Information Release

PI & CFT 2002-01 - Depreciation Deductions for Taxable Years Ending in 2001 and Thereafter – Issued July, 2002 - Revised October 2003; June 2004; July 2005; and June 2009

The purpose of this information release is to explain recent changes in Ohio law regarding the amount of allowable depreciation expense deductions. Specifically, the changes in Ohio law affect Ohio taxpayers claiming bonus depreciation under Internal Revenue Code ("IRC") section 168(k) and for taxpayers claiming depreciation expensing under IRC section 179. While most changes apply for taxable years ending after September 10, 2001, this revised information release addresses changes necessitated by the adoption of business/nonbusiness income provisions for the Ohio corporation franchise tax. The business/nonbusiness income changes affect corporation franchise taxpayers and certain pass-through entities¹ that have taxable years ending after June 25, 2003.

The revisions to this information release that appeared temporarily in May 2009 regarding the calculation of the addback required by Ohio Revised Code sections 5733.04(I)(17)(a)(ii) and 5747.01(A)(20)(a)(ii) were made in response to comments received by ODT and were intended to be clarifying and correcting. However, based on further research and feedback from the tax professional community, those revisions were incorrect and have been subsequently withdrawn. Specifically, the original revision changed the 179 limitation for taxable years beginning in 2003 and thereafter from $25,000 to $24,000. The current revision corrects our error from $24,000 back to $25,000.

(Note: An addendum to this release describes five examples of the IRC section 179 Ohio add-back).

The changes in the law related to the amount of allowable depreciation and depreciation deductions apply to the following taxpayers:

• Corporation franchise taxpayers (filing Ohio form FT-1120),
• Individual income taxpayers (filing Ohio forms IT-1040 and IT-1040ES),
• Individual school district income taxpayers (filing Ohio forms SD-100 and SD-100ES),
• Estate income taxpayers (filing Ohio forms IT-1041 and IT-1041-ES),
• Trust income taxpayers (filing Ohio forms IT-1041 and IT-1041-ES -- for taxable years beginning after 2001, and
• Pass-through entity taxpayers (filing Ohio forms IT-1140 and IT-1140ES or IT-4708 and IT-4708ES).

The changes in the law apply to depreciation expenses which taxpayers claim with respect to the following depreciable assets:

• Depreciable assets which the taxpayer owns (excluding depreciable assets to the extent the depreciation expense for such assets is an itemized deduction for federal income tax purposes), and
• Depreciable assets which are owned by pass-through entities in which the taxpayer directly or indirectly owns at least five per cent. See Ohio Revised Code ("ORC") sections 5733.04(I)(17)(a) and 5747.01(A)(20)(a).

Ohio Depreciation Expense Deduction Adjustments for Bonus Depreciation Claimed for Taxable Years Ending After June 4, 2002

The changes in the law require the following adjustments:

Amount of adjustments:

• In determining Ohio taxable income for taxable years ending after June 4, 2002 taxpayers claiming bonus depreciation under IRC section 168(k) must add to income, prior to apportionment or allocation, five-sixths of the amount of the bonus depreciation expense claimed for that taxable year.
• In determining Ohio taxable income for taxable years ending after December 31, 2002 taxpayers claiming depreciation expensing under IRC section 179 must add to income, prior to apportionment or allocation, five-sixths of the excess of the IRC section 179 amount allowed over the amount which would have been allowed based upon IRC section 179 in effect on December 31, 2002. Applying section 179 of the IRC as that section existed on December 31, 2002, the annual limitation is (i) $24,000 for taxable years beginning in 2002 and (ii) $25,000 for taxable years beginning in 2003 and thereafter.

• Individuals and trusts filing amended income tax returns in order to claim the benefit of a net operating loss carryback must reduce the NOL carryback by both amounts described above.
• In each of the next five taxable years, taxpayers must deduct one-fifth of the add-back amount.²

Note: For purposes of the corporation franchise tax for tax year 2004, the test for ascertaining situs differs depending on the taxable year end. The first bullet below applies the test prior to adoption of the business/nonbusiness income test effective June 26, 2003. The second bullet below applies the business/nonbusiness income test effective on that date.

