Maryland Administrative Release No. 38 addresses Job Creation and Worker Assistance Act of 2002

NOTE: Administrative Release No. 38 from the Maryland Comptroller's Office appears here at the suggestion of the MACPA's State Tax Committee. This release has important information regarding decoupling legislation that will be helpful to all practitioners. It is reprinted here with permission of the Comptroller's Office.

I. General

This release relates to the interaction between the recently enacted "Job Creation and Worker Assistance Act of 2002" and the "Budget Reconciliation and Financing Act of 2002" (Chapter 440, Laws of Maryland, 2002). For an overview of all of the changes to federal law under the Job Creation and Worker Assistance Act of 2002, see IRS Publication 3991.

Generally, the Maryland tax laws conform to the federal income tax laws except where the Maryland Legislature has enacted legislation otherwise. The Budget Reconciliation and Financing Act of 2002 provides for a decoupling from federal income tax law for Maryland purposes with regard to two components of the Job Creation and Worker Assistance Act of 2002 — special 30 percent depreciation allowance and five-year net operating loss carryback. These provisions of the Maryland Act are applicable to all tax periods affected by the federal Act.

II. The Budget Reconciliation and Financing Act of 2002 (BRFA)

The BRFA created two new sections in the Tax-General Article, Annotated Code of Maryland. Section 10-210.1 provides for an addition to or subtraction from federal adjusted gross income to reflect the determination of the depreciation deduction provided under §167(a) of the Internal Revenue Code and the adjusted basis of property without regard to the additional allowance under §168(k) of the Internal Revenue Code and to determine the net operating loss deduction allowed under §172 of the Internal Revenue Code without regard to the special five-year carryback period provided under §172(b)(1)(H) of the Internal Revenue Code. New §10-310 of the Tax-General Article provides that the federal taxable income of a corporation shall be adjusted as provided for an individual under §10-210.1 of the Tax-General Article.

In essence, the depreciation expense, depreciation recapture, gain/loss on the sale of depreciable assets, and net operating losses must be recomputed under the remaining provisions of the Internal Revenue Code.

III. Job Creation and Worker Assistance Act of 2002 (JCWAA)

The JCWAA has two main provisions that affect the calculation of federal taxable income or federal adjusted gross income. The first provision is a special 30 percent depreciation allowance for property acquired and placed-in-service after Sept. 10, 2001 and before Sept. 11, 2004. The additional first-year depreciation is equal to 30 percent of the adjusted basis of the property, which is generally its cost or other basis multiplied by the percentage of business/investment use, reduced by the amount of any IRC §179 expense deduction and adjusted to the extent provided by other provisions of the Internal Revenue Code. The adjusted basis of qualified property for which the additional first year depreciation is deductible must be reduced by the amount of the additional first year depreciation deduction before computing the amount otherwise allowable as a depreciation deduction for the year the property was placed in-service and subsequent taxable years. The remaining adjusted basis of the qualified property is depreciated using the applicable depreciation provisions of the Internal Revenue Code for the property class.

The second provision provides that net operating losses (NOLs) arising in tax years ending in 2001 and 2002 may be carried back five years and carried over 20 years. Prior to this change, net operating losses could be carried back only two years. The entire NOL is required to be carried back to the earliest year, i.e., fifth preceding year, and, if not completely used to offset income in that year, is applied to succeeding taxable years until the full amount of the NOL is either utilized or expires (i.e., exceeds the 20-year carry-forward period).

IV. 30 percent first-year additional depreciation allowance

A. General
BRFA requires that Maryland taxable income must be computed in accordance with federal income tax laws as if the taxpayer elected not to utilize the special first year additional depreciation allowance and basis adjustment provisions. A corporation or individual must file an election at the federal level in order to opt out of the 30 percent additional depreciation allowance and related provisions. To the extent an election is not made at the federal level, an addition or subtraction modification is required.

For example, if a corporation includes the 30 percent additional depreciation allowance in calculating federal taxable income, the 30 percent depreciation allowance must be added back to federal taxable income to compute Maryland taxable income. When the corporation includes the 30 percent additional depreciation allowance in calculating federal taxable income, the corporation must adjust the basis of the property for computing the first-year depreciation expense, as well as the subsequent year's depreciation expense, on the qualifying property. An addition or subtraction is also required in the calculation of Maryland taxable income for the difference in the depreciation expense claimed for federal purposes and the amount allowed for Maryland purposes.

Similarly, an addition or subtraction may be required when qualifying property is sold to reflect the difference in the amount of the gain or loss on the sale of the property and the amount of depreciation recapture, if any, as a result of the different basis in the property for federal and state purposes.

