State and Local Tax Partner Jaime Reichardt shares his thoughts on upcoming tax changes in Pennsylvania and Philadelphia in this article.
Q: What is all the news I hear about Pennsylvania corporate tax reforms?
JR: On July 8, Governor Wolf signed a series of state tax changes into law, including lowering the corporate net income (“CNI”) tax rate to 4.99% by 2031 and shifting the method for sourcing revenue from intangibles to a customer based/intangible-use approach when apportioning net income. The rate will be reduced to 8.99% for the 2023 tax year and further reduced by .5% annually until reaching 4.99% in 2031.
Under current law, businesses who generate research, intellectual property and know-how in Pennsylvania are penalized. The sourcing change of looking to customer location/use takes effect for tax year 2023 and is consistent with the market sourcing change for revenue from services enacted in 2014. The sourcing changes should produce a significant tax benefit for companies producing intangibles and providing services in the state.
Q: What about small businesses and pass-through entities?
JR:Most businesses operate as pass-through entities (PTE), meaning the owners or partners are taxed, not the entity. The state reforms include two major personal income tax (PIT) changes as well: PIT rules will recognize Internal Revenue Code (IRC) 1031 transactions and conform with IRC 179. IRC 1031 allows taxpayers to defer capital gains from real estate if proceeds are invested in-kind. Certain depreciable business assets can be expensed through IRC 179. These PIT changes are set to take effect for tax year 2023. The legislation also codified the Department of Revenue’s position on not taxing PPP loan forgiveness, while permitting expenses paid with loan proceeds. Legislation enacting an elective PTE tax is under consideration, which would help small business owners with the federal $10,000 cap on state and local taxes to be deducted.
Q: What kind of tax changes can we expect for Philadelphia?
JR: The wage tax and net profits tax for residents will drop to 3.79% (3.44% for nonresidents), while the net income tax rate of the Business Income and Receipts Tax (BIRT) will fall to 5.99%. Philadelphia also approved legislation to source revenue from services based on a market sourcing approach, which requires state approval. Currently, only software companies and those businesses selling tangible personal property use a customer/destination-based sourcing approach for apportioning net income under the BIRT. The market sourcing change should eliminate a major disincentive from locating and performing services in the city. Coupled with broad economic nexus (tax subjectivity) rules, this change will cause the tax burden to shift more towards out-of-city taxpayers, as opposed to Philadelphia-based taxpayers engaged in providing services.
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