• With respect to the Ohio corporation franchise tax, to the extent the add-back is attributable to property generating income or loss allocable under ORC section 5733.051 for taxable years ending prior to June 26, 2003, the add-back amount is allocated to the same location as the income or loss generated by the property. Otherwise, the add-back must be apportioned, subject to the alternative methods of apportionment enumerated in ORC section 5733.05(B)(2)(d).
  
• With respect to the Ohio corporation franchise tax, to the extent the add-back is attributable to property generating nonbusiness income or loss allocable under ORC section 5733.051 for taxable years ending after June 25, 2003 the add-back amount is allocated to the same location as the income or loss generated by the property. Otherwise, the add-back must be apportioned, subject to the alternative methods of apportionment enumerated in ORC section 5733.05(B)(2)(d).
  
• With respect to all other taxpayers, to the extent the add-back is attributable to property generating income or loss allocable under ORC section 5747.20, the add-back amount is allocated to the same location as the income or loss generated by the property. Otherwise, the add-back must be apportioned, subject to the alternative methods of apportionment enumerated in ORC section 5733.05(B)(2)(d) and 5747.21.
  
• The amount deducted in each of the next five taxable years following an add-back is an allocable item if the add-back amount was an allocable item; otherwise, the amount deducted is an apportionable item.³
  
• If the deduction is apportionable, the apportionment ratio for the deduction year (not the add-back year) applies. The new law also states that for taxable years ending after June 4, 2002 the five-sixth add-back provision and the one-fifth deduction provision do not adjust or modify the adjusted basis of any asset. However, during the remaining five-taxable year period, if any, the taxpayer is entitiled to the remaining one-fifth deductions each year – even if the taxpayer does dispose of the asset at any time during the five taxable years immediately following the taxable year for which the taxpayer makes the "five-sixth" add-back to income. The taxpayer is not entitled to deduct, in the year of the disposition of the asset, all the remaining "one-fifth" amounts.

Ohio Depreciation Expense Deduction Adjustments for Bonus Depreciation Claimed for Taxable Years Ending Prior to June 5, 2002⁴

Taxpayers who had a taxable year ending prior to June 5, 2002 and who claimed bonus depreciation under IRC section 168(k) for such year must recompute Ohio taxable income based upon the depreciation expense available to the taxpayer without regard to the bonus depreciation amount for assets acquired between September 11, 2001 and the last day of the taxable year ending prior to June 5, 2002.⁵ Alternatively, under noncodified section 4(B)(2) of Am. Sub. S.B. 261 taxpayers can elect to compute Ohio taxable income as if the new Ohio law applied to taxable years ending prior to June 5, 2002. Under this election, taxpayers must add back five-sixths of the bonus depreciation claimed for the taxable year ending prior to June 5, 2002 and then deduct one-fifth of that add-back amount in each of the next five taxable years.

Whether the taxpayer either recomputed the depreciation expense without regard to the changes enacted by the Job Creation and Workers Assistance Act of 2002 or made the election, the taxpayer must file an amended Ohio report if the taxpayer has filed an Ohio return that did not reflect the Ohio adjustment now required. See "Amended Returns and Reports" later in this information release. Set forth below is a detailed discussion of both the recomputation and the election. Following the discussion are examples illustrating the recomputation and the election.

Recomputing Ohio Taxable Income Without Regard to Bonus Depreciation Claimed for Taxable Years Ending Prior to June 5, 2002

Unless making the election discussed below, in determining Ohio taxable income taxpayers must recompute depreciation expense for the taxable year ending prior to June 5, 2002 as if IRC section 168(k) did not apply for that year with respect to assets acquired between September 11, 2001 and the last day of the taxable year ending prior to June 5, 2002. This recomputation, with respect to assets acquired between September 11, 2001 and the last day of the taxable year ending prior to June 5, 2002, applies only to the taxable year ending prior to June 5, 2002. That is, with respect to assets acquired between September 11, 2001 and the last day of the taxable year ending prior to June 5, 2002, the depreciation expense shown on the federal income tax return for all subsequent taxable years will also be the depreciation expense for Ohio tax purposes. Thus, if the taxpayer fails to make the election, the taxpayer generally will not fully depreciate those assets for Ohio tax purposes (see the three examples later in this information release).