The remainder of this section is devoted to calculating and reporting the modifications required under BRFA. These instructions apply to individuals, fiduciaries, corporations and pass-through entities (collectively, "taxpayer" or "taxpayers").

B. 2000/2001 return filed and election is made NOT to deduct 30 percent additional depreciation allowance.
If a taxpayer has satisfied all of the requirements of Rev. Proc. 2002-33 (April 29, 2002), no action is required by the taxpayer because federal taxable income or federal adjusted gross income has been computed under federal law without regard to the decoupled provisions of the JCWAA.

C. 2000/2001 return not yet filed and election will be made NOT to deduct 30 percent additional depreciation allowance.
Follow the requirements of Rev. Proc. 2002-33 for election not to deduct additional first year depreciation. No adjustments are required to the Maryland return.

D. 2000/2001 amended return will be filed to claim 30 percent additional depreciation allowance.
If federal and Maryland returns have already been filed for tax year 2000 or 2001 and taxpayer intends to amend its federal return to claim the 30 percent additional depreciation allowance, an amended Maryland return IS required even though the Maryland taxable income is correct on the Maryland return as filed. The following steps must be followed to properly prepare the Maryland amended return:

Prepare the amended federal income tax return for the taxpayer under the provisions of the JCWAA.
Prepare an amended pro forma Maryland income tax return based on the amended federal income tax return.
Prepare an amended Maryland income tax return. Compare the Maryland adjusted gross income and deductions on the return as originally filed and the amended Maryland pro forma income tax return. With the exception of a pass-through entity, the net differences should be shown as an addition modification on the amended Maryland return. The Maryland taxable income on the amended Maryland income tax return should equal the Maryland taxable income reported on the originally-filed Maryland return. The Maryland taxable income may not equal the amount originally reported if changes other than for the 30 percent additional depreciation allowance are made on the amended federal return.

The adjustment made on the amended Maryland income tax return must be reported on the Maryland Form 500DM, Decoupling Modification.

A pass-through entity will compute the adjustment as set forth above, but must allocate the required adjustment to the partners, shareholder, members or beneficiaries (commonly referred to as "owner" or "owners") of the pass-through entity and report the allocable share on the owner's modified federal Schedule K-1. The owner then reports the modification(s) on the owner's amended Maryland income tax return.

E. Original federal income tax return will be filed claiming the 30 percent additional depreciation allowance and related provisions.
If federal and Maryland returns have not been filed and taxpayer intends to claim the 30 percent additional depreciation allowance, the following steps must be taken to properly prepare the Maryland return.

Prepare the federal income tax return for the taxpayer under the provisions of the JCWAA.
Prepare a pro forma federal income tax return as if the 30 percent additional depreciation allowance and related provisions are not being claimed.
Prepare a pro forma Maryland income tax return based on the pro forma federal income tax return.
Prepare the Maryland income tax return based on the federal income tax return. Compare the federal adjusted gross income and deductions on the Maryland return with the federal adjusted gross income and deductions on the pro forma Maryland income tax return. With the exception of a pass-through entity, the net differences should be shown as an addition or subtraction modification on the Maryland return. The Maryland taxable income on the Maryland income tax return should equal the Maryland taxable income computed on the pro forma Maryland income tax return.
The modification(s) made on the Maryland income tax return must be reported on the Maryland Form 500DM, Decoupling Modification. A pass-through entity will compute the modification(s) as set forth above, but must allocate the required modification(s) to the owners of the pass-through entity and report the allocable share on the owner's modified federal Schedule K-1. The owner then reports the modification(s) on the owner's Maryland income tax return.

F. Copies of all pro forma returns, forms and schedules must be clearly labeled and attached to the amended Maryland tax return. Do not attach copies of the pro forma returns to original filings. Retain the pro forma returns with your tax records.

V. Five-year NOL carryback provisions

A. Individual and Fiduciary
As a result of BRFA, Maryland does not recognize the special five-year NOL carryback period or special depreciation allowance provided by the JCWAA. If an election out of the special five-year NOL carryback is not made, follow the steps outlined below. If an election out of the special five-year NOL carryback is made and the conventional carryback period is used, but the special depreciation allowance is claimed in the loss year, go to Paragraph 4 of this subsection.

