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Are You Taking Full Advantage of Bonus Depreciation?

Are You Taking Full Advantage of Bonus Depreciation?

An overview of the new bonus depreciation rules from both a federal and state perspective.

Old Law
Simply put, bonus depreciation (also referred to as Internal Revenue Code Section 168(k)) allows taxpayers to deduct a specified percentage of depreciation in the year the qualifying property is acquired and placed in service.  It was set up as a tax incentive for businesses to invest in capital improvements.  Prior to recent tax reform, taxpayers could only expense 50% of the asset initially, leaving the other 50% to be depreciated over time.  Under the old law, the amount of bonus depreciation was scheduled to gradually decrease on a yearly basis and would have been entirely phased out by 2021.  However, with the passage of the Tax Cuts and Jobs Act (TCJA)in December of 2017, bonus depreciation has been increased and the phase out date has been delayed, making it possible for larger initial deductions on fixed assets.

Bonus Depreciation Provisions in the Tax Cuts and Jobs Act:
One of the most significant changes made by the TCJA was to allow for 100% bonus depreciation.  In addition to increasing the bonus depreciation percentage, the TCJA also made it available over a longer period of time.  These new rules are as follows:

  • 100% for any qualifying asset acquired and placed in service after September 27, 2017 and before December 31, 2022
  • 80% for any qualifying asset placed in service in 2023
  • 60% for any qualifying asset placed in service in 2024
  • 40% for any qualifying asset placed in service in 2025
  • 20% for any qualifying asset placed in service in 2026
  • 0% for any qualifying asset placed in service after 2026

It is important to note that the 100% bonus depreciation rule is retroactive, meaning that qualified assets acquired and placed in service after September 27, 2017 are eligible for the 100% deduction.  However, assets acquired before September 28, 2017 but placed in service after September 27, 2017 remain eligible for bonus depreciation under the bonus depreciation rules.  It is also important to note that, similar to the old rules, the TCJA still allows taxpayers to elect out of bonus depreciation.

Qualified Property for Bonus Depreciation:
The TCJA made significant changes to the definition of qualified property in regard to bonus depreciation.  It is currently defined as tangible personal property with a recovery period of twenty years or less.  Additionally, property no longer has to be new in order to qualify for bonus depreciation.  Under the TCJA, as long as the acquired property was not previously used by the taxpayer and the property was not acquired from a related party, it is eligible for bonus depreciation.  This is a noteworthy change from prior bonus depreciation rules and makes bonus depreciation more accessible to taxpayers.

It is also important to understand what is not considered qualified property for bonus depreciation purposes.  Property used in the trade or business of the furnishing or sales of electrical energy, water or sewage disposal services, gas or steam through a local distribution system or transportation of gas or steam by pipeline does not qualify.  In addition, any property used in a trade or business that has floor-plan financing, such as a car dealership, is excluded from bonus depreciation.  These are the two most significant exclusions from bonus depreciation property, but overall, the TCJA has changed bonus depreciation for the better.

Pennsylvania and Surrounding States Treatment of Bonus Depreciation:
State income tax laws often differ from federal tax laws and bonus depreciation is no exception. Here is a closer look at state income tax treatment of bonus depreciation in Pennsylvania and nearby states. As soon as the TCJA was passed, Pennsylvania issued Corporation Tax Bulletin 2017-02, disallowing federal 100% bonus depreciation and requiring it to be added back to taxable income.  In addition, this bulletin provided no additional mechanism for recovering the cost of the disallowed depreciation deduction.  After an outcry from Pennsylvania corporate businesses, the state legislature passed PA Senate Bill 1056, allowing for the recovery of the disallowed depreciation deduction over the life of the property.  This bill applies to tax years beginning on or after January 1, 2017 and applies to property acquired and placed in service after September 27, 2017.  While Pennsylvania still disallows 100% bonus depreciation, the passage of PA Senate Bill 1056 provides some benefit to C-Corporations in the state.

It is also important to note that in Pennsylvania, the rules for bonus depreciation are different for C-Corporations and pass through entities.  PA Senate Bill 1056 does not change the state’s treatment of bonus depreciation for pass through entities or personal income tax purposes.  Pennsylvania continues to disallow the 100% bonus depreciation deduction and, in general, allows depreciation deductions using regular depreciation methods for these entities.  Notable states that decouple from federal income taxation law provisions include Maryland, Ohio, and New York.  West Virginia, however, enacted House Bill 4135 in February of 2018, updating its conformity to the Internal Revenue Code. 

Conclusion
Bonus depreciation provides taxpayers with an additional way to lower their tax liability.  The Tax Cuts and Jobs Act allows for 100% expensing of a qualifying asset in the period that it was acquired and placed in service.  These new depreciation provisions are retroactive to property purchased and placed in service after September 27, 2017 and will extend through the year 2026.  The TCJA also changed up the definition of qualified property for bonus depreciation, making used property eligible for the deduction as well as new property.  And finally, state treatment of bonus depreciation varies from state-to-state, so it is important to stay updated on current tax laws.  For more information regarding bonus depreciation, please contact a member of the Herbein tax team, or email us at info@herbein.com.    

Article prepared by Richard M. Staniszewski.