States May Not Follow Tax Reform on Treatment of Machinery

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By Che Odom

States may not conform to a possible change in the federal tax code requiring businesses to include full and immediate expensing of machinery purchases and other capital investments, creating administrative headaches for companies.

The decision on whether to conform may depend on the full details of whatever tax reform package comes out of Washington, although, increasingly, economists and tax experts doubt sweeping tax changes will occur this year.

Joe Crosby, principal at MultiState Associates Inc., told Bloomberg BNA that state lawmakers should begin discussing how they might react if Congress and President Donald Trump manage to pass a tax package that no longer involves companies taking deductions over time as the value of equipment or machinery depreciates.

While moving from depreciation to immediate full expensing would result in lower revenue for states, “any reform that is enacted at the federal level will reflect a complex set of changes” that may expand the base, having the opposite impact on states, he said.

States that decide not to allow full expensing—a method that would enable businesses to lower their taxes by factoring the cost of buying various types of equipment—would cause administrative and financial costs on companies.

Still, the issue could be moot because prospects for tax reform this year may be dwindling as Washington concentrates on possible improper ties between the Trump campaign and Russia.

Reform’s Low Odds

White House “missteps and unforced errors serve as a stark reminder that the GOP’s legislative agenda is slowly slipping from its hands,” Issac Boltansky and Lukas Davaz of the political research firm Compass Point wrote May 16.

However, Tony Sayegh, a spokesman for Treasury Secretary Steven Mnuchin, told Bloomberg BNA in a statement that tax changes will happen this year. “We are very aware of what is in process right now. We are working with our partners on the Hill to get this done. We feel like we can certainly accomplish that.”

During a panel discussion May 12 at a meeting in Washington of the American Bar Association’s tax section, a room of roughly 40 tax attorneys were asked to raise their hands if they thought a sweeping tax bill would be enacted this year. None raised their hands.

Be Prepared

Still, state officials should prepare to act if and when tax reform is enacted, Crosby said. Full expensing of major capital purchases could be part of the package.

MultiState Associates senior policy analyst and economist Liz Malm said it is included in the U.S. House’s tax blueprint, which is backed by House Speaker Rep. Paul Ryan (R-Wis.). The one-page White House tax plan released April 26 doesn’t mention full expensing, but it was “partially” in Trump’s campaign tax reform plans, “so it could go either way,” Malm told Bloomberg BNA.

Two-Year Budgets

The conservative-leaning Tax Foundation takes the position that full expensing would encourage economic growth because it lowers the cost of new investment. Its impact on states, overall, would be minimal when looking at taxes as a whole, according to Jared Walczak, a Tax Foundation policy analyst.

The associated revenue loss for states by moving from annual depreciation to full expensing is “front-loaded” and “smooths out over the 10-year federal budget window,” he said.

State governments operate under one- or two-year budgets, which must be balanced. That adds a “wrinkle not present at the federal level,” he said.

“However, other elements of federal reform, like eliminating the deduction for net interest expenses, would increase collections,” he added.

Some States Won’t Conform

A strong possibility exists that if tax reform is enacted, and it includes full expensing of capital investments, some states will decouple from that provision of the Internal Revenue Code, Jamie Yesnowitz, state and local tax principal and national tax office leader at Grant Thornton LLP, told Bloomberg BNA.

“The most likely states to consider decoupling in this area would be the ones that have historically decoupled from the bonus depreciation provision,” he said.

Bonus depreciation allows businesses to take an immediate first-year deduction of 50 percent on the purchase of eligible business property. The percentage phases down to 40 percent in 2018 and 30 percent in 2019.

More than half of states don’t conform to bonus depreciation, including California, Florida, Georgia, Massachusetts, Michigan, New Jersey, New York, Texas and Virginia.

Many of the states require taxpayers to add back bonus depreciation in the year of purchase and capture the deduction through subtraction modifications in later years. The full and immediate expensing considered under the blueprint for capital investments could operate similarly to the historic bonus depreciation modification.

Burdens on Business

“To the extent that decoupling happens, compliance burdens for taxpayers could become even more significant than they have been in the current era of bonus depreciation,” Yesnowitz said.

Decoupling could take many forms. For example, states could allow the deduction over a defined period of years or allow the deduction in line with historic federal depreciation schedules “or potentially deny the deduction altogether,” he said.

Such an impact on businesses will be considered by states, Crosby said.

“If the federal governments adopts full expensing, but states maintain existing, and sometimes varied, depreciation schedules, much of the administrative efficiency expensing offers would be lost,” he said.

To contact the reporter on this story: Che Odom in Washington at COdom@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

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