In order to use a 2001 or 2002 federal NOL carryback for Maryland purposes when using the special five-year NOL carryback period provided by the JCWAA, the following must be submitted:

A Maryland amended return filed for the carryback year(s) as actually amended for federal purposes, a copy of federal Form 1045 or 1040X (whichever was used to claim the NOL carryback for federal purposes), Schedules A and B of Form 1045, and a copy of the federal loss year return. This amended return must include an addition modification equal to the change to the taxable net income on Form 502X and there will be no net Maryland tax effect due to this amendment.
A Maryland amended return filed for the carryback year(s) that would have applied had the special five-year carryback period provided by the JCWAA not been used for federal purposes. If the federal NOL includes the special depreciation allowance also allowed by the JCWAA, follow the requirements set forth in Paragraph 3 of this subsection first. Otherwise, proceed to Paragraph 2.a. of this subsection. To properly determine the NOL deduction for Maryland purposes, the taxpayer should:
- Complete a pro forma federal Form 1045, including pro forma Schedules A and B as if the NOL was used for federal purposes in a conventional carryback period.
- Prepare a pro forma Maryland Form 502X using the NOL deduction from the pro forma Form 1045 as a reduction to the federal adjusted gross income; any changes to other items on the Maryland return (e.g., itemized deductions) that result from this NOL deduction should also be made. A fiduciary should prepare a pro forma Maryland Form 504 including the NOL deduction as if used to reduce taxable income.
- Prepare Maryland Form 502X and include the amount of reduction to Maryland net taxable income from the pro forma Form 502X as a subtraction modification. A fiduciary should prepare Maryland Form 504 using the difference in Maryland taxable net incomes on the original return and the pro forma Form 504 as a subtraction modification. Copies of all pro forma returns, forms and schedules must be clearly labeled and attached to the amended return
  
  NOTE: If one or more of the carryback years involved in this calculation overlap with the returns filed for the special 5-year carryback period, the addition modification required in Paragraph 1 of this subsection is required in addition to the subtraction modification required in this paragraph.
If the federal NOL includes the special depreciation allowance provided by the JCWAA, use the following steps to properly determine the NOL deduction for Maryland purposes:
- Prepare a pro forma federal Form 1040 (Form 1041 for a fiduciary) for the year of the loss without using the special depreciation allowance provided by the JCWAA.
- Prepare a pro forma federal Form 1045, including pro forma Schedules A and B as if the NOL (without the special depreciation allowance) was used in a conventional carryback period.
- Prepare a pro forma Maryland Form 502X using the NOL deduction from the pro forma Form 1045 as a reduction to the federal adjusted gross income; any changes to other items on the Maryland return (e.g., itemized deductions) that result from this NOL deduction should also be made. A fiduciary should prepare a pro forma Maryland Form 504 showing the NOL deduction as if used to reduce taxable income.
- Prepare Maryland Form 502X and include the amount of reduction to Maryland net taxable income from the pro forma Form 502X as a subtraction modification. A fiduciary should prepare Maryland Form 504 using the NOL deduction from the pro forma Form 504 as a subtraction modification. Copies of all pro forma returns, forms and schedules must be clearly labeled and attached to the amended return.
If a conventional carryback period is being used but the federal NOL includes the special depreciation allowance provided by the JCWAA, use the following steps to properly determine the NOL deduction for Maryland purposes:
1. Prepare a pro forma federal Form 1040 (Form 1041 for a fiduciary) for the year of the loss without using the special depreciation allowance provided by the JCWAA.
2. Complete a pro forma federal Form 1045, including pro forma Schedules A and B, based on the pro forma Form 1040 (or Form 1041).
3. Prepare Maryland Form 502X using the NOL deduction as used on the federal return as a reduction to the federal adjusted gross income. Include an addition modification on Form 502X that is equal to the difference between the NOL deduction on the federal Form 1045 and the pro forma federal Form 1045
  
  A fiduciary should prepare an amended Maryland Form 504 using the NOL deduction as used on the federal return as a reduction to taxable income. Include an addition modification on amended Form 504 that is equal to the difference between the NOL deduction on the federal Form 1045 and the pro forma federal Form 1045. Copies of all pro forma returns, forms and schedules must be clearly labeled and attached to the amended return.
  
  NOTE: If the addition modifications in the loss year are more than the subtraction modifications in the loss year, an addition equal to the amount by which the additions exceed the subtractions is required. If the net addition modification from the loss year includes the addition required for the special depreciation allowance and related adjustments, reduce this addition modification by the amount included under Paragraph 4.c. of this subsection.
If the NOL will be carried forward, an addition modification is required in an amount equal to the net effect of the Maryland taxable income that would result if the NOL had been allowed in a conventional carryback/carryforward period without the effect of the special depreciation allowance. Attach a schedule showing the calculation of any addition or subtraction modifications claimed to the Maryland income tax return. Retain copies of any pro forma returns used in these calculations in the event a request to verify the modifications claimed is made.

