On December 11, Ohio Governor John Kasich signed legislation which makes significant changes to the bonus depreciation addback rules applicable for purposes of calculating the Ohio income tax.1 The bill allows owners of pass-through entities who claim bonus depreciation and who increase payroll to reduce the amount of bonus depreciation required to be added back to adjusted gross income. The law also clarifies the effect of a federal net operating loss (NOL) on the Ohio bonus depreciation deduction.2 The new law applies to individuals, estates, and trusts that own all or a share of a sole proprietorship, partnership, S corporation, limited liability company or other form of pass-through entity that withholds employees' Ohio income taxes.3
Historic 5/6 Bonus Depreciation Rule
Historically, Ohio has decoupled from the federal treatment of bonus depreciation deductions for purposes of the state's income tax imposed on individuals engaged in business activities through pass-through entities. Specifically, Ohio has required an addback of 5/6 of the bonus depreciation and 5/6 of the qualifying Internal Revenue Code (IRC) Section 179 expenses when calculating Ohio taxable income.4 In tax years following the addback, taxpayers were then entitled to deduct 1/5 of the addback for each of the succeeding five years.5
New Addback Rules
While maintaining the historic addback rules for many, the new legislation is changing the amount of the addback and recapture of the benefit in situations where a taxpayer is increasing the amount of income tax withholding from year to year, and clarifying the calculation when NOLs are the result of taking bonus depreciation.
Taxpayers Incrementally Increasing Income Tax Withholding
For tax years beginning in 2012 and thereafter, if a business owner increases income tax withholding by 10 percent or more than the immediately preceding taxable year, Ohio will allow a reduced addback of 2/3 of the bonus depreciation and 2/3 of the qualifying IRC Section 179 expense when calculating the taxpayer's Ohio taxable income.6 The taxpayer is then entitled to deduct 1/2 of the amount added back for each of the succeeding two years.7 Whether a business increases Ohio payroll withholding is measured by whether the total Ohio income tax withholdings for employees of the business increases.8
Taxpayers with More Income Tax Withholding than Bonus Depreciation
If the increase in income taxes withheld by the business owner is greater than the sum of the bonus depreciation and qualifying IRC Section 179 expense, then no addback is required when calculating Ohio taxable income.9
Taxpayers with Federal NOLs Due to Bonus Depreciation
If a taxpayer incurs a federal NOL that is due in any part to bonus depreciation or a qualifying IRC Section 179 deduction, Ohio requires an addback of the entire bonus depreciation and qualifying IRC Section 179 expense when calculating the taxpayer's Ohio taxable income.10 The taxpayer is then entitled to deduct 1/6 of the addback for each of the succeeding six years.11 Practically speaking, this is not a change from the historic rule, under which a taxpayer whose federal NOL was caused by or increased by a deduction for bonus depreciation was subject to the 5/6 addback and the 1/6 deduction was disallowed.12 The disallowance of the 1/6 deduction had the same effect as requiring the entire bonus deduction to be added back.
The new law clarifies that any of the 1/6 deductions disallowed under the prior law are eligible to be deducted in subsequent taxable years until all amounts disallowed are claimed.13 For example, if a taxpayer had a federal NOL on a calendar year 2011 return, the taxpayer would have been required to add back 6/6 (all) of the bonus depreciation deduction taken for federal income tax purposes. In 2012, the taxpayer is eligible to deduct the 1/6 deduction disallowed in 2011, 1/5 of the remaining 2011 addback and any 2012 bonus depreciation amounts deductible under the new law (if the taxpayer meets the withholding requirements explained above). However, no refunds are permitted for bonus depreciation deductions that may have been forfeited before the clarification above was enacted. Therefore, amended returns cannot be filed to claim adjustments for taxable years before 2012.14
Commentary
The new Ohio law on bonus depreciation addback is novel in that no state previously had tied its state-specific bonus depreciation addback rules to the level of income tax withholding from employees of a taxpayer's business. The rules are intended to provide a potential timing benefit to owners of pass-through entities with growing Ohio operations. As many states continue to consider their conformity to federal bonus depreciation provisions for purposes of their personal and corporate income tax regimes, to the extent that such provisions are re-enacted for federal purposes in 2013 and beyond, states may begin to consider whether using preferential state-specific bonus depreciation as a tool to encourage economic development is worthwhile.
Footnotes
1 H.B. 365, Laws 2012.
2 Bill Analysis for H.B. 365, Ohio Legislative Service Commission.
3 Id.
4 OHIO REV. CODE ANN. § 5747.01(A)(20)(a)(1)(i), (ii).
5 OHIO REV. CODE ANN. § 5747.01(A)(21)(a)(i).
6 OHIO REV. CODE ANN. § 5747.01(A)(20)(a)(1)(iii).
7 OHIO REV. CODE ANN. § 5747.01(A)(21)(a)(1)(i).
8 Bill Analysis for H.B. 365, Ohio Legislative Service Commission.
9 OHIO REV. CODE ANN. § 5747.01(A)(21)(a)(ii).
10 OHIO REV. CODE ANN. § 5747.01(A)(20)(a)(1)(v).
11 OHIO REV. CODE ANN. § 5747.01(A)(21)(a)(iii).
12 OHIO REV. CODE ANN. § 5747.01(A)(21)(c).
13 Id.
14 Bill Analysis for H.B. 365, Ohio Legislative Service Commission.
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