On July 9, 2013, Governor Corbett signed into law House Bill 465, officially known as Act 52 of 2013. More recently, on July 18, 2013, Governor Corbett signed a second bill into law, Senate Bill 591, officially known as Act 72. Together, the two bills result in some notable changes to Pennsylvania’s tax statutes.
Following is a brief yet detailed summary of the changes impacting the major areas of taxation. For any clarification or additional information, contact the author: James H. Nehr at [email protected] or 610-378-1175.
Corporate Net Income Tax
Add-backs to Taxable Income to Eliminate, the “Delaware Loophole”
H.B. 465 attempts to close the “Delaware Loophole” for tax years beginning after December 31, 2014. Under the new provisions, corporations generally will not be allowed to deduct an “intangible expense or cost” or an “interest expense or cost” paid directly or indirectly to an affiliate. Intangible expenses or costs include royalties, licenses, fees paid for the acquisition, use maintenance, management, ownership, sale, exchange or other disposition of patents, patent applications, trade names, trademarks, service marks, copyrights, and similar expenses or costs.
However, the adjustment will not apply to a transaction that does not have as the “principal purpose” the avoidance of tax “and is done at arm’s-length rates and terms.” Determination of an affiliate is generally based on a 50% ownership test.
Net Operating Losses
The bill increases the annual utilization cap of the net operating loss deduction from the greater of $3 million or 20% of Pennsylvania apportioned income to the following:
- Tax Year 2014 — Greater of $4 million or 25% of income
- Tax Year 2015 and after — Greater of $5 million or 30% of income
The bill adopts “market-based” sourcing for the Corporate Net Income Tax sales apportionment factor with regard to the sale of services. Such sales will be sourced to where the benefit is being derived by the customer. The change is effective January 1, 2014. Sales of intangibles will continue to be sourced based upon cost of performance rules.
Capital Stock / Franchise Tax
The Capital Stock / Franchise Tax which was scheduled to expire in 2014, is extended for two additional years with the phase-out modified as follows:
- Tax Year 2013 — 0.89 mills
- Tax Year 2014 — 0.67 mills
- Tax Year 2015 — 0.45 mills
- Tax Years 2016 and after — Capital Stock / Franchise Tax is eliminated
S. B. 591 repeals the corporate loans tax effective for tax years beginning after December 31, 2013.
Personal Income Tax
H.B. 465 aligns Pennsylvania with Federal rules allowing start-up businesses to deduct $5,000 from taxable income in the year a business is established. The “start-up” deduction will be effective for tax year 2014.
In addition, the bill eliminates the resident tax credit for taxes paid to foreign countries. The change is effective beginning in Tax Year 2014. Note, credits allowed for taxes paid to other states remain in effect.
The bill permits taxpayers to immediately elect to expense intangible drilling and development costs as ordinary and necessary business expenses similar to the Federal IRC Section 263(c) rules. If a taxpayer does not make the election to expense intangible drilling and development costs they must be capitalized and recovered over a 10-year period. As an alternative, a taxpayer may elect to currently expense up to one-third of the costs in the taxable year in which the costs are incurred and recover the remaining costs over a ten-year period.
House Bill 465 extends the Personal Income Tax check-offs through tax year 2017 for contributions to the (1) Wildlife Resource Conservation, (2) Organ and Tissue Donor Awareness and the (3) Military Family Relief Assistance through 2017. Also, the legislation adds two new check-offs for contributions to the (1) Children’s Trust Fund and (2) American Red Cross.
Partnership and S Corporation and Other Pass-through Taxes
Effective for tax years beginning after December 31, 2013, partnerships and S corporations that underreport income by more than $1 million dollars can be directly assessed the underlying income tax. The provision applies to partnerships with 11 or more partners that are natural persons, and S corporations with 11 or more shareholders, to partnerships with at least one partner that is a corporation, LLC, partnership or trust. The tax does not apply to publically traded partnerships. Partners and shareholders are entitled to a credit for their share of the tax paid at the entity level and may be able to claim a refund if they would have owed no tax individually on the unreported income.
In addition, the bill expands the withholding tax requirements on pass-through entities by requiring estates and trusts to withhold tax on Pennsylvania-source income from non-resident beneficiaries.
Bank Shares Tax
The bill provides comprehensive reform of the Bank Shares Tax effective for the calendar year beginning January 1, 2014. The legislation significantly changes the calculation and apportionment provisions of the bank share tax and expands the tax to all banks that meet the definition of “doing business” in Pennsylvania. In addition the tax rate is reduced from 1.25% to 0.89%.
Sales & Use Tax
The bill provides an exclusion from sales tax for the sale of aircraft parts, services to aircraft and aircraft components. Aircraft eligible for the exemption include fixed wing aircraft, powered aircraft, tilt-rotor or tilt- wing aircraft, glider and unmanned aircraft.
In addition, the sales and use tax Call Center Credit is repealed.
House Bill 465 authorizes an extension of the additional 1% Philadelphia sales tax adopted in 2009 and scheduled to expire on June 30, 2014. Therefore, sales and use tax transactions within the City of Philadelphia will continue to be subject to tax at an aggregate rate of 8% permanently.