Furthermore, for taxable years ending after June 4, 2002 the taxpayer must also make the "5/6th -- 1/6th" adjustments in connection with bonus depreciation claimed on assets acquired during taxable years ending after June 4, 2002. In addition, each taxpayer subsequently disposing of any such assets acquired during taxable years ending after June 4, 2002 and recognizing a gain or loss for federal income tax purposes with respect to that disposition will recognize the same amount of gain or loss for Ohio purposes as for federal purposes.

Electing to Add Back Five-sixths of the Bonus Depreciation Claimed for Taxable Years Ending Prior to June 5, 2002

Under this election, in determining Ohio taxable income the taxpayer will apply the "5/6th -- 1/6th" adjustments to taxable years ending prior to June 5, 2002 as well as to taxable years ending after June 4, 2002. A taxpayer can make this election at any time within the statute of limitations period (generally three years for corporations and four years for all other taxpayers⁶). Furthermore, the taxpayer can revoke this election at any time prior to the ninetieth day before the last day of the statute of limitations period. Taxpayers who make this election and later revoke their election must then recompute the taxable income and tax for all affected years, file amended returns or reports, and pay the additional Ohio tax and interest.

How to Report the Bonus Depreciation Expense Adjustment

The bonus depreciation expense adjustments affect many different tax returns for taxpayers having a taxable year that ends on or after September 11, 2001 but before June 5, 2002. Set forth below is a listing of those returns and instructions regarding where to show the bonus depreciation expense adjustment:

• Corporation franchise taxpayers (filing Ohio form FT-1120 for tax year 2002): page 2, Schedule B, immediately above line 1a,
  
• Individual income taxpayers (filing Ohio form IT-1040 for the taxable year beginning in 2001): back side of return, Schedule A, above line 28,
  
• Individual school district income taxpayers (filing Ohio form SD-100 for the taxable year beginning in 2001): no additional line necessary since the change to IT-1040 automatically will "flow through" to line l of form SD-100,
  
• Estate income taxpayers (filing Ohio form IT-1041 for the taxable year beginning in 2001): back side of return, Schedule A, above line 20,
  
• Pass-through entity taxpayers (filing Ohio form IT-1140 for the taxable year beginning in 2001): page 2, Schedule B, above line 4 (both columns), and
  
• Pass-through entity taxpayers (filing Ohio form IT-4708 for the taxable year beginning in 2001): page 2, Schedule I, on line 31.
  

Taxpayers should label the adjustment "depreciation add-back". Taxpayers need not attach to the return or report a schedule supporting the amount of the add-back. However, taxpayers must maintain this schedule for review by the tax commissioner upon examination or audit.

Amended Returns and Reports

Taxpayers having a taxable year ending prior to June 5, 2002 and claiming bonus depreciation for federal income tax purposes and who have already filed their tax returns or reports for such taxable year must amend their returns or reports, recompute Ohio taxable income (either by adding back all of the bonus depreciation expense or by electing to add back only 5/6 of the bonus depreciation expense) recompute the tax, and pay any additional Ohio tax and interest. The tax commissioner will not impose the failure-to-pay penalty with respect to such amended tax returns and reports for taxpayers filing the amended tax returns or reports and paying the related increased tax and interest (7%) by November 15, 2002.⁷

Questions: If you have any questions regarding this information release, please e-mail us through our web site at tax.ohio.gov.⁸

Statutory References: ORC sections 5733.04(I)(17), 5733.04(I)(18), 5733.40(A)(5), 5747.01(A)(20), 5747.01(A)(21), 5747.01(S)(13), and 5747.01(S)(14).

Other references: Section 4(B)(2) of the Amended Substitute Senate Bill No. 261, 124th General Assembly.

Example #1

Facts:

• A calendar year taxpayer purchases and places in service on 12/15/01 a $1,000 5-year asset. The taxpayer elects IRC section 168(k) bonus depreciation and straight-line depreciation.
• Because of other asset acquisitions earlier in the year, the taxpayer is eligible for half-year convention.
• The taxpayer is not eligible for IRC section 179 additional depreciation.

Analysis:

Taxable year ending December 31	Depreciation expense allowable on federal tax return	Net depreciation expense allowable on Ohio tax return if "Section 4(B)(2)" election is not made	Net depreciation expense allowable on Ohio tax return if "Section 4(B)(2)" election is made
2001	$300 + $709	$300 + $70 - $270 =$10010	$300 + $70 - $25011
2002	$140	$140	$140 + $5012
2003	$140	$140	$140 + $50
2004	$140	$140	$140 + $50
2005	$140	$140	$140 + $50
2006	$ 70	$ 70	$ 70 + $50
Total	$1,000	$ 730	$1,000

Observation: Most taxpayers should make the "Sec. 4(B)(2)" election in order to depreciate the full cost of the asset.

