Understanding Bonus Depreciation
Understanding the complex world of tax laws can be a challenging task, especially when those laws vary from one jurisdiction to another. One such example is the issue of state conformity with federal bonus depreciation rules. But what exactly is bonus depreciation? And how do states conform, if at all, with the federal regulations? Let's break it down.
Definition of Bonus Depreciation
Bonus depreciation is a tax incentive that allows businesses to deduct a large portion of a qualifying asset's cost in the year the asset is placed in service. This results in a lower tax liability, thus incentivizing businesses to invest in new assets.
The Purpose of Bonus Depreciation
The core aim of bonus depreciation is to stimulate economic growth. By providing this tax incentive, businesses are more likely to invest in new assets, contributing to overall economic activity.
How Bonus Depreciation Works
With bonus depreciation, businesses can deduct a certain percentage of the cost of eligible assets in the first year of use. The remaining cost can be depreciated over the asset's useful life.
Impact of the Tax Cuts and Jobs Act on Bonus Depreciation
The Tax Cuts and Jobs Act (TCJA) of 2017 made several significant changes to bonus depreciation rules, making the provision even more generous and far-reaching.
These changes significantly broadened the applicability and benefit of the bonus depreciation, providing substantial tax savings opportunities for businesses. However, it also introduced new complexities, especially when considering state-level conformity with these federal rules.
State Conformity With Federal Bonus Depreciation Rules
Concept of State Conformity
While federal law might allow for bonus depreciation, whether a business can claim bonus depreciation on their state tax returns is a different story. This is where state conformity with federal tax laws comes into play.
State conformity refers to the degree to which states align their tax codes with federal tax law. In the context of bonus depreciation, a state's conformity status determines whether or not a business can claim bonus depreciation on their state tax returns. This can vary widely, with some states fully conforming to federal laws, while others choose to partially conform or not conform at all.
Most states begin their tax calculations with federal taxable income, then add or subtract specific elements to arrive at the state's taxable income. If a state doesn't follow the federal bonus depreciation rules, further calculations are needed. It's vital to monitor these modifications as they shift annually, eventually contributing to an overall adjustment to state taxable income.
Benefits of State Conformity
Conformity simplifies tax preparation for businesses and individuals. If state tax laws closely mirror federal ones, taxpayers do not have to maintain different sets of records or calculate their taxes in different ways.
Overview of State Conformity with Federal Bonus Depreciation Rules
States that Conform
These are states that follow the federal rules for bonus depreciation. The federal government might introduce a tax provision that allows businesses to deduct a certain percentage of the cost of qualifying assets in the year they are placed in service (bonus depreciation). States that conform to this provision will also allow businesses to take advantage of the same bonus depreciation rules when calculating their state income taxes. This means that if the federal government offers a 100% bonus depreciation, businesses in "states that conform" can also deduct the full cost of qualifying assets for state tax purposes.
States that Partially Conform
These states may limit the percentage of bonus depreciation or impose other restrictions. In these states, although they may recognize bonus depreciation in some form, there could be limitations or differences compared to the federal rules. For example, a state might limit the percentage of bonus depreciation that businesses can claim. Instead of allowing a 100% deduction like the federal government, the state might set a lower percentage, such as 80% or 50%. Additionally, these states might impose other restrictions, such as excluding certain types of assets or industries from qualifying for bonus depreciation.
States that Do Not Conform
These states do not conform to the federal rules regarding bonus depreciation at all. This means that businesses in these states cannot claim any bonus depreciation deductions when calculating their state income taxes, regardless of what the federal government allows. In such states, businesses will have to calculate their state income tax liability without factoring in any bonus depreciation benefits.
Different Options for State Conformity
When it comes to tax law, not all states are created equal. There are distinct approaches that states adopt when deciding how to align their tax codes with federal law, particularly concerning bonus depreciation. These approaches can be broadly categorized into three types: rolling conformity, static conformity, and selective conformity.
Rolling Conformity
States with rolling conformity automatically update their tax laws to match current federal laws. when federal tax laws change, states with rolling conformity automatically update their tax codes to reflect these changes without the need for legislative action. The advantage of this approach is that it ensures consistency between federal and state tax codes, which can simplify tax compliance and planning for businesses.
However, rolling conformity also means that states have less control over their tax policy and must accept changes made at the federal level, whether or not they align with the state's fiscal or policy goals. For businesses, while rolling conformity may simplify tax planning, it also can lead to uncertainty as federal tax law changes are automatically adopted.
Static Conformity
Static conformity, also known as fixed-date conformity, means that a state's tax code aligns with the federal tax code as of a certain date. Any federal changes made after that date are not automatically adopted. States with static conformity must enact legislation to adopt any subsequent changes to the federal tax code.
This approach provides states with more control over their tax policy, allowing them to assess federal changes and decide whether to adopt them. However, static conformity can also create complexity for taxpayers, as they may have to comply with two different sets of tax rules - federal rules and state rules that vary from federal law based on the conformity date.
Selective Conformity
Selective conformity is somewhat of a hybrid approach. States with selective conformity pick and choose which parts of the federal tax code to adopt and which to ignore. This method allows states maximum control over their tax policy, as they can align with federal law on some issues while maintaining independent policies on others.
However, selective conformity can lead to a complex tax landscape, with state tax codes potentially differing significantly from the federal code. For businesses, this can increase the burden of tax compliance and planning, as they may need to navigate a patchwork of different tax rules across multiple states.
List of States and their Conformity Status
We referenced Bloomberg Tax in compliling the following list of states with their conformity status. Please note that tax laws are continually changing, and the information below is up-to-date as of the writing of this article. It's recommended to always consult with a tax professional or your state's tax authority for the most accurate and current information.
Impact of State Conformity on Businesses
In the context of bonus depreciation, these different approaches to conformity can significantly impact how much a business can deduct in a given state. As a result, understanding state conformity is crucial for businesses to accurately calculate their tax liabilities and make informed investment decisions.
It's essential for businesses operating in multiple states to be aware of these variations in bonus depreciation rules, as they can significantly impact tax planning and the overall tax liability of the business. Tax laws can be complex and subject to change, so it's advisable for businesses to consult with tax professionals or accountants familiar with the tax regulations in each specific state to ensure compliance and optimize their tax strategies.
Frequently Asked Questions
- What is bonus depreciation? Bonus depreciation is a tax incentive that allows businesses to deduct a large portion of a qualifying asset's cost in the year the asset is placed in service.
- What is state conformity? State conformity refers to whether a state's tax laws align with federal tax laws. This can vary widely, with some states fully conforming to federal laws, while others choose to partially conform or not conform at all.
- What are the benefits of state conformity? Conformity simplifies tax preparation for businesses and individuals. If state tax laws closely mirror federal ones, taxpayers do not have to maintain different sets of records or calculate their taxes in different ways.
- What are the different options for state conformity? States can choose between rolling conformity, static conformity, and selective conformity.
- How does state conformity impact businesses? The varying degrees of state conformity can significantly impact a business’s overall tax situation. Companies must consider this when making decisions about purchasing assets and investing in different states.
Article by Melanie Baldridge, CEO RE Cost Seg, published August 2023.
