Pennsylvania Depreciation Rules for Businesses

Depreciation is an accounting method used to allocate the cost of a tangible asset over its useful life. While many businesses follow rules set by the Internal Revenue Service (IRS), business owners in Pennsylvania must navigate a separate and distinct set of state-specific regulations. These differences mean the depreciation claimed on a federal tax return can be significantly different from what is permissible for Pennsylvania tax purposes, creating a separate layer of compliance and impacting state tax liability.

Pennsylvania’s Decoupling from Federal Depreciation

A key aspect of Pennsylvania’s tax law is its “decoupling” from certain provisions of the federal Internal Revenue Code (IRC). This means Pennsylvania does not automatically adopt all federal tax law changes, especially those for accelerated depreciation. For example, Pennsylvania explicitly disallows bonus depreciation, a federal incentive that allows businesses to immediately deduct a large percentage of an asset’s purchase price.

For federal purposes, a business can deduct a large portion of an asset’s cost in its first year using bonus depreciation. In contrast, Pennsylvania requires businesses to follow the standard Modified Accelerated Cost Recovery System (MACRS) depreciation schedules over the asset’s recovery period, without any bonus enhancement.

For example, consider a business that purchases a $100,000 piece of equipment with a five-year MACRS life. For federal taxes with a 40% bonus depreciation rate, the business could deduct $40,000 immediately, plus regular first-year depreciation on the remaining $60,000 basis. For Pennsylvania tax purposes, the deduction is limited to the regular first-year MACRS depreciation on the full $100,000 cost, resulting in a smaller initial deduction and higher state taxable income.

Section 179 Expense Deduction Limitations

Pennsylvania updated its treatment of the Section 179 expense deduction. Previously, the state’s limit was lower than the federal allowance. However, for property placed in service on or after January 1, 2023, Pennsylvania law now conforms to the federal Section 179 deduction limits.

This change means businesses in Pennsylvania can take the same immediate expense deduction on their state returns as on their federal returns. Both federal and Pennsylvania law allow businesses to expense over $1 million in qualifying asset purchases, with the amount adjusted annually for inflation. For example, a company that buys $500,000 of qualifying machinery can now elect to expense the entire amount on both its federal and Pennsylvania tax returns.

Calculating and Reporting Pennsylvania Depreciation

The differences between federal and Pennsylvania depreciation rules require specific adjustments on the state tax return to correctly calculate state taxable income. The process involves reconciling the depreciation claimed for federal purposes with the amount allowed by Pennsylvania, beginning with the net income from the federal return.

First, the taxpayer must add back the entire depreciation deduction claimed on the federal tax return. This adjustment effectively cancels out the federal depreciation expense, with the primary difference often stemming from the disallowance of federal bonus depreciation. This add-back increases the income that is subject to Pennsylvania tax.

Next, the taxpayer calculates and subtracts the depreciation amount permissible under Pennsylvania law. This figure is composed of the allowable Section 179 deduction plus the standard MACRS depreciation calculated on the asset’s cost basis, without any bonus depreciation. This subtraction reduces the previously adjusted income to arrive at the final Pennsylvania taxable income.

Asset Dispositions and Basis Adjustments

Separate depreciation calculations for federal and Pennsylvania tax purposes also affect an asset’s sale. Because the annual depreciation deductions differ, the asset’s adjusted basis, which is its original cost minus accumulated depreciation, will also be different for federal and state records. This directly impacts the taxable gain or loss when the asset is sold.

Gain or loss on a sale is determined by subtracting the adjusted basis from the sale price. Since federal depreciation is often accelerated, the federal adjusted basis will be lower than the Pennsylvania adjusted basis during the asset’s life. A lower basis results in a larger taxable gain or a smaller deductible loss when the asset is sold.

For instance, assume an asset was purchased for $150,000. After three years, accumulated federal depreciation (including bonus) might be $120,000, leaving a federal adjusted basis of $30,000. During the same period, accumulated Pennsylvania depreciation (without bonus) might only be $70,000, resulting in a state adjusted basis of $80,000. If the asset is sold for $100,000, the federal taxable gain would be $70,000 ($100,000 – $30,000), while the Pennsylvania taxable gain would be only $20,000 ($100,000 – $80,000).