Example #2

Facts: Same as in example #1 except the taxpayer's taxable (fiscal) year-end is May 31.

Analysis:

Taxable year ending May 31	Depreciation expense allowable on federal tax return	Net depreciation expense allowable on Ohio tax return if "Section 4(B)(2)" election is not made	Net depreciation expense allowable on Ohio tax return if "Section 4(B)(2)" election is made
2002	$300 + $70	$300 + $70 - $270 =$100	$300 + $70 - $250
2003	$140	$140	$140 + $50
2004	$140	$140	$140 + $50
2005	$140	$140	$140 + $50
2006	$140	$140	$140 + $50
2007	$ 70	$ 70	$ 70 + $50
Total	$1,000	$ 730	$1,000

Observation: Most taxpayers should make the "Sec. 4(B)(2)" election in order to depreciate the full cost of the asset.

Example #3

Facts: Same as in examples #1 and #2 except the taxpayer's taxable (fiscal) year end is November 30 (recall that the taxpayer placed the asset in service on 12/15/01).

Analysis:

• The December 15, 2001 asset acquisition occurs during the taxable (fiscal) year ending November 30, 2002.
• Section 4(B)(2) does not apply to taxable (fiscal) years ending after June 4, 2002.
• Taxpayers must make the "5/6 -- 1/6" adjustment for taxable (fiscal) years ending after June 4, 2002.

Taxable year ending November 30	Depreciation expense allowable on federal tax return	Net depreciation expense allowable on Ohio tax return
2002	$300 + $70	$300 + $70 - $250
2003	$140	$140 + $50
2004	$140	$140 + $50
2005	$140	$140 + $50
2006	$140	$140 + $50
2007	$ 70	$ 70 + $50
Total	$1,000	$1000

____________________________________________

¹ORC section 5733.04(0) defines "pass-through entities." Under this definition, pass-through entities include disregarded entities (single member limited liability companies not treated as corporations for federal income tax purposes and qualified subchapter S subsidiaries), partnerships, limited liability companies treated as partnerships for federal income tax purposes, and subchapter S corporations.

²Note that deducting one-fifth of the add-back amount is equivalent to deducting one-sixth of the bonus depreciation amount since the add-back amount is five-sixths of the bonus depreciation amount and de-ducting 1/5 of 5/6 of the bonus depreciation is the same as deducting 1/6 of the bonus depreciation (1/5 X 5/6 = 1/6). Hence, we refer to these adjustments as the "5/6th – 1/6th adjustments provisions."

³While corporations, pass-through entities, and trusts apportion and allocate income for purposes of determining Ohio taxable income, individual income taxpayers and estate income taxpayers do not allocate or apportion income for purposes of calculating Ohio taxable income. However, nonresident individual income taxpayers, part-year resident individual income taxpayers, and nonresident estates use the allocation and apportionment provisions for computing the nonresident tax credit.

⁴Based upon a previous Ohio Supreme Court case, State v. Gill (1992), 63 Ohio St. 3d 53, the Department’s position is that IRC section 168(k) bonus deprecation does not automatically apply for taxable years ending prior to June 5, 2002. The remainder of this Information Release discusses the extent to which the bonus depreciation is allowable for Ohio tax purposes for taxable years ending prior to June 5, 2002.

⁵In the event that a taxpayer that has more than one taxable year that ends after September 10, 2001 and before June 5, 2002 (for example, because the taxpayer was acquired or because the taxpayer changed its taxable year), this recomputation applies to both taxable years.

⁶See ORC sections 5733.12(B) and 5747.11(B).

⁷Individuals who have already filed their Ohio form IT-1040 for their taxable year ending on or after September 12, 2001 and prior to June 5, 2002 should not file an amended Ohio form IT-1040; rather, they must file Ohio form IT-1040X, amended individual income tax return. Such taxpayers need not attach to the Ohio form IT-1040X a copy of the Ohio form IT-1040, Schedule A.

⁸See the Department’s "Home Page", select "Contact Us" and "E-mail Us" your question.

