“You need to make sure that you watch out for particular state conformity issues when computing, not just your depreciation, but all of your state taxable income,” Sheehan says.
Static conformity means the state conforms to the Internal Revenue Code as of a certain date, and legislation is required to change that conformity date. So when the 2017 tax act passed, these states were automatically not conforming to any of the new standards, and they had to enact legislation to make any desired changes.
“What we saw is states tended to focus on individual tax pieces first, such as the things that were affecting your 1040,” Sheehan says. “They actually have just recently started to finally give us some answers on what they’re doing to conform to TCJA on the corporate side.”
Texas is a static conformity state that is conforming to the IRC as of Jan. 1, 2007, which means that the bonus rules that were enacted at that time don’t apply. Since they’re using an old law that has expired, and bonus depreciation is considered a tax extender and not a permanent part of the tax code, that’s why Texas is not following bonus as of this year.
For states that conform to the IRC automatically on a rolling basis, legislation is also required if the state chooses to opt out, or “decouple,” from particular provisions. This creates a risk for taxpayers in the state, as they are essentially required to file their taxes without knowing for certain if the state plans to opt out.
In the area of bonus depreciation, a number of states have made changes to conformity over the years, including recent changes post-TCJA. As of 2018, there are 16 states that fully conform to the federal code, 28 states that have opted out, and three states that partially conform to the provision but have some unique differences. And then, as always, there are exceptions. California, for instance, uses different depreciation methods from the federal government.
Minnesota is an example of a partially conforming state that has made recent changes through legislation. A tax bill was signed on May 30, 2019, that generally conforms Minnesota law to TCJA, whereas the state previously conformed to the Internal Revenue Code as amended through December 16, 2016.
Under the new law, Minnesota will continue to require 80% of Section 179 and federal bonus depreciation to be added back and then deducted pro rata over five years to arrive at Minnesota taxable income.
“The Department of Revenue is still working on publishing some revised forms for 2017 and 2018 to address these last-minute tax law changes,” says Ellen Barker, a subject matter expert for Bloomberg Tax & Accounting.
Another example is Connecticut, which has disallowed bonus depreciation for corporate business tax purposes since 2001 but allowed the deduction for personal income tax purposes until recently. Illinois and Pennsylvania are previously partially conforming states that switched following the passage of TCJA. Illinois now allows you to take bonus depreciation, while Pennsylvania has switched from its complicated method to a simple no-bonus treatment.
Keeping a close eye on legislative activity is critical to ensuring you’re using the most up-to-date standards when calculating for state. One way is to set up website alerts so that you’ll receive an email if a state tax webpage is updated. Another way is to subscribe to tax research platforms. Resources such as Bloomberg Tax offer updates as well as analysis from leading practitioners so you can plan and comply with confidence.
Consider the implications of decoupling.
The most obvious impact of decoupling is that you’re going to have different depreciation expense between federal and state. While that sounds simple enough, it can create a number of complications from a process standpoint.
First, it creates a modification that you’re going to have to report on your state tax returns. And then, considering that states all have different forms, you will need to figure out how to report and what numbers you actually need to report to the state.
You’re going to have a different adjusted basis for your asset, which could mean you have a different adjusted gain or loss whenever you dispose of that asset – whether it’s a sale or just a simple disposal.
“One thing that people don’t often think of when it comes to differences in gains or losses is how that impacts the apportionment factor for states,” Sheehan says. “Some states will actually include a gain or loss in the denominator of a sales factor or in the numerator of a sales factor. So that’s something that can be impactful.”
It can also cause confusion when determining which gain or loss to use in a sales factor.
Having a different adjusted basis also impacts like-kind exchange assets. You’ll need to be stepping into a different set of shoes when you have state depreciation that’s different from federal. Some states, such as Illinois and Pennsylvania, have pretty complex schedules that require you to track your addbacks and subtractions over multiple years, which can be challenging, particularly if you have software that does not do that automatically for you.
Partially conforming states add another layer of complexity. With the multiyear tracking of bonus and 179 expense, you can’t just focus on one year when you run your depreciation reports. You have to be able to look back and track that number across years and then track the subtractions as they go forward.
Finally, another area that can be particularly complex is transfers of assets between states that have different rules for bonus depreciation. If you’re in a state that allows bonus depreciation and then you transfer an asset to a state that doesn’t allow bonus depreciation, what should you do? This is something important to consider when it comes to state tax planning.