On May 1, the Pennsylvania General Assembly passed HB 2150 that would make some significant changes to the state’s corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. system. The proposal will go to the Senate for consideration.
Gradual Rate Reduction
A major feature of the legislation is the reduction of the flat corporate income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
to 6.99 percent from 9.99 percent. The gradual phase down would occur in increments over six years, beginning in 2014 (see table below). The state’s current high tax rate, second only to Iowa (12% top rate), contributes to their ranking of 44th in the corporate income tax section our State Business Tax Climate Index (they are 19th overall). This rate reduction, coupled with a broadening of the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.
(largely avoided in this bill), would be a great way to improve the state’s business tax system.
Single Sales Factor
The second part of the bill changes Pennsylvania’s apportionmentApportionment is the determination of the percentage of a business’ profits subject to a given jurisdiction’s corporate income or other business taxes. U.S. states apportion business profits based on some combination of the percentage of company property, payroll, and sales located within their borders.
formula for state corporate income tax to a single sales factor. All business income will be apportioned by 100 percent of a company’s sales instead of a mix of property, payroll, and sales.
Switching to a single sales factor could be problematic. States that adopt such an apportionment formula are essentially shifting the corporate tax burden from in-state businesses with lots of property and employees to out-of-state businesses with substantial sales into the state. Large corporations with headquarters in Pennsylvania that have a majority of sales outside of the state would be taxed less than in-state businesses that derive most of their sales from within Pennsylvania.
The “Delaware Loophole”
The bill attempts to address the so-called “Delaware loophole” as it pertains to expenses related to the lease of intangible property from affiliated companies in Delaware. In this tax arrangement, a corporation doing business in Pennsylvania can lease intangible property, such as a corporate logo, from a company located in Delaware that holds the rights to that property. The lease payments are deductible as a cost of doing business for the Pennsylvania company, but as far as Delaware is concerned, the payments are not taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income.
for the holding company. Thus this provides a tax advantage, especially when the two companies involved are affiliated (e.g the Delaware company is a subsidiary of the Pennsylvania company). The Pennsylvania bill would disallow the deduction for lease/royalty payments if the two companies are affiliated.
Uncaps Net Operating Loss Deductions
Generally, when a company’s expenses exceed its taxable total income for the year (a net operating loss, or NOL) that company can use the losses to lower their income and reduce their taxes for past or future years, helping to smooth out often volatile business income. Pennsylvania caps net operating loss carry-forwards, one of only a few states to do so, at the greater of $3 million or 20% of taxable income. This bill will eliminate Pennsylvania’s cap over nine years, putting them in line with the vast majority of other states.
More information on the Keystone State.
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HR 2150 Tax Rate Reduction Schedule |
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Corporate Tax Rate |
Net Operating Loss Deduction from Taxable Income (Lesser of) |
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December 31, 2013 |
9.99% |
33% or four million dollars ($4,000,000) |
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December 31, 2014 |
9.49% |
45% or five million dollars ($5,000,000) |
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December 31, 2015 |
8.75% |
56% or six million dollars ($6,000,000) |
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December 31, 2016 |
8.25% |
66% or seven million dollars ($7,000,000) |
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December 31, 2017 |
7.75% |
75% or eight million dollars ($8,000,000) |
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December 31, 2018 |
7.25% |
83% or nine million dollars ($9,000,000) |
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December 31, 2019 |
6.99% |
90% or ten million dollars ($10,000,000) |
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December 31, 2020 |
6.99% |
96% or eleven million dollars ($11,000,000) |
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December 31, 2021 |
6.99% |
100% or twelve million dollars ($12,000,000) |