⁹The $300 amount is the IRC section 168(k) bonus depreciation: 30% X $1,000 = $300. The $70 is the straight-line depreciation, 1/2-year convention depreciation expense: 1/2 X 1/5 X ($1,000 - $300) = $70.

¹⁰The $100 is the recomputed straight-line, 1/2 year convention depreciation expense available if the taxpayer did not claim bonus depreciation: 1/2 X 1/5 X $1,000 = $100. The depreciation adjustment on the return for the taxable year ending 12/31/01 would be "+ $270." The $270 add-back is the difference between the $370 depreciation allowable on the federal income tax return and the $100 recomputed depreciation expense.

¹¹The depreciation adjustment (add-back) on the return for the taxable year ending 12/31/01 would be "+ $250." The $250 add-back is 5/6 X $300.

¹²The depreciation adjustment (deduction) on the return for the taxable year ending 12/31/02 would be "- $50." The $50 deduction is 1/6 X $300.

 

                            Addendum -- Five Examples of the IRC Section 179 Ohio Add-back

Overview

Ohio Revised Code sections 5733.04(I)(17)(a)(ii) and 5747.01(A)(20)(a)(ii) require that each taxpayer add back five-sixth of  “the difference between (I) the amount of depreciation expense directly or indirectly allowed to the taxpayer under section 179 of the internal Revenue Code and (II) the amount of depreciation expense directly or indirectly allowed to the taxpayer under section 179 of the Internal Revenue Code as that’s section existed on December 31, 2002.”  Because of the complexities of IRC section 179 and because of confusion over the add-back computation, this memo (i) summarizes that section of the IRC and (ii) sets forth five examples of the required add-back. 

Per IRS form 4562 for the 2004 year (see icon on the last page in this file), the maximum amount of the IRC section 179 expense is $102,000¹ for taxpayers whose filing status is single, qualifying widower/widow, head of household, or “MFJ.”  “MFS" taxpayers in the aggregate can expense no more than $102,000.  Per page 2 of the instructions for that form, under certain situations the maximum amount increases by as much as $35,000 for certain businesses.  

The $102,000 maximum amount limitation applies both at the entity level and at the individual level (with respect to PTE's and to sole proprietorships and to estates & trusts if the estate or trust "passes through" depreciation expenses).  Each controlled group of corporations must also “share” this maximum amount.

The law also provides that the $102,000 maximum amount is phased out if the taxpayer,  the business, or the controlled group purchases more than $410,000 of “section 179 property” during the year (the IRS refers to amounts in excess of $410,000 as “excess section 179 property”).  Each dollar of section 179 property purchased during the year in excess of $410,000 reduces by one dollar the amount otherwise available to be expensed.  So, the taxpayer, business, and controlled group cannot expense any amount if purchases of section 179 property equal or exceed $512,000 ($512,000 purchases - $410,000 threshold = $102,000 decrease in the maximum amount which generally can otherwise be expensed²). 

Under IRC section 179 as that section existed on December 31, 2002, the maximum amount which could be expensed was $25,000, and the phase-out began once the cost of purchases of section 179 property during the year exceeded $200,000.  So, under the prior law the taxpayer could not claim any section 179 expense if the taxpayer’s purchases of section 179 property during the year were $225,000 or more.

Please note that for purposes of computing the phase-out, equity investors in one or more PTE’s do not have to aggregate their proportionate shares of each entity’s purchases of section 179 property.  U. S. Treasury regulation section 1.179-2(b)(3)(ii) illustrates this aspect of the law with the following example:³

              “During 1991, CD, a calendar-year partnership, purchases and places in service  
            section 179 property costing $150,000 and elects under [IRC] section 179(c)
            and [U.S. Treasury regulation] section 1.179-5 to expense $10,000 of the cost of
            that property.  CD properly allocates to C, a calendar-year taxpayer and a part-
            ner in CD, $5,000 of section 179 expenses (C’s distributive share of CD’s sec 
            tion 179 expenses for 1991).  In applying the dollar limitation to C for 1991, C
            must include the $5,000 of section 179 expenses allocated from DC.  However,
            in determining the amount of any excess secton 179 property C placed in service
            during 1991, C does not include any cost of section 179 property placed in ser-
            vice by CD, including the $5,000 of cost represented by the $5,000 of section 
            tion 179 expenses allocated to C by the partnership.”

