On June 28, 2018, the Pennsylvania Legislature enacted legislation allowing companies to depreciate bonus depreciation property placed in service after September 27, 2017 pursuant to the normal federal depreciation rules under Internal Revenue Code ("IRC") Section 167 and IRC Section 168, without application of IRC Section 168(k) (i.e., without applying the bonus depreciation provisions). In response, the Pennsylvania Department of Revenue acted swiftly over the July 4th holiday week to issue new guidance on the Commonwealth's treatment of bonus depreciation property. In Corporation Tax Bulletin 2018-03, issued on July 6, 2018 (the "2018 Bulletin"), the Department explains that, pursuant to the new legislation, property placed in service after September 27, 2017 may be depreciated under the Modified Accelerated Depreciation System.
The new legislation and new guidance signal an end (hopefully) to the flurry of activity and confusion in Pennsylvania surrounding bonus depreciation property that began late last year after the Department issued Corporation Tax Bulletin 2017-2 (the "2017 Bulletin"). In the 2017 Bulletin, the Department took the position that companies could not claim any Pennsylvania deductions for bonus depreciation property placed in service after September 27, 2017 on which 100% federal bonus depreciation had been claimed, until the company sold or otherwise disposed of the property. The 2017 Bulletin was issued in reaction to the increase in federal bonus depreciation to 100% for property placed in service after September 27, 2017 under the federal Tax Cuts and Jobs Act. The 2017 Bulletin has now been superseded by the 2018 Bulletin.
Background of Pennsylvania's Treatment of Bonus Depreciation
In 2002, after the federal government enacted 30% bonus depreciation under IRC Section 168(k), Pennsylvania legislatively decoupled from those provisions by requiring companies to add back the federal bonus depreciation deduction to their Pennsylvania taxable income. However, Pennsylvania provided a depreciation deduction to recover the disallowed bonus depreciation. This deduction was computed by multiplying the bonus depreciation property's remaining normal federal depreciation deduction under IRC Section 167 by a 3/7th fraction. Therefore, companies were entitled to deduct: (1) their remaining normal federal depreciation (only bonus depreciation was required to be added back to taxable income); and (2) Pennsylvania's additional 3/7th fraction. If any of the federal bonus depreciation deduction was not recovered through Pennsylvania's additional depreciation deduction, the remaining amount could be deducted in the taxable year that the company sold or otherwise disposed of the property.
Mathematically, when the federal bonus depreciation deduction was at 30% the 3/7th fraction allowed companies to depreciate property as if there was no federal bonus depreciation. However, the 3/7th fraction created issues in Pennsylvania when federal bonus depreciation deductions increased above 30%. For example, with 100% federal bonus depreciation, there was no remaining normal federal depreciation after the property was fully depreciated under IRC Section 168(k) and the 3/7th fraction would be multiplied by zero. Therefore, arguably a company would be provided with no Pennsylvania depreciation on that property, until the company sold or otherwise disposed of the property.
To avoid this result, in 2011, after federal bonus depreciation was temporarily increased to 100%, the Department issued Corporation Tax Bulletin 2011-01 (Feb. 24, 2011) (the "2011 Bulletin"). In the 2011 Bulletin, the Department stated that companies were permitted "full recovery of disallowed 100% bonus depreciation in the year that such depreciation is claimed and allowable for federal tax purposes." Therefore, no adjustment to Pennsylvania taxable income was necessary for 100% bonus depreciation property.
However, in 2017, when the federal Tax Cuts and Jobs Act once again increased federal bonus depreciation to 100%, the Department did a sudden about-face and reversed its position. On December 22, 2017, the Department issued the 2017 Bulletin and took the position that no Pennsylvania depreciation deductions were allowed on bonus depreciation property placed in service after September 27, 2017, until a company sold or otherwise disposed of the property. For property placed in service on and prior to September 27, 2017, the 2017 Bulletin stated that the Department would continue to allow bonus depreciation deductions pursuant to the 2011 Bulletin.
After the 2017 Bulletin was issued, companies and practitioners objected to the Department's harsh new position and legislation was quickly proposed in the Pennsylvania House and Senate to provide for Pennsylvania depreciation on bonus depreciation property.
The Newly Enacted Legislation
For property placed in service on and prior to September 27, 2017, the newly enacted legislation leaves in place the previous 3/7th fraction depreciation computation and codifies the Department's position in the 2011 Bulletin permitting an additional deduction when the property is fully depreciated for federal income tax purposes. Accordingly, the 2018 Bulletin notes that the Department will continue to follow the 2011 Bulletin for property placed in service on and prior to September 27, 2017.
For property placed in service after September 27, 2017, federal bonus depreciation property may be depreciated for Pennsylvania purposes pursuant to normal federal depreciation rules under IRC Section 167 and IRC Section 168, without the application of IRC Section 168(k). As noted in the 2018 Bulletin, this results in depreciation under the Modified Accelerated Depreciation System.
Regardless of when property is placed in service, if property is sold or otherwise disposed of, an additional deduction is permitted in that taxable year to recover any amount that has not yet been recovered.
The new legislation and the 2018 Bulletin resolve the confusion and frustration that had been surrounding Pennsylvania's treatment of bonus depreciation property and should come as a welcome relief to companies.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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