Under the Tax Cuts and Jobs Act of 2017 (“Federal Tax Reform”), Internal Revenue Code (“IRC”) section 168(k) provides 100% immediate expensing for qualified property placed into service after September 27, 2017 and before January 1, 2023. Pennsylvania, like many states, currently decouples from IRC section 168(k). In most states, decoupling from the immediate expensing provisions in IRC section 168(k) will merely result in a timing difference as most states allow some alternate form of state-level depreciation. However, the Pennsylvania Department of Revenue (“Department”), in a departure from its prior interpretation of Pennsylvania law, recently announced its view that taxpayers are not entitled to a state-level depreciation deduction for property that is fully expensed under IRC section 168(k). A bill has recently been proposed to legislatively reverse the Department’s interpretation and allow a state-level depreciation deduction for property that is fully expensed under IRC section 168(k).
Pennsylvania’s New Position
The Department recently announced its position with respect to immediate expensing under IRC section 168(k) in Pennsylvania Corporation Tax Bulletin 2017-02 (Dec. 22, 2017) (“2017 Bulletin”). In the 2017 Bulletin, the Department explains that Pennsylvania does not conform to IRC section 168(k) and requires that any deduction for depreciation under IRC section 168(k) be added back to Pennsylvania taxable income for corporate income tax purposes. See 72 P.S. 7401(3)(1)(q). The Department goes on to explain that, in the case of a 100% federal depreciation deduction (which is the case under IRC section 168(k)), Pennsylvania law does not provide any additional deduction or cost recovery mechanism with respect to the qualified property. See 72 P.S. § 7401(3)(1)(r). As a result, according to the Department, taxpayers are required to defer recovery of such cost until the qualified property is sold or otherwise disposed of.
What Happened to Pennsylvania’s Prior, Taxpayer-Friendly Position?
The Department’s position in the 2017 Bulletin is a departure from its prior position, articulated in Pennsylvania Corporation Tax Bulletin 2011-01 (Feb. 24, 2011) (“2011 Bulletin”). In the 2011 Bulletin, the Department interpreted the same two statutory provisions addressed in the 2017 Bulletin; however, unlike the 2017 Bulletin, the Department concluded that Pennsylvania effectively conforms to any 100% depreciation deductions allowed IRC section 168(k). While Pennsylvania law requires that deductions for depreciation under IRC section 168(k) be added back to state taxable income, the Department concluded that Pennsylvania law also provides for full recovery of the disallowed depreciation in the year such qualified property is fully depreciated for federal tax purposes. Thus, the Department concluded that there is no adjustment required to a taxpayer’s Pennsylvania taxable income for full expensing allowable under IRC section 168(k).
Contrary to the Department’s position in the 2017 Bulletin, the Department previously adopted a taxpayer-friendly interpretation of Pennsylvania law in light of the 2010 Tax Relief Act, thereby allowing the full benefit of 100% immediate expensing under IRC section 168(k) to flow through to taxpayers for Pennsylvania corporate income tax purposes. Interestingly, in the 2017 Bulletin, the Department states that its new position is effective for property placed in service after September 27, 2017 but that it will continue to follow its position in the 2011 Bulletin for property placed in service before that date.
Proposed Legislation Would Reverse Pennsylvania’s New Position
Not surprisingly, legislation has been proposed in Pennsylvania (H.B. 2017) that directly addresses and reverses the Department’s new position in the 2017 Bulletin. In short, the proposed legislation would allow an additional state-level depreciation deduction equal to the amount of depreciation that would otherwise be allowed under IRC sections 167 and 168 without regard to IRC section 168(k). As clearly stated in a Memorandum by Representative Franchise X. Ryan (dated Jan. 9, 2018), the proposed legislation is specifically designed to reverse the position articulated by the Department in the 2017 Bulletin. Pennsylvania taxpayers should follow this proposed legislation closely.
It should also be noted that even if the proposed legislation is not enacted, the Department’s position in the 2017 Bulletin does not appear to be on solid footing based on the Department’s contrary historic position (as stated in the 2011 Bulletin) and practice. The Department’s new position may also be vulnerable to challenge under the state’s administrative procedures for rule making.