B. Corporations
Maryland does not recognize the special five-year NOL carryback period or special depreciation allowance provided by the federal JCWAA. If an election out of the special five-year NOL carryback is not made, follow the steps outlined below. If an election out of the special 5-year NOL carryback is made and the conventional carryback period is used, but the special depreciation allowance is taken in the loss year, go to Paragraph 4 of this subsection.

In order to use a 2001 or 2002 federal NOL carryback for Maryland purposes when using the special five-year NOL carryback period provided by the JCWAA, the following must to be submitted:

A Maryland amended return filed for the carryback year(s) as actually amended for federal purposes and a copy of federal Form 1139 or 1120X, whichever was used to claim the NOL carryback for federal purposes. This amended return must include an addition modification equal to the change to the taxable net income on Maryland Form 500X and there will be no net Maryland tax effect due to this amendment.
A Maryland amended return filed for the carryback year(s) that would have applied had the special 5-year carryback period provided by the JCWAA not been used for federal purposes. If the federal NOL includes the special depreciation allowance also provided by the JCWAA, follow the provisions of Paragraph 3 of this subsection first. Otherwise, proceed to Paragraph 2.a. of this subsection. To properly determine the NOL deduction for Maryland purposes, the taxpayer must:
- Complete a pro forma federal Form 1139 as if the NOL was used for federal purposes in a conventional carryback period.
- Prepare a pro forma Maryland Form 500X using the NOL deduction from the pro forma Form 1139 as a reduction to federal taxable income; any changes to other items on the Maryland return (e.g., addition modifications for Net Addition Modification [NAM]. See Administrative Release No. 18) that result from this NOL deduction should also be made.
- Prepare Maryland Form 500X and include the amount of reduction to Maryland net taxable income from the pro forma Form 500X as a subtraction modification. Copies of all pro forma returns, forms and schedules must be clearly labeled and attached to the amended return
  
  NOTE: If one or more of the carryback years involved in this calculation overlap with the returns filed for the special 5-year carryback period, the addition modification required in Paragraph 1 of this subsection is required in addition to the subtraction modification required in this paragraph.
If the federal NOL includes the special depreciation allowance provided by the JCWAA, use the following steps to properly determine the NOL deduction for Maryland purposes:
- Prepare a pro forma federal Form 1120 for the year of the loss without using the special depreciation allowance provided by the JCWAA.
- Complete a pro forma federal Form 1139 as if the NOL (without the special depreciation allowance) was used in a conventional carryback period.
- Prepare a pro forma Maryland Form 500X using the NOL deduction from the pro forma Form 1139 as a reduction to the federal taxable income; any changes to other items on the Maryland return (e.g., addition modification for NAM) that result from this NOL deduction should also be made.
- Prepare Maryland Form 500X and include the amount of reduction to Maryland net taxable income from the pro forma Form 500X as a subtraction modification on line 4. Copies of all pro forma returns, forms and schedules must be clearly labeled and attached to the amended return.
If a conventional carryback period is being used but the federal NOL includes the bonus depreciation deduction allowed by JCWAA, use the following steps to properly determine the NOL deduction for Maryland purposes:
- Prepare a pro forma federal Form 1120 for the year of the loss without using the special depreciation allowance provided by the JCWAA.
- Complete a pro forma federal Form 1139 as if the NOL did not include the special depreciation allowance.
- Prepare Maryland Form 500X using the NOL deduction as used on the federal return as a reduction to the federal taxable income. Include an addition modification on Form 500X that is equal to the difference between the NOL deduction on the federal Form 1139 and the pro forma federal Form 1139. Copies of all pro forma returns, forms and schedules must be clearly labeled and attached to the amended returns.
  
  NOTE: If the addition modifications in the loss year are more than the subtraction modifications in the loss year, an addition equal to the amount by which the additions exceed the subtractions is required. If the net addition modification from the loss year includes the addition required for the bonus depreciation expense and related adjustments, reduce this addition modification by the amount included under Paragraph 4.c. of this subsection.
If the NOL will be carried forward, include an addition modification equal to the net effect to the Maryland taxable income that would result if the NOL had been allowed in a conventional carryback/carryforward period without the effect of the special depreciation allowance. Attach a schedule showing the calculation of any addition or subtraction modifications claimed to the Maryland income tax return. Retain copies of any pro forma returns used in these calculations in the event a request to verify the modifications claimed is made.

C. Pass-through entities
The returns for pass-through entities should be prepared in accordance with the provisions in Subsection B of this section, except that the modifications are not reported on the pass-through entity return, but must be allocated to the owner's of the pass-through entity on the modified federal Schedule K-1. The owners are required to claim the modification on the owner's individual income tax return.

D. The modification(s) made on the Maryland return must be reported on the Maryland Form 500DM, Decoupling Modification.

Effective: Sept. 30, 2002

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