3 depreciation and bonus depreciation adjustment

8,745

28,135

3,748

37,942

 

 

 

 

 

 

 

S Corporation

Remaining

Depreciation

Remaining

 

 

 

property

life

method

basis

 

 

 

Equipment

54 mths

S/L

59807

(1)

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

Depreciaiton

depreciaiton

 

 

 

Year 1 depreciation 

 

13290

13290

 

 

 

Year 2 depreciation 

 

13291

26581

 

 

 

Year 3 depreciation 

 

13290

39871

 

 

 

Year 4 depreciation 

 

13291

53162

 

 

 

Final year depreciation 

 

6645

59807

 

 

 

(1) original cost less bonus depreciation less Year 3 accumulated depreciation plus Year 3 PA bonus adjustment balance                                         
          100,000 - 50,000 - 28,135 + 37,492 = 59,807                                         

If an asset is sold, abandoned or otherwise disposed of, the taxpayer uses the new adjusted basis less accumulated depreciation to determine the asset's basis when calculating any gain or loss on its sale, exchange or disposition.

There are no adjustments/recalculations of depreciation required on assets where 100% bonus depreciation was claimed.

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These documents provide a summary of the answers provided by the Department of Revenue to the PICPA Committee on State Taxation at its annual question and answer session. These documents are classified as revenue information issued for informational purposes only for the convenience of PICPA members. Pursuant to 61 Pa. Code Section 3.4, these documents should not be relied upon for any purpose or used in tax appeals. Taxpayers requiring a binding opinion on their specific fact situation may request a written letter ruling under 61 Pa. Code Section 3.3.