Background – Pennsylvania disallows depreciation. In December 2017, the Pennsylvania Department of Revenue announced that it will abandon its six-year-old policy allowing taxpayers to claim 100% bonus depreciation deduction for Pennsylvania purposes if that deduction is allowed at the federal level. Instead, the Department now asserts that taxpayers who take advantage of the 100% bonus deduction for federal purposes must, when computing the Pennsylvania corporate net income tax, add the 100% bonus deduction to income. Further, the Department will not allow any depreciation deduction with respect to property for which the 100% bonus deduction was claimed until such property is disposed of, effectively denying taxpayers any depreciation deduction until disposing of the property.
As we discussed in our January 3, 2018 alert, the Department’s new bonus depreciation position is, in our view, inconsistent with the legislative intent to decouple from federal bonus depreciation. When the Pennsylvania Legislature originally decoupled from federal bonus depreciation in 2002, it intended to allow taxpayers to take depreciation deductions, computed as if federal bonus depreciation was never enacted. We continue to believe that Pennsylvania law authorizes a taxpayer to claim depreciation deductions during the time property is in service and to compute that depreciation as if bonus depreciation was never enacted at the federal level.
Now, the City of Philadelphia follows along. The City of Philadelphia announced on May 2 that it would “adhere to the policy” announced by the Department in December 2017. Accordingly, the city revenue agency announced that “the amount of a 100% deduction under IRC 168(k)” must be “added back to taxable income” and that there is “no additional mechanism for cost recover with respect to the qualified property.” The City’s policy is wrong for the same reason the Department’s policy is wrong: it ignores the intent of the Pennsylvania Legislature to decouple from federal bonus depreciation while allowing for depreciation deductions computed as though federal bonus depreciation was never enacted. When the Pennsylvania Legislature decoupled from bonus depreciation for state purposes, it also decoupled the city from bonus depreciation. And it did so using language identical to the decoupling provision for state purposes. In our view, this identical language commands the identical result: a taxpayer may compute its state and city depreciation deduction as if Congress never enacted bonus depreciation.
Conclusion. In our view, taxpayers should compute their Pennsylvania and Philadelphia income tax liability as if federal bonus depreciation never existed. That is, notwithstanding the “guidance” issued by the taxing authorities, taxpayers should take their standard depreciation deductions during the time the property is in service. Philadelphia, with its whopping 6.3% rate, and Pennsylvania, with its 9.99% rate, together impose tax at 16.29%. Taxpayers should take a stand on this issue to avoid an even higher effective rate. Further, as we discussed in our webinar, Philadelphia taxpayers based outside the city should consider using traditional three-factor apportionment, notwithstanding the agency’s decision, by administrative fiat, to switch to a single sales factor..