8.3.22 – Bloomberg
A new Oklahoma law allows for full corporate income tax deductions for the cost of business asset expenditures. Other states should review the pros and cons of permanent full expensing before following in the Sooner State’s footsteps, say Jennifer W. Karpchuk and Alissa Gipson of Chamberlain, Hrdlicka, White, Williams & Aughtry.
Typically, when a business engages in a capital expenditure, it deducts the cost of the asset over its useful life. The government historically has enacted bonus expensing policies to inspire investment in economic downturns. Most recently, the Tax Cuts and Jobs Act of 2017 provided for a temporary 100% cost recovery of qualifying business assets that were acquired and placed in service between Sept. 27, 2017, and Jan. 1, 2023.
On May 26, Oklahoma approved H.B. 3418, which authorizes permanent full expensing, or 100% bonus depreciation, of “certain expenditures in research and experimentation and depreciable business assets by immediately deducting the full cost of such expenditures in the tax year in which the cost is incurred, or the property is placed in service.” The new law applies to qualified property and qualified improvement property as defined by IRC Section 168(k) and Section 168(e)(6) and applies to property placed in service after Dec. 31, 2021.
Oklahoma’s change is historic because it becomes the first US state to authorize permanent full expensing. This, of course, poses the question: Should other states follow Oklahoma’s lead?
Benefits and Advantages
Full expensing certainly has its pros. Businesses that elect to fully expense capital investments in the year of purchase decrease their taxable income, making way for increased spending capacity. Not only does it benefit the business taking advantage of the arrangement, but it also can greatly benefit the state if its investments in the business’s assets are successful.
In essence, the government is financing a portion of the capital expenditure’s cost by allowing its full expense to be deducted in the year of purchase, which reduces the business’s taxes. A statute allowing a business to expense the entire value of its capital investments signifies that Oklahoma is investing in its businesses in a way no other state currently is.
Full expensing also has advantages over states’ traditional attempts to attract businesses through credits and incentives. It seeks to incentivize every business across all industries to move forward with or fast track plans for purchasing capital expenditures.
Conversely, tax credits or subsidies offer incentives specifically targeted only to certain industries. Full expensing also has the benefit of eliminating any type of application or vetting process—a benefit to both the applicants and the state employees reviewing applications. Meanwhile, credits and incentives programs can have burdensome application or vetting processes to determine if credits or grants are available to certain businesses.
Taxpayers’ depreciation schedules are constantly included in state tax audits. If there was an option to elect full expensing, under which the taxpayer could deduct the full cost of the investment in year one and move forward with their businesses, many would choose to do so. State tax departments should be equally thrilled to have fewer depreciation schedules to analyze on audit.
Moreover, full expensing provides the benefit of actually receiving a tax benefit equal to the cost of the investment. When deductions are spread over several years, the amounts deducted in later years are worth less when inflation is considered. Thus, the full cost of an investment in today’s dollars is never fully deducted when deducted over time.
Furthermore, many taxpayers don’t fully comprehend depreciation and fail to deduct the amount they are entitled to as a result of the regime’s complexity. A deduction of the entire cost up front ensures the full cost benefit is realized by the investor. A number of academics—including Eric Ohrn, Eric Zwick and James Mahon, and others—analyzed the effect of federal bonus expensing from 2002 to 2011 and the states that adopted it. Their findings suggest that allowing for immediate full expensing spurs new investment and jobs.
Potential Drawbacks
Like any tax policy, full expensing has its cons in addition to its pros. There are instances when it would not benefit businesses. For instance, startup businesses with many capital expenses may find that full expensing is not helpful. Before the business is profitable or when the profits are minimal, it may be more ideal for the business to carry the deduction forward to more profitable years instead of full expensing in the year of purchase.
When inflation is high and businesses are experiencing a decrease in consumer spending, there may be less capital and more hesitation to make capital investments. If businesses are struggling and unable to make investments, 100% bonus depreciation on minimal capital investments won’t be as impactful.
Further, full expensing is likely to have an immediate negative fiscal impact on the state that enacts it. As deductions are shifted to be 100% allowed in the year of purchase, Oklahoma tax revenue likely will decrease in the first few years as the economy adjusts to the new depreciation provision. And whereas a temporary policy tends to encourage immediate investment to take advantage, a permanent policy may or may not encourage the same level of proactivity. Although this implies a negative aspect of full expensing, it could prove beneficial to Oklahoma.
If businesses decide to move to or incorporate in Oklahoma based on its full expensing allowance, they may be more likely to have capital, perhaps meaning that more successful or promising businesses will gravitate to incorporation in Oklahoma, boosting Oklahoma’s economy and providing more job opportunities in the state.
Whether states will or should jump on Oklahoma’s bandwagon is a difficult decision and will depend in part on each state’s risk tolerance. As any adviser will caution, investment opportunities are better for some than others. After all, allowing full expensing is a blind decision to invest in unknown businesses. It can be worthwhile when made in businesses that succeed but can be harmful when made in those that fail.
The tax revenue generated from successful businesses may greatly outweigh the loss from unsuccessful businesses, but each state will have to weigh its willingness to invest without business specific analysis to back each investment.
Because of the benefits full expensing offers in attracting successful businesses to a state, other states should consider adopting Oklahoma’s approach. However, the unpredictable outcome of a first-of-its-kind law may push states to watch and see for the time being.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Jennifer W. Karpchuk is a shareholder with Chamberlain Hrdlicka and co-chair of the firm’s State and Local Tax Controversy and Planning practice.
Alissa Gipson is an associate in the Chamberlain Hrdlicka’s Tax Controversy and Planning practice.