States Lag Behind Federal Government on Small Business Expensing

December 22, 2015

The congressional deal on tax extenders includes good news for small businesses, which will enjoy greater certainty under the revised Section 179 provision. At the federal level, expensing levels have been at temporarily increased levels since 2003; under the extenders deal, the current $500,000 expensing level will be maintained in perpetuity. Now it’s the states’ turn to follow suit.

Forty-five states and the District of Columbia allow first-year expensing of small business capital investment under Section 179. Of those, thirty-four states are in conformity with the now-permanent $500,000 federal expensing level. Georgia most recently joined their ranks, while Mississippi’s conformity is temporary. Nevertheless, eleven states and the District of Columbia still maintain lower expensing levels, some as low as $25,000:

Arizona (a) $120,000
Arkansas $25,000
California $25,000
District of Columbia (b) $25,000
Florida $128,000
Hawaii $25,000
Indiana $25,000
Kentucky $25,000
Maryland (c) $25,000
Minnesota (d) $196,000
New Hampshire $25,000
New Jersey $25,000

(a) Includes addition for amount of federal deduction exceeding $25,000 and subtraction equal to addback amount in first and subsequent four years.
(b) The District of Columbia offers a $40,000 expense limitation for "qualified high technology companies."
(c) Subtraction allowed to extent amount claimed for federal purposes is less than amount permitted for state purposes.
(d) Addition to federal base required for 80% of amount that exceeds $25,000, and subtraction allowed equal to 1/5th of addback amount in first and succeeding four tax years.

Corporate taxation is ostensibly a tax on net income: corporate revenues less the cost of doing business. In practice, however, rather than the cost of equipment being deducted from gross income the year in which the cost is incurred, businesses are required to deduct the cost of the equipment over time according to a depreciation schedule. The theory behind this is that companies can only deduct the portion of capital investment consumed in each year as equipment depreciates, although the practical effect is that companies must defer deductions for completed business expenditures to future years, effectively making a zero-interest loan to the government.

The ideal policy would be one of full expensing, but Section 179 of the Internal Revenue Code serves as an important stopgap for small businesses by partially bridging the gap between accounting practices and actual business expenses. Under Section 179, and state provisions linked to Section 179, businesses may deduct up to $500,000 on $2 million of equipment purchases, with the deduction then phasing out before it is completely removed for businesses with more than $2.5 million in annual equipment expenditures.

Particularly now that Congress has acted to make the higher expensing provisions permanent, the remaining states below the $500,000 expensing allowance would benefit from addressing this anomaly in their tax codes. More on state Section 179 deductions here.

Correction: an earlier version of this post erroneously indicated that the higher expensing levels since 2003 have all been set retroactively, whereas in fact the American Jobs Creation Act and the American Recovery and Reinvestment Act established multi-year (but still temporary) increases.

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