Understanding how bonus depreciation applies in different U.S. states can significantly impact business tax planning and financial forecasting. While the federal government allows for accelerated depreciation under Section 168(k) of the Internal Revenue Code, not all states conform to this provision. These states, known as nonconforming states, reject or modify federal bonus depreciation rules, leading to a mismatch between federal and state taxable income. This divergence has major implications for businesses operating across multiple jurisdictions and adds a layer of complexity to corporate tax compliance.
What Is Bonus Depreciation?
Bonus depreciation is a tax incentive that allows businesses to deduct a large percentage of the purchase price of eligible assets upfront in the year the asset is placed in service, rather than spreading the deduction over the asset’s useful life. This accelerated depreciation can reduce taxable income and generate significant tax savings in the early years of an asset’s use.
Federal Rules for Bonus Depreciation
Under the Tax Cuts and Jobs Act (TCJA) of 2017, businesses were allowed to immediately expense 100% of qualified property placed in service after September 27, 2017, and before January 1, 2023. However, beginning in 2023, this percentage began phasing down as follows:
- 80% for property placed in service in 2023
- 60% in 2024
- 40% in 2025
- 20% in 2026
- 0% in 2027 unless new legislation is passed
Although federal rules are clear, states are not required to conform to them. This leads to the existence of bonus depreciation nonconforming states.
What Are Bonus Depreciation Nonconforming States?
Nonconforming states are those that do not fully follow the federal tax code when it comes to bonus depreciation. These states either disallow bonus depreciation altogether or require adjustments to taxable income to reverse the federal deduction. As a result, businesses operating in these states may face higher state taxable income and increased tax liability in the year the asset is placed in service.
Examples of Nonconforming States
The list of nonconforming states may change over time, but as of recent tax years, the following states are typically considered nonconforming:
- California
- Connecticut
- Illinois
- Massachusetts
- New Jersey
- New York
- North Carolina
- Pennsylvania
- Wisconsin
Each state applies its own approach to depreciation, and the disallowance may apply to all assets or only to certain types.
State Adjustments and Add-Back Requirements
In nonconforming states, taxpayers often need to add back the amount of federal bonus depreciation to state taxable income. This means they must recalculate depreciation using state-allowed methods such as straight-line or Modified Accelerated Cost Recovery System (MACRS) without the bonus.
Typical Adjustments Include:
- Add-back of Federal Bonus Depreciation: The entire bonus deduction is added back to income.
- State-Specific Depreciation Schedules: Depreciation is then recalculated using slower methods.
- Tracking Basis Differences: Businesses must track separate book values for federal and state tax purposes.
These adjustments can affect both current-year and future-year state tax liabilities, and they require careful recordkeeping to avoid errors.
Implications for Businesses
Operating in bonus depreciation nonconforming states introduces complications for both large corporations and small businesses. The primary effect is increased tax compliance burden and cash flow differences between state and federal returns. Businesses must maintain two sets of depreciation schedules, one for federal and one for each nonconforming state.
Key Challenges
- Increased administrative costs due to dual reporting requirements
- Higher state tax payments in early years due to lack of accelerated deductions
- Potential risk of noncompliance due to misaligned depreciation tracking
Businesses need accurate systems to track depreciation for each state, and tax professionals must be aware of ongoing legislative changes that can impact compliance and planning.
Tax Planning Strategies
While nonconformity to bonus depreciation can be a disadvantage, there are strategies that can help minimize its impact. Businesses should adopt a proactive approach to depreciation planning by analyzing each state’s rules and integrating those considerations into asset acquisition and investment decisions.
Helpful Strategies Include:
- Segmenting Asset Purchases: Grouping assets based on state conformity to manage timing and location of acquisitions.
- Using State-Allowed Methods: Apply MACRS or straight-line schedules as required by the state to project tax liability accurately.
- Monitoring Legislative Changes: Keep current with each state’s treatment of bonus depreciation to adjust planning.
- Leveraging Software Tools: Use tax compliance software that can handle state-level depreciation rules.
Effective tax planning can help mitigate the effects of nonconformity and ensure businesses are prepared for both current and future obligations.
How Bonus Depreciation Nonconformity Affects Financial Reporting
Aside from tax compliance, bonus depreciation nonconformity can influence financial reporting. Differences in depreciation schedules create temporary differences between book and tax income, impacting deferred tax assets and liabilities under generally accepted accounting principles (GAAP).
These differences must be reconciled properly in financial statements and may require disclosures in footnotes or management discussion and analysis (MD&A) sections. Companies with significant operations in nonconforming states need to coordinate between their finance and tax departments to ensure accuracy.
Looking Ahead: Legislative Outlook
Bonus depreciation remains a dynamic area of tax policy, both federally and at the state level. As the federal bonus depreciation rate continues to phase down, pressure may mount on nonconforming states to review their policies. Some may consider aligning with federal provisions to attract investment and reduce compliance costs for businesses.
However, state budgets and political considerations will continue to influence these decisions. Businesses must stay vigilant and adapt to evolving tax landscapes.
Bonus depreciation nonconforming states create a complex environment for businesses navigating multi-state tax compliance. Understanding which states do not follow federal rules, and how to adjust accordingly, is critical to managing tax liabilities and ensuring accurate reporting. By recognizing the implications, implementing effective planning strategies, and staying updated on regulatory changes, businesses can maintain compliance and optimize their tax positions despite the challenges posed by state-level nonconformity.