Home Stretch to a PA Budget

by McNees Wallace & Nurick LLC

As the Pennsylvania General Assembly heads down the home stretch to the June 30th deadline for passage of a budget for 2013-14, all indications suggest that the budget package will include significant substantive and administrative tax changes. The real question is whether the changes will include any surprises.

On May 6th, the Pennsylvania House of Representatives passed H.B. 440, as amended, and sent it to the PA Senate where it likely will undergo further revisions before possible passage as part of the 2013-14 budget package. As we reported in our February newsletter, this bill was introduced by Representative Dave Reed and a host of co-sponsors to reprise tax legislation which also passed the House but did not make it through the Senate last year. This time, the bill was amended in committee before reaching the floor, to retain Reed’s royalty add-back provisions and incorporate many of the tax provisions from Governor Corbett’s budget proposal.

The question now is whether the provisions now in H.B. 440 will survive in the final 2013-14 budget package and whether there will be any significant changes or additions. Following are short summaries of the current H.B. 440 provisions.

  • Corporate Net Income (CNI) Tax Rate would be phased down from the current 9.99% to 9.89% for taxable years beginning on or after January 1, 2015, and then in annual increments until being reduced to 6.99% for tax years beginning on or after January 1, 2025.
  • CNI Sales Factor Sourcing Rules would be amended for tax years beginning after December 31, 2013. Receipts from sale, lease, rental or otherwise of real property would be sourced to the property location. Receipts from rental, lease or licensing of tangible personal property would be sourced initially to Pennsylvania if the customer first obtained possession in PA and, if subsequently taken out of state, a reasonable estimate of PA usage could be applied. Instead of applying the current “costs of performance” rules, receipts from sales of services would be sourced to PA if “delivered to a location in” PA and, if delivered to locations in multiple states, part of the receipts would be attributed to PA, based on the percentage of the value of the service delivered to PA. If a taxpayer could not determine the delivery point, sales to an individual (not a sole proprietor) would be sourced to the person’s billing address and sales to other customers would be sourced to the point from which the customer placed its order in the regular course of operations (or to the customer’s billing address if the taxpayer could not determine where the order was issued). The standard “destination” rule would continue to apply to sales of tangible personal property and the “costs of performance” rules would continue to apply to sales of intangibles.
  • CNI Net Loss Deduction Cap would be increased from the greater of 20% or $3 million to the greater of 25% or $4 million for tax years beginning in 2014 and to the greater of 30% or $5 million thereafter.
  • Add-back of Royalties and Interest - Deductions would be disallowed for “intangible expenses or costs” (i.e., royalties, license fees, etc,) and “interest expenses or costs” to the extent “directly related to an intangible expense or cost,” when paid to an “affiliated entity” (50% ownership test). A credit would be provided where the affiliate pays tax to PA or another state on the income. Deductions would not be required where (a) the affiliate passes payment through to an entity which is not an affiliate; (b) the affiliate to which payment is made is located in a foreign nation with a comprehensive U.S. income tax treaty; or
    (c) the transaction with the affiliate is directly related to a “valid business purpose” (which is presumed if done at arm’s length terms).
  • CNI Penalties for failure to file a timely report would be increased to $500 plus one percent “for every dollar of tax determined to be due in excess of … $25,000.”
  • Capital Stock/Franchise Tax Phase-out would not be changed - the tax rate is 0.89 mills for 2013 and 0 mills thereafter.
  • Sales & Use Tax provisions would remain essentially unchanged. As passed by the House, there would be no change in the 1% vendor’s collection allowance. The “call center” credit provisions would be repealed. County treasurers would no longer be designated as local receivers of use tax.
  • PIT - “Net Profits” would be reduced to the extent a deduction is taken for federal tax purposes under IRC § 195(6)(1)(A) (start up business deduction).
  • PIT - “Net Gains or Net Income, less net losses” would no longer include gain or loss from exchange of property qualifying under IRC § 1031 and related regs.
  • PIT - Partnership - The classification or character of income would be determined at the partnership level.
  • PIT - Partnership and S Corporation Tax - Certain partnerships underreporting reportable income by more than $1 million would be jointly liable with each partner. Publicly traded partnerships would not be covered. The provisions would apply to partnerships with 11 or more individual partners and those with at least one partner that is a corporation, limited liability company, partnership or trust. Other partnerships with only individual partners could elect to be subject. Similar provisions would apply to Pennsylvania S Corporations with 11 or more shareholders or which elect to be covered.
  • PIT - Credit would not be allowed for taxes paid to a foreign country.
  • PIT - Estates and trusts receiving PA-source income would be required to pay withholding tax for nonresident beneficiaries.
  • PIT - The Revenue Department could establish requirements for information to be provided by Pennsylvania S Corporations to their shareholders, by partnerships to their partners and by estates and trusts to their beneficiaries.
  • PIT - Estates, trusts, Pennsylvania S Corporations and partnerships (except publicly traded partnerships) which fail to maintain appropriate lists of beneficiaries, shareholders and partners would become responsible for tax, penalties and interest otherwise due from the beneficiaries, shareholders and partners, as would the respective trustees, corporate officers, general partners and tax matters partners.
  • Realty Transfer Tax - Would eliminate the provision allowing tax avoidance by transferring 89% of interests in a “real estate company” with an option to purchase the remaining 11% after three years.
  • Credits - The Coal Waste Removal and Ultraclean Fuels Tax Credit would be repealed.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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