On December 22, 2017 in Corporation Tax Bulletin 2017-02 (the 2017 Bulletin), the Pennsylvania Department of Revenue (DOR) concluded that for Pennsylvania corporate income tax purposes, the commonwealth will decouple from the new federal 100% bonus depreciation deducted under IRC Section 168(k) for assets placed in service after September 27, 2017. Moreover, the 2017 Bulletin states that Pennsylvania will provide no recovery with respect to 100% bonus depreciation added back to taxable income until the asset to which it relates is sold or otherwise disposed.

This guidance directly contradicts the DOR's earlier guidance in Corporation Tax Bulletin 2011-01, issued on February 24, 2011 (the 2011 Bulletin), which interpreted the same Pennsylvania statute to mean that Pennsylvania would conform to 100% bonus depreciation for qualified property acquired after September 8, 2010 and before January 1, 2012.

Background

For corporate net income tax purposes, Pennsylvania by statute expressly disallows a deduction for bonus depreciation under IRC Section 168(k) by stating that " … taxable income shall include the amount of the deduction for depreciation of qualified property claimed and allowable under [IRC Section] 168(k)."¹ In the event that a bonus depreciation deduction was included in taxable income, the statute further provides:

 … if a deduction for depreciation of qualified property was included in taxable income in accordance with paragraph (q), an additional deduction for depreciation of the qualified property shall be allowed from taxable income until the total amount included as taxable income under paragraph (q) has been claimed. The additional deduction shall be equal to the product of taking three sevenths of the amount of the deduction for depreciation of the qualified property allowable under [IRC Section 167], not including the amount of the deduction for depreciation of the qualified property claimed and allowable under [IRC Section 168(k)] for the tax year.²

The Pennsylvania statute also provides an additional deduction for unrecovered basis at the time qualified property is sold or otherwise disposed of and such basis has not been recovered by the "3/7ths" recovery mechanism described above.³

The 2011 Bulletin interpreted the statute to "permit full recovery of disallowed 100% bonus depreciation in the year that such depreciation is claimed and allowable for federal tax purposes." The net result under the 2011 Bulletin was that no adjustment was necessary to Pennsylvania taxable income for 100% bonus deprecation of qualified property claimed and allowable for federal tax purposes under IRC Section 168(k).

The 2011 Bulletin goes on to say that if a taxpayer has a method change under IRC Section 481(a) and subsequently writes off the remaining basis of the qualified property, the DOR will permit full recovery consistent with the interpretation that property fully depreciated for federal tax purposes can be fully depreciated for Pennsylvania corporate income tax purposes. Moreover, this view has consistently been upheld by the Pennsylvania Treasury Department's Board of Finance and Revenue (administrative appellate review) in numerous published decisions.

The DOR's position in the 2017 Bulletin represents a complete departure from its previous position. Moreover, the 2017 Bulletin provides that 100% bonus depreciation cannot be recovered until the respective asset is sold or otherwise disposed of because:

 … there is no deduction for depreciation of qualified property included in taxable income in accordance with paragraph (q). In the case of 100% depreciation claimed for qualified property under IRC [Section] 168(k), this additional deduction is not applicable because there is no deduction for depreciation of qualified property included in taxable income in accordance with paragraph (q). Furthermore, if the additional deduction were allowed, the amount would be zero because there is no remaining depreciation amount after the 100% depreciation deduction. As a result, Pennsylvania law requires the amount of a 100% deduction under IRC [Section] 168(k) to be added back to taxable income, and provides no additional mechanism for cost recovery with respect to the qualified property. Under [Pennsylvania tax law] Section 401(3)1.(s), the taxpayer may take an additional deduction when the qualified property is sold or otherwise disposed of during a taxable year to the extent the amount of depreciation claimed has not been fully recovered.

Implications

Based on the September 27, 2017 effective date, the DOR is releasing this guidance in reaction to the recently signed federal Tax Cuts and Jobs Act (i.e., tax reform) of 2017, which explicitly provides for 100% bonus depreciation under IRC Section 168(k) for property placed in service as early as September 27, 2017. This dramatic change from existing policy under the 2017 Bulletin will likely generate numerous discussions with respect to the financial statement consequences of this interpretation, and may cause one or more groups of taxpayers to approach the DOR and/or General Assembly to provide a more reasonable solution consistent with the earlier bulletin or perhaps with the new federal law.

The 2017 Bulletin raises questions regarding statutory interpretation. For example, how can the DOR reconcile its 2017 Bulletin position (add back the entire amount of 100% bonus depreciation), with the 2011 Bulletin position (full deduction of the entire amount of 100% bonus depreciation), when the new interpretation is diametrically opposed to the prior interpretation and there has not been a change in Pennsylvania law? Further, the DOR leaves unanswered the policy question as to why it can allow a taxpayer to recover disallowed depreciation over the life of an asset subject to 50% and 30% bonus depreciation, but no recovery at all for qualified property subject to 100% bonus depreciation.

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ENDNOTES

¹ 72 P.S. Section 7401(3)1.(q).

² 72 P.S. Section 7401(3)1.(r).

³ 72 P.S. Section 7401(3)1.(s).