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Pennsylvania Basic Business Taxes

Feb/Mar 09
Corporate net income tax:
Pennsylvania's corporate net income tax rate is 9.99 percent based on federal taxable income before the net operating loss deduction with certain modifications (e.g., addition of taxes based on income and federal "bonus" depreciation and deduction of dividends received). Generally, Pennsylvania follows the federal rules for depreciation, EXCEPT that Pennsylvania does not allow for the deduction of post-9/11 "bonus" depreciation. For corporate net income tax purposes, limited liability companies are treated in the same manner as for federal income tax purposes.
                    
Pennsylvania corporate net income tax is calculated on a separate company basis, meaning each corporation in the state, regardless of its affiliation with any other entity, individually computes its income or loss and apportions the income or loss with regard to activities of related group members. States that require legal entities to report their income on a combined or consolidated return often have a higher effective income tax rate.

Pennsylvania does not require adjustments for inter-company expenses (e.g. interest and royalty). Several states have recently passed legislation disallowing interest and/or intangible expