How do North Carolina and federal tax rules differ in calculating depreciation expense for a $10,000 production machine when bonus depreciation is elected federally?
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When calculating depreciation expense for a $10,000 production machine placed in service in 2025, and bonus depreciation is elected for federal tax purposes, the treatment under federal and North Carolina tax rules differs significantly. Here’s a detailed comparison:
1. Federal Tax Treatment (IRC §168(k)):
- Bonus Depreciation Election: Under federal law, as amended by the One Big Beautiful Bill Act (OBBBA), 100% bonus depreciation is available for qualified property (including most production machinery with a recovery period of 20 years or less) acquired and placed in service after January 19, 2025. This means the entire $10,000 cost of the machine can be deducted in the year it is placed in service, provided all other requirements are met (e.g., original use, not required to use ADS, etc.).
- Depreciation Calculation: The taxpayer deducts the full $10,000 as bonus depreciation in 2025. The basis of the machine is reduced to $0 for subsequent depreciation calculations.
2. North Carolina State Tax Treatment:
- Decoupling from Federal Bonus Depreciation: North Carolina does not conform to federal bonus depreciation under IRC §168(k) or §168(n). Instead, North Carolina requires an adjustment (add-back) to federal taxable income for 85% of the bonus depreciation claimed federally.
- Required Add-Back: In the year the $10,000 machine is placed in service and 100% bonus depreciation is claimed federally, the taxpayer must add back 85% of the bonus depreciation ($8,500) to North Carolina taxable income for that year.
- Subsequent Deductions: The taxpayer is then allowed to deduct 20% of the add-back ($1,700) in each of the next five taxable years (2026–2030), effectively spreading the $8,500 over five years.
- Basis Consistency: The adjustments do not result in a difference in the basis of the asset for state and federal purposes, except in certain transfer situations not relevant here.
3. Example Calculation:
Suppose a taxpayer places a $10,000 production machine in service in North Carolina in 2025 and claims 100% bonus depreciation federally.
- Federal Return (2025):
- Deducts $10,000 as bonus depreciation.
- No further depreciation on this asset in future years.
- North Carolina Return (2025):
- Starts with federal taxable income (which includes the $10,000 deduction).
- Adds back $8,500 (85% of $10,000) to North Carolina taxable income.
- Net deduction for 2025: $1,500 ($10,000 federal deduction minus $8,500 add-back).
- North Carolina Returns (2026–2030):
- Each year, deducts $1,700 (20% of $8,500) from North Carolina taxable income.
4. Summary Table:
- Federal: IRC §168(k) (as amended by OBBBA) allows 100% bonus depreciation for qualified property placed in service after January 19, 2025.
- North Carolina: N.C. Gen. Stat. §§ 105-130.5B (corporate) and 105-153.6 (individuals/flow-throughs) require the 85% add-back and 20% per year deduction for five years.
5. Conclusion:
- Federal: Immediate full deduction of $10,000 in 2025.
- North Carolina: Only $1,500 deduction in 2025, with the remaining $8,500 spread evenly over the next five years ($1,700 per year), due to the required add-back and subsequent deductions. This results in a slower recovery of the deduction for state tax purposes compared to the federal treatment.
This difference can create a temporary disparity between federal and North Carolina taxable income, affecting cash flow and tax planning.
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