                                                                   * * * * *

The following examples illustrate the Ohio add-back.


Example #1

Facts

• Individuals A and B each own 50% of the equity of PTE #1.
• During 2004 the PTE purchased $105,000 of section 179 property.  For 2004 the PTE is allowed to elect, and does so elect, to expense $102,000 under IRC section 179 (so, PTE #1 will “pass through” to each investor $51,000 of section 179 expense).⁴
• Neither A nor B has any other PTE investments
• Neither A nor B, as sole proprietors,  purchased any section 179 property.
• A and B are not married.
  

Analysis

Current federal law allows A and B, when calculating year 2004 FAGI, each to claim a deduction of $51,000 for IRC section 179 expense.

Under IRC section 179 as that section existed on December 31, 2002 (i) the PTE would have been able to elect to expense only $25,000 and (ii) A and B each would have been able to claim only $12,500 of IRC section 179 expense.

      So, for Ohio income tax purposes for year 2004, A and B must each add back
      5/6 X ($51,000 – $12,500) =  $32,083.⁵

Example #2

Facts

• Same facts as in Example #1 but with the following additional facts.
• B owns 25% of the stock in each of four S corporations:  PTE #2, PTE #3, PTE #4, and PTE #5.
• Individuals C, D, E, & F each own 75% of the stock if PTE #2, PTE #3, PTE #4, and PTE #5, respectively.⁶

• During 2004 PTE #2, PTE #3, PTE #4, and PTE #5 each purchased  $109,000  of section 179 property.  For 2004 each of these PTE’s is allowed to elect, and does so elect, to expense $102,000 under IRC section 179 (so, PTE #2, PTE #3, PTE #4, and PTE #5 will each “pass through” to B section 179 expense of
  25% X $102,000 = $25,500.
  

Analysis

As set forth in Example #1, A must add back on A’s year 2004 Ohio income tax return is 5/6 X ($51,000 – $12,500) = $32,083. 

With respect to B, the PTE’s have passed through to B the following section 179 expense amounts:

        $ 51,000 from PTE #1

         25,500 from PTE #2

         25,500 from PTE #3
         25,500 from PTE #4

         25,500 from PTE #5
      $153,000 total amount passed through to B.

As noted above, the limitation applies to both the PTE and to the investor.  So, when computing year 2004 FAGI, B can only deduct $102,000 of the $153,000 amount.⁷ Based upon the Internal Revenue Code as it existed on December 31, 2002, set forth below are the section 179 amounts which the PTE’s would have passed through to B with respect to each PTE’s year 2004 purchases of section 179 property:

      $ 12,500 from PTE #1

           6,250 from PTE #2

           6,250 from PTE #3
           6,250 from PTE #4

           6,250 from PTE #5
     $ 37,500 total amount passed through to B – based upon 12/31/02 IRC.

However, based upon the Internal Revenue Code as it existed on December 31, 2002, B would have been able to deduct only $25,000.⁸

So, B’s year 2004 Ohio add-back is 5/6 X ($102,000 - $25,000) = $64,167.  


Example #3

Same facts as in example #2, but with the following additional fact:  B, as a sole proprietor, purchased $300,000 of section 179 property in 2004.

Analysis

In determining whether B purchased excess section 179 property (recall that (i) the $102,000 maximum section 179 expense is phased out if purchases of section 179 property equal or exceed $410,000 and (ii) there is no section 179 expense allowed if purchases of section 179 property equal or exceed $512,000), B does not aggregate B’s own $300,000 in purchases of 179 property with B’s proportionate share of qualifying 179 expenses allocated to B from PTEs #1, 2, 3, 4 and 5.  So, there is no phase-out for B since B’s purchases of section 179 property do not equal or exceed $410,000.  

As set forth above in example #2, B can claim section 179 expense of only $102,000 – even though the pass-through entities in the aggregate “passed through” to B a total of $153,000 of  section 179 expense.   

Under IRC section 179 as that section existed on December 31, 2002, B could not claim any section 179 expense because B’s year 2004 purchases of 179 property as a sole proprietor exceed $225, 000.⁹ So, B’s year 2004 Ohio add-back is 5/6 X 102,000 = $85,000.

