A few days late but a few dollars ($1.5 billion) higher than Governor Wolf’s proposal, Pennsylvania has passed its budget for the 2022-23 fiscal year. Beyond simply allowing the state to continue to pay its bills, the annual budget legislation is a primary source of tax law changes in the state. This year brought much-discussed changes to the Corporate Net Income Tax (CNIT) and some last-minute changes to the Personal Income Tax (PIT).
PA Corporate Net Income Tax Changes
Tax rate: It has been a theme for years that Pennsylvania needs to do something about its CNIT rate. At a flat rate of 9.99 percent on C Corporation taxable income, Pennsylvania had the highest rate in the country except for New Jersey, which imposes an 11.5 percent rate on income over $1 million. In 2023, the corporate tax rate will drop to 8.99 percent and then will drop another half a percent per year until it bottoms out at 4.99 percent in 2031. Once fully phased down to 4.99 percent, Pennsylvania’s rate will have dropped from the second-highest in the country to the ninth-lowest among states that impose a CNIT (given current rates in other states, which are subject to change).
Taxing income from intangibles: As a separate filing state, Pennsylvania has long been susceptible to losing tax revenue from tax planning strategies of a C Corporation setting up an intangible holding company (IHC) in another state (primarily Delaware), with the operating company then paying substantial royalties to the IHC, siphoning taxable income out of Pennsylvania to a state where it was non-taxable. Expense addback provisions have lessened the effectiveness of this tax planning strategy, but there were still exceptions to these provisions and some outdated laws that kept this strategy alive…until now.
While the full leap to combined reporting (instead of separate filing) did not occur, two other changes make the use of IHCs virtually obsolete for Pennsylvania-based C Corporations:
- Pennsylvania codified an economic nexus rule that says a C Corporation is subject to tax if it has over $500,000 of sales sourced to the state.
- The sourcing for receipts derived from intangibles was changed from cost-of-performance (where the intangible was managed) to market-based (where the intangible is used).
The combination of these changes means Pennsylvania can now directly tax IHCs that previously escaped tax altogether in the state or were, at best, maybe taxed indirectly through the expense addback provisions.
Note that the economic nexus rule above will apply not only to IHCs but to any non-Pennsylvania C Corporation with sales over $500,000 that are not otherwise protected from income tax by federal Public Law 86-272. That law can protect certain sellers of tangible personal property, but not companies that generate revenue through providing services to customers, so non-Pennsylvania service providers will get caught by the newly-codified economic nexus rule as well.
PA Personal Income Tax Changes
A last-minute set of amendments to the tax code as part of the budget process provides opportunities for individuals, including owners of pass-through entities, to save on their PIT when acquiring assets, starting in tax year 2023.
- The amount that can be expensed under Internal Revenue Code 179 for Pennsylvania PIT purposes has been increased from $25,000 per year to match the federal amount ($1,080,000 for 2022 and adjusted annually for inflation).
- Pennsylvania will now allow tax-deferred like-kind exchanges as allowed under Internal Revenue Code 1031 for real estate.
Items Not in the PA Budget Legislation
Three items of significance were not in the budget legislation – here is where things stand with elective pass-through entity tax, accelerated sales tax payment requirements and sales and use tax on non-fungible tokens (NFTs).
Elective pass-through entity tax: Pennsylvania is now one of only 13 states that have not passed a law to allow owners of pass-through entities to avoid the federal $10,000 state and local tax deduction cap. There has been a bill pending for over a year in the General Assembly, but the state Department of Revenue (DOR) is opposed to it and its future is unclear.
Accelerated sales tax payment requirements: Although the business community hoped it would be eliminated, the requirement for certain businesses to prepay their monthly sales tax liability continues to exist. This applies to companies with sales tax remittances of at least $25,000 in the third quarter of the prior year, with these companies needing to continue to prepay about half of their sales tax by the 20th of each month instead of being able to remit their entire balance by the 20th of the following month.
Sales and use tax on NFTs: Without any fanfare or explanation, DOR announced in June that NFTs are subject to sales and use tax as a digital product. This emerging technology and market presents many questions regarding state taxes, and Pennsylvania is one of the first states to address the matter at all. Hopefully, DOR will provide more robust guidance soon to support their assertion of taxability. In the meantime, contact your RKL advisor if you invest in NFTs to discuss tax consequences.
RKL’s State and Local Tax team closely tracks state budget negotiations, along with all proposed legislative efforts, for taxpayer impact. Contact us via the form below with any questions or for more information on these budget provisions.