The bonus is championedas a kick-start to a shaky economy that will stimulate additional business investment. The provision allows a taxpayer to expense immediately 30 percent of its basis in property (including leasehold improvements) placed in service over the next three years and to depreciate the remaining 70 percent using the normal recovery periods and methods allowed under federal tax laws. The bonus is set to expire September 11, 2004. The provision is expected to reduce federal revenues by over $100 billion in FY 2002-2004.
State officials are concerned that the bonus depreciation provision could cause a number of states to lose state tax revenues because of the conformity between state and federal depreciation rules. At the time it was passed, every state except California generally followed federal depreciation rules for state income tax purposes. In about one-half of the states, the conformity was "automatic," meaning that the new bonus depreciation would be incorporated into the state tax code unless the legislature took action to "decouple" the state depreciation system from the federal. In other states, the state tax law was tied to the Internal Revenue Code as of a particular date, and the state's legislature would have to take specific action to incorporate the new bonus depreciation system into the state system.
The Center on Budget and Policy Properties (CBPP) estimates state revenues will be reduced approximately $4.8 billion in the current year if all states were to maintain their conformity to the federal law. If the District of Columbia and New York City are included, that number rises to $5.1 billion. Because the bonus provision will remain in effect for the next three years, states (including D.C. and NYC) would lose an additional $9 billion in 2003 and 2004, for a total of $14.1 billion.
This increases the damage to state budgets already on the ropes from last year's recession and the repercussions of September 11. According to the National Governor's Association (NGA), states are already facing budget shortfalls of $40 billion, with "an expectation they will rise to $50 billion this fiscal year." The situation is exacerbated by the fact that the enactment comes in mid-year and the act provides no fiscal relief to mitigate the losses created by the bonus depreciation, thus forcing states to look to tax hikes and service cuts for relief.
It is likely that a number of states will consider "decoupling" from the federal law to offset the revenue impact of the bonus depreciation. The decoupling is likely to take the approach of simply retaining prior law depreciation rules or requiring the "add-back" of the bonus depreciation and specifying some alternative depreciation schedule. Though this is a possible solution to the state tax revenue loss, decoupling creates a series of taxpayer compliance, burden and audit issues in future years. By not conforming with the bonus, taxpayers will have to deal with the complexities of having two different depreciation deductions for as long as they are depreciating the asset or property. This can be difficult for both the state and the taxpayer.
Among those states that conform to the Internal Revenue Code as of a certain date, West Virginia and Maine have acted to conform to the bonus depreciation. Maine will conform fully in 2001 and 2003. The degree of conformity in 2002 will depend on state's fiscal condition at the end of FY 2002. Florida is also working aggressively to incorporate the new bonus depreciation system into the state rules. In several of these states (e.g., Arkansas and Idaho) the legislature is not in session or has adjourned for the year, meaning that the state will not conform to the new rules in 2001 unless this is accomplished at a special session or on a retroactive basis.
Serious legislative consideration is also being given to decoupling in several states that currently have automatic conformity to the Internal Revenue Code. Among these states are New Jersey, Vermont, Nebraska, Pennsylvania and Louisiana. In addition, Virginia earlier this year enacted legislation to switch from an automatic conformity state to conform to the Internal Revenue Code as of December 31, 2001, meaning it will not incorporate the bonus depreciation allowance.
Information provided by states on their conformity to the bonus depreciation provisions is accessible through the FTA Home Page.
State Conformity to Federal Depreciation Rules*
* This chart reflects only the state conformity to federal depreciation rules and should not be construed to necessarily apply to other aspects of the income tax. Some states (Alabama, Arkansas, Mississippi, New Jersey and Pennsylvania) do not have a formal "federal starting point" for tax computations, but they generally incorporate depreciation rules either automatically or by reference to a specific date. Ohio policy is undertermined.
Note that West Virginia has passed a law incorporating the bonus depreciation for state tax purposes. In addition, Maine has passed a law fully conforming to the bonus depreciation in tax year 2001 and tax year 2003. The degree of conformity in 2002 is dependent on state fiscal performance, and the amount of the bonus allowed may be prorated.
Article from Tax Administrators News, April 2002.