Example #4

Facts

• During 2004 taxpayer G, a C corporation, purchases $430,000 worth of section 179 property.
• G is eligible to elect, and does so elect, to expense $82,000 under IRC section 179.¹⁰ G is not a member of a controlled group.
• G is not an equity investor in any PTE.

Analysis

Under the IRC in effect on December 31, 2002, G would not have been eligible to claim any section 179 expense because G’s year 2004 purchases of section 179 property equal or exceed $225,000.¹¹ So, the add-back on G’s 2005 Ohio form FT-1120 is 5/6 X $82,000 = $68,333.   

Example #5

Facts

• Individual H owns 10% of the equity of PTE #6.
• During 2004 PTE #6 purchases $210,000 worth of section 179 property.
• PTE #6 is eligible to elect, and does so elect, to expense $102,000 under IRC section 179 (so, H’s share of the section 179 expense is $10,200).
• H has no other PTE investments
• H, as a sole proprietor, has not purchased any other section 179 property.
• H is not married.

Analysis

Current federal law allows H, when calculating year 2004 FAGI, to deduct $10,200 for IRC section 179 expenses.

Under the IRC in effect on December 31, 2002, PTE #6’s year 2004 purchases of section 179 property exceed $200,000, the “threshold” for the phase-out under the IRC in effect on December 31, 2002.  Since PTE #6’s excess purchases under the IRC in effect on December 31, 2002 are $10,000,¹² then under the IRC in effect on December 31, 2002 the maximum section 179 expense which PTE #6 could have claimed would have been $15,000: $25,000 maximum amount under the IRC in effect on December 31, 2002 minus the $10,000 in excess purchases under the IRC in effect on December 31, 2002. H’s share of the $15,000 would have been $1,500 (H is a 10% owner of PTE #6). So, H must add back on H’s 2004 Ohio income tax return 5/6 X ($10,200 - $1,500) = $7,250.

                                                                     * * * * *

IRS form 4562 for year 2004 (double “left-click” on form number):

f4562

IRS instructions for IRS form 4562 for year 2004 (double “left-click” on form number):

i4562

 

ENDNOTES

¹The year 2003 maximum was generally $100,000.

²Assume the “as much as $35,000 increase" (discussed above) does not apply. 

³Please note that the IRS has not updated this example to reflect increased deductions and limitations allowable under current law.

⁴Note that line 11 on IRS form 4562 does not allow any taxpayer or business to claim IRC section 179 expenses in excess of the taxpayer’s/business’ “business income.”  These examples assume that each PTE and each taxpayer has business income equal to or greater than the expensed amount.

⁵Note that in each of the next five taxable years each taxpayer can deduct on her/his Ohio form IT-1040 one-fifth of the $32,083 add-back – even if the taxpayer(s) no longer is (are) equity investors in the PTE and/or even if the PTE no longer owns the property to which the add-back relates.  The subsequent examples will not address the deduction.

⁶For purposes of brevity and to avoid repetition, these examples will not address the Ohio income tax implications for shareholders C, D, E, & F. 

⁷B can never deduct, either as section 179 expense or as section 168 depreciation expense, the remaining $51,000.

⁸ The $12,500 excess ($37,500 amount passed through to B minus the $25,000 maximum amount which B can deduct) is "lost" forever: B will never be able to deduct the $12,500 excess.

⁹Recall that under the IRC in effect on December 31, 2002 the phase-out begins once section 179 purchases exceed $200,000.  Under the IRC in effect on December 31, 2002 there is no section 179 expense if section 179 purchases equal or exceed $225.000.

¹⁰The taxpayer’s purchases of section 179 property were $430,000.  Because the taxpayer purchased more than $410,000 of section 179 property, the IRC requires that the taxpayer reduce the $102,000 maximum amount by amount of the cost of excess section 179 property.  In this example, the amount of the excess is $430,000 - $410,000 = $20,000; so, the taxpayer can claim a maximum section 179 expense amount of $102,000 - $20,000 = $82,000.

¹¹Recall that under the IRC in effect on December 31, 2002 the phase-out begins once section 179 purchases exceed $200,000.  Under the IRC in effect on December 31, 2002 there is no section 179 expense if section 179 purchases equal or exceed $225,000.

¹²$10,000 = $210,000 amount of purchases minus $200,000 which was the threshold for the phase-out under the IRC in effect on December 31, 2002.