States generally approach corporate taxation by determining whether or not they will conform to the Internal Revenue Code (IRC). This flexibility, while helpful to states from a budgetary standpoint, can lead to significant complexity for multistate corporate taxpayers. In the case of depreciation, it is often not as simple as determining whether the state follows IRC Section 168(k) bonus depreciation. Pennsylvania is one of the clear examples of a state taking advantage of this flexibility and the resulting headache for corporate taxpayers.
At the inception of bonus depreciation, Pennsylvania required corporate taxpayers to add back all bonus depreciation claimed under Section 168(k) when computing Pennsylvania taxable income. However, taxpayers were allowed an additional Pennsylvania deduction equal to 3/7 of the annual Section 168 (i.e., MACRS) depreciation amount until the bonus depreciation added back was fully deducted.
When the bonus depreciation rate was 30%, the 3/7 formula worked such that the bonus depreciation disallowed was effectively deducted over the life of the asset for Pennsylvania purposes. However, when the bonus depreciation rate increased to 50% in 2003, Pennsylvania did not change its 3/7 formula.
This resulted in assets that were partially depreciated for state tax purposes but fully depreciated for federal tax purposes. Pennsylvania recognized this as a problem and issued guidance that allowed taxpayers to deduct the remaining unrecovered bonus depreciation in the year that the asset is fully depreciated for federal purposes or disposed, whichever is earlier.
When the bonus depreciation rate reverted to 50% in 2012, Pennsylvania returned to its 3/7 formula. Most recently, the 2017 Tax Cuts & Jobs Act (TCJA) enacted on Dec. 22, 2017, increased the bonus depreciation rate back to 100%. The Pennsylvania Department of Revenue responded immediately by releasing Corporation Tax Bulletin 2017-02 on the same day, disallowing any depreciation deduction for property subject to 100% bonus depreciation and placed in service between Sept. 28, 2017, and Dec. 31, 2022. Under the guidance in Corporate Tax Bulletin 2017-02, taxpayers were only able to claim a deduction when the qualified property was sold or otherwise disposed.
Recognizing this as overly restrictive guidance, Pennsylvania later passed legislation on June 28, 2018, to reverse the Department of Revenue’s guidance. Pennsylvania Senate Bill 1056 requires corporations to compute depreciation for property placed in service after Sept. 27, 2017, under the regular MACRS rules without regard to bonus depreciation. The current Pennsylvania law ultimately eliminates the complexity of the 3/7 formula and results in greater annual depreciation deductions than under prior law. This should be a welcome change for corporate taxpayers doing business in Pennsylvania.