Realty Transfer Tax
Effective January 1, 2014, the definition of “real estate” is expanded to include all real property owned and not just real property “in the Commonwealth.” The definition of a “real estate company” is expanded to include holding companies whose assets consist of 90% or more of a direct or indirect interest in a real estate company.
In addition, the exemption from the realty transfer tax is restricted for “89/11” transactions by defining an “acquired company” to include transactions in which the purchasing party has a binding commitment or option to purchase 90% or more of a “real estate company” at any future date. In an 89/11 transaction, the buyer would acquire 89% of the real estate company, along with an option to purchase the remaining 11% after 3 years.
For estates of decedents dying on or after July 1, 2013, the transfer of all business assets, including real estate, between members of the same family, will not be subject to the inheritance tax if the qualified family-owned business interest continues to be owned by a qualified transferee (family member) for a minimum of seven years after the decedent's date of death. A "qualified family business interest” is a business that has been in existence for 5 years, has fewer than 50 full time equivalent employees, has a net book value less than $5 million, and is owned as a proprietorship by the decedent or by the decedent and members of the decedent’s family. If an asset that was exempt is no longer owned by a qualified transferee during the 7-year period, the asset will be subject to inheritance tax in the amount that would have been paid (plus interest accrued as of the date of death). In addition, the exemption does not apply to the transfers of businesses primarily engaged in the management of investments or income producing investments.
Repeals Section 2112 which is an obsolete provision relating to an exemption for poverty for spouses. Inheritance tax is no longer imposed on transfers to spouses.
Mobile Telecommunications Broadband Investment Tax Credit
A credit against the corporate income tax is provided for investment in qualified broadband equipment placed into service during the tax year for tax years starting January 1, 2014 and ending before December 31, 2023.
The credit is equal to 5% of the purchase price of the qualified broadband equipment, but cannot exceed 50% of the taxpayer's tax liability. The credit may be carried forward for up to five years, and a pass-through entity can transfer all or a portion of the credit to shareholders, members or partners in proportion to the share of the entity's distributive income. The total amount of credits approved by the Department may not exceed $5 million in any year.
Innovate in PA Tax Credit Program
A credit against the insurance premiums tax is created for investments by insurance companies in the Ben Franklin Technology Development Authority, the Ben Franklin Technology Partners, regional biotechnology research centers, the Department of Community and Economic Development and venture capital funds.
The Department is authorized to sell up to $100 million in tax credits after October 1, 2013. Credits can be claimed against insurance premiums tax liability incurred for tax years beginning on or after January 1, 2016 starting in 2017. The total amount of tax credits applied against the insurance premiums tax liability of all taxpayers in a fiscal year cannot exceed $20 million per year. Credits may be carried forward to subsequent tax years up 2025, and may be sold or transferred 30 days after written notice to the Department of Insurance and the Department of Revenue.
- House Bill 465 made modifications to the existing Film Tax Credit
- Clarifies Department of Community and Economic Development policy allowances in regard to the existing Job Creation Tax Credit
- Repeals the Coal Waste Removal and Ultraclean Fuels Tax Credit, which expired on January 1, 2013 and was never utilized.
City Revitalization and Improvement Zones (CRIZ)
The legislation establishes the CRIZ program to promote economic development and job creation in third class cities. Between July 9, 2013 and December 31, 2016 the Department of Community and Economic Development (DCED) may establish two zones in cities of the third class, allowing for abatement of several Pennsylvania and local taxes within the zones. After 2016, the DCED can approve 2 additional zones each year. There are 53 cities of a third class in Pennsylvania including Allentown, Harrisburg, Lancaster, Lebanon, Pottsville, Reading and York.
Tax Appeals Reform
Effective April 1, 2014, or the date when the two board members appointed by the governor have been sworn in, the Board of Finance and Revenue will be reorganized to include three full-time members two of which will be appointed by the governor and the state treasurer or the state treasurer's designee. All members must be attorneys or certified public accountants and have substantial knowledge of Pennsylvania tax law. Effective for all petitions filed with the Board of Finance and Revenue and all other business of the Board of Finance and Revenue on or after April 1, 2014, and all petitions filed with the Board of Finance and Revenue prior to April 1, 2014, that have not been the subject of a final and irrevocable decision by the Board of Finance and Revenue as of April 1, 2014, a petitioner and the Department of Revenue are each entitled to present oral and documentary evidence before the board with regard to tax appeals. The board may order a compromise settlement agreement of both parties. Board decisions will be published and publicly available online.
Electronic Payment Threshold Reduced to $1,000
Effective January 1, 2014, S. B. 591 mandates that payments of $1,000 or more for corporation, employer withholding and sales taxes be made electronically.
Lower Threshold for Preparers to E-file
Effective immediately, S.B. 591 requires electronic filing by third-partly preparers who annually submit 11 or more state tax reports or returns.
Contact the author, James H. Nehr at [email protected] or 610-378-1175.