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IOWA DEPRECIATION - THE FUN NEVER ENDS

November 24, 2003

The "bonus depreciation" rules have been a boon for taxpayers buying (and selling) capital goods. Bonus depreciation was designed as a short-term boost to the economy, and most industries are slated to lose its benefits after 2004, when the provision expires.

Still, one sector will be stimulated by bonus depreciation for years: tax preparers.

THE JOYS OF NON-CONFORMITY

State income taxes are mostly based on the federal tax system as a convenience to both taxpayers and tax administrators. The downside of conforming to the federal system is that it puts state budgets at the mercy of Congress.

Most state legislatures decided that their budgets were too tight to tolerate a revenue loss from bonus depreciation. Iowa, for example, voted to continue to ignore bonus depreciation in the computation of Iowa taxable income; instead, Iowa depreciation is the same as federal depreciation would be if bonus depreciation had not been enacted.

Other states have enacted their own depreciation rules, some of them strange. For example, North Carolina disallowed bonus depreciation deductions entirely in 2002 and 70% in 2003 and 2004; the disallowed amount can be recovered over five years, starting in 2005. This is a hefty short-term tax increase for capital-heavy North Carolina taxpayers.

IT'S NOT JUST DEPRECIATION

It's not so bad as keeping separate depreciation schedules for different states. It's worse.

Changes in depreciation computatons ripple through other income computations. Inventory values reflect tax depreciation. The basis of depreciable property is reduced by the depreciation allowed. The basis of S corporation stock and partnership interests are reduced by depreciation. When state depreciation is different, all of these items have to be recomputed to complete the state tax return. For those of us charging by the hour, this is all wonderful; it's not so great for those paying for it.

IOWA EMBRACES NON-CONFORMITY...

..well, at least in the tax law. Iowa today released a policy letter on the ripple effects of Iowa's choice to not adopt bonus depreciation. In a policy letter dated October 30, 2003, the Department of Revenue confirmed that basis computations affected by depreciation, such as C corporation stock basis, must be recomputed for Iowa. Taxpayers with "passive" losses will also have different passive loss carryforwards resulting from the different depreciation.

It remains to be seen whether Iowa will embrace non-conformity in other areas.

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