Beware of the potential pitfalls of using federal tax documents as data sources for filing business personal property returns.
All companies should be aware that their business personal property is subject to property taxation in most states. Owners of business personal property must annually report a list of their assets to the county in which their property is located for taxation. The local assessor requires a comprehensive list of information that includes an asset description, year acquired, and acquisition cost. Often times companies will utilize their Fixed Asset Listing (FAL) and Balance Sheet, which are expressly produced for the purpose of federal income tax returns compliance, as the data source to submit business personal property returns. Unfortunately, the use of these federal tax documents as the data source for business personal property compliance is fraught with potential errors that could lead to significant over-valuation and resulting excess taxation.
The potential over-valuation and excess taxes can arise due to a multitude of issues from using data directly from these documents. Because assets that are fully depreciated have no impact on federal income tax liability, it is quite common for a business to have “ghost assets” on their FAL for multiple years post asset retirement. A “ghost asset” in an asset on the company FAL or balance sheet which in no longer physically on the site as of the assessment date. If a company is not diligent in deleting retired assets from their FAL, these assets tend to be reported, assessed, and taxed year after year.
Tangible vs Intangible Costs
Another frequent cause of over-valuation is the methodology used to derive the attributed fixed asset cost capitalized on the FAL. In many states, only tangible personal property is taxable. However, the FAL asset cost is often a composite of tangible as well as intangible costs. The resulting composite cost is often capitalized as a single asset in the FAL. Since market value of tangible personal property is the standard for assessment, costs incurred, but that do not have a contributory value if an asset is sold, should not be deemed tangible and are therefore not taxable.
Double Taxation - Real vs Personal Property
A third potential pitfall associated with assets capitalized on the FAL is the inclusion of assets that could be construed as real property. If submitted on the business personal property return, the result can lead to an effective double assessment on both the real and business personal property tax rolls. Additionally, it is important to review the FAL for leasehold improvements which may be taxable or exempt from taxation depending on the local reporting requirements.
Cost Approach Value Methodology and Depreciation
Rendering cost from the FAL, even if all the prior mentioned items are addressed, does not ensure that one’s business personal property is being assessed at true market value. The assessor, by gathering the requested data from the FAL, will implement the cost approach to determine a property’s final assessed value. The cost approach to value methodology is, “replacement cost new less depreciation.” Further clarification is needed in order to define depreciation. Depreciation is typically defined as loss of value due to physical wear as well as functional and economic inutility.
The cost approach is surely a valid method for arriving at market value as long as the process begins using the correct cost basis and then depreciates that cost reviewing all forms of depreciation. The process is flawed if the assessor merely depreciates the property using only physical depreciation. This is the only form of depreciation commonly addressed by most assessors. All forms of depreciation must be analyzed and deducted from the original cost. Only once all forms of depreciation are considered and deducted from the original cost basis can a true market value be determined.
Balance Sheet vs True Market Value
Some states consider inventory to be reportable and taxable in nature. A key area that often leads to assessed values in excess of market value is submitting the inventory value directly from a Balance Sheet on the business personal property return. Although there is absolutely no question that this value indicates the inventory cost, it does not necessarily reflect the market value. Analysis must be undertaken to determine market value based on this definition. Such analysis should consider factors such as bulk sale discounts, holding costs, shrinkage, transportation costs, etc. Only once a detailed analysis is completed can one truly determine the market value of inventory as defined by the local statutes.
Although a cookie cutter approach to submitting assets for taxation is often used, simply submitting cost information directly from the FAL and balance sheet will lead to inflated values and taxes. A thorough analysis needs to be done prior to submission of an annual business personal property return in order to obtain a truly fair determination of market value and its associated property tax burden.
You can use our Property Tax Calendar to find all business personal property filing and appeal deadlines listed by state. If you have any questions regarding business personal property taxation or would like assistance conducting a thorough analysis prior to filing your return, please don't hesitate to contact me.
Senior Managing Consultant | Subject Matter Expert