Does Indiana Allow Bonus Depreciation?

Indiana does not conform to the federal bonus depreciation rules established by Internal Revenue Code (IRC) Section 168(k). This creates a difference between how depreciation is calculated for federal and state income tax returns. While federal law allows businesses an additional first-year depreciation deduction for qualifying assets, Indiana does not permit this accelerated deduction on state tax returns.

The federal bonus depreciation percentage has been subject to a phase-out, dropping from 100% to 80% in 2023 and to 60% in 2024, with further reductions scheduled. Regardless of the federal rate, Indiana requires that for state purposes, the depreciation calculation must be adjusted as if the federal bonus provision was never elected.

Indiana’s Decoupling from Federal Bonus Depreciation

Indiana’s policy of not adopting the federal bonus depreciation rules is known as “decoupling.” While the state generally follows the federal framework for depreciation under IRC Sections 167 and 168, it requires a separate calculation for state tax returns that excludes the bonus amount.

Businesses must compute their Indiana depreciation deduction using standard methods, like the Modified Accelerated Cost Recovery System (MACRS), over the asset’s recovery period. This calculation is the same one used for federal purposes if bonus depreciation were not elected. This results in a lower depreciation expense and higher taxable income for Indiana in the first year.

The main consequence is the requirement to make an “add-back” adjustment on the Indiana return. This adjustment accounts for the difference between the larger federal depreciation and the smaller Indiana deduction. This policy spreads the depreciation deduction over the asset’s full life for state purposes.

Calculating the Indiana Depreciation Add-Back

To comply with Indiana’s rules, a business must calculate the difference between its federal and state depreciation amounts. This difference is the amount that must be added back to the income on the Indiana tax return.

First, determine the total depreciation claimed on the federal return. For example, a business buys a $50,000 piece of equipment with a 5-year MACRS recovery period. If the asset qualifies for 100% federal bonus depreciation, the entire $50,000 is deducted in the first year.

Next, calculate the depreciation for the same asset under Indiana’s rules, ignoring the bonus amount. The $50,000 cost basis is depreciated using the standard 5-year MACRS method. The first-year deduction is 20% of the cost, which amounts to $10,000 ($50,000 x 20%).

The required add-back is the difference between the federal and Indiana depreciation. In this example, the federal deduction was $50,000 and the Indiana deduction is $10,000. The resulting add-back is $40,000 ($50,000 – $10,000), which is added to federal taxable income on the Indiana return.

Reporting the Adjustment on Indiana Tax Forms

The calculated add-back amount must be reported on the appropriate Indiana income tax form, depending on the business’s entity type. The specific form used determines where the adjustment is made.

• Corporations report the adjustment on Form IT-20.
• Partnerships report this on Form IT-65.
• S corporations use Form IT-20S.
• Individuals, including sole proprietors or those with pass-through income, report the adjustment on Schedule 1 of Form IT-40.

These forms have specific lines for depreciation modifications, often titled “Bonus Depreciation Add-Back.” The calculated amount is entered as a positive number, which increases the taxpayer’s Indiana adjusted gross income.

Subsequent Year Depreciation Subtractions

The initial add-back is a deferral, not a permanent loss of the deduction. In subsequent years, the depreciation calculated for Indiana will be larger than for federal purposes, creating a subtraction modification on the Indiana return. This happens because the asset’s basis for Indiana tax purposes is higher than its federal basis after the first year.

Continuing the earlier example, the $50,000 asset had a first-year federal depreciation of $50,000, leaving a federal basis of $0. For Indiana, the first-year depreciation was $10,000, leaving a basis of $40,000. In year two, the federal depreciation is $0 since the asset was fully depreciated.

For Indiana, the year-two depreciation is calculated on the original cost. The 32% MACRS rate for a 5-year asset in its second year results in a $16,000 deduction ($50,000 x 32%). This $16,000 difference is taken as a subtraction modification on the Indiana return, reducing state taxable income.

This process of taking annual subtractions continues over the asset’s remaining life. The total subtractions will eventually equal the initial add-back amount, ensuring the full cost is depreciated for state tax purposes over a different schedule than for federal taxes.