What are the common adjustments required for NC vs federal depreciation during tax preparation?
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When preparing North Carolina (NC) corporate or individual income tax returns, there are several key adjustments required to reconcile federal depreciation (including bonus depreciation and Section 179 expensing) with NC’s state-specific rules. These adjustments are necessary because North Carolina does not fully conform to federal accelerated depreciation provisions, especially regarding bonus depreciation and Section 179 expensing. Below are the most common adjustments and their legal basis:
1. Bonus Depreciation (IRC §168(k))
Federal Treatment:Federal law allows immediate expensing (bonus depreciation) of 100% (or a phased-down percentage) of the cost of qualifying property in the year placed in service under IRC §168(k).
North Carolina Treatment:- Addback: NC requires an addback of 85% of the federal bonus depreciation deduction to state taxable income in the year the deduction is claimed federally. This increases NC taxable income for that year.- Subsequent Deductions: NC then allows a deduction of 20% of the addback amount in each of the following five tax years, effectively spreading the deduction over six years.- No Basis Difference: These adjustments do not create a difference in the asset’s basis for NC and federal tax purposes, except in certain asset transfer situations (see below).
Legal Authority:- N.C. Gen. Stat. § 105-130.5B(a) (corporate) and § 105-153.6(a) (individuals)- North Carolina Corporate Income, Franchise, and Insurance Tax Bulletin, “Adjustments When State Decouples from Bonus Depreciation and Section 179 Expensing”- See also,
Example:If a business claims $50,000 in federal bonus depreciation, it must add back $42,500 (85%) to NC taxable income in year one, then deduct $8,500 (20% of $42,500) in each of the next five years.
2. Section 179 Expensing (IRC §179)
Federal Treatment:Federal law allows expensing of up to $1,250,000 (2025) of qualifying property, with a phase-out threshold of $3,130,000.
North Carolina Treatment:- Lower Limits: NC limits the Section 179 deduction to $25,000 with a $200,000 investment limit for tax years beginning on or after 2013.- Addback: Taxpayers must add back 85% of the amount by which the federal Section 179 deduction exceeds the NC limit.- Subsequent Deductions: The addback is then deducted over the next five years at 20% per year.- No Basis Difference: These adjustments do not result in a basis difference for state and federal tax purposes, except in certain asset transfer situations.
Legal Authority:- N.C. Gen. Stat. § 105-130.5B(c) (corporate) and § 105-153.6(c) (individuals)- North Carolina Corporate Income, Franchise, and Insurance Tax Bulletin
3. Asset Transfers and Bonus Asset Basis Adjustments
Federal Treatment:In certain transfers (e.g., like-kind exchanges, mergers), the tax basis of assets may carry over from transferor to transferee.
North Carolina Treatment:- If an asset is transferred and the tax basis carries over for federal purposes, the transferee must add any remaining bonus depreciation deductions (from the original addback) to the basis of the asset for NC purposes and depreciate the adjusted basis over the remaining life of the asset.- The transferor is not allowed any remaining future bonus depreciation deductions associated with the transferred asset.
Legal Authority:- N.C. Gen. Stat. § 105-130.5B(e) (corporate) and § 105-153.6(e) (individuals)- North Carolina Corporate Income, Franchise, and Insurance Tax Bulletin
4. Reporting on State Tax Forms
- Corporations:
- Addback is reported on Form CD-405, Schedule H, Line 3.
- Subsequent 20% deductions are reported on Line 9.
- Individuals:
- Addback is reported on Form D-400 Schedule S under “Other Additions to Federal Taxable Income.”
- Subsequent 20% deductions are reported under “Other Deductions.”
Documentation:Taxpayers must maintain detailed records of the original federal depreciation, the NC addback, and the five-year deduction schedule. Supporting schedules may be requested by the NC Department of Revenue.
5. Other Depreciation Adjustments
- MACRS (Non-Bonus) Depreciation:
NC generally conforms to federal MACRS depreciation for property not subject to bonus depreciation or Section 179 expensing, so no adjustment is required for regular MACRS depreciation. - Qualified Improvement Property (QIP):
QIP is eligible for bonus depreciation federally, but the same NC addback and phased deduction rules apply.
6. Effect on Deferred Taxes and Asset Schedules
- The timing difference between federal and NC depreciation creates deferred tax assets or liabilities for financial reporting.
- Businesses must maintain separate federal and NC depreciation schedules to track these differences and ensure proper reporting upon asset disposition.
7. Summary Table of Adjustments
8. Key Takeaways
- Add back 85% of federal bonus depreciation and excess Section 179 expensing to NC taxable income in the year claimed federally.
- Deduct 20% of the addback in each of the next five years.
- Maintain detailed records and reconcile federal and NC depreciation schedules.
- Report adjustments on the correct lines of NC tax forms (CD-405 for corporations, D-400 Schedule S for individuals).
- Be aware of special rules for asset transfers and basis adjustments.
If you need more detail on a specific asset class or scenario, please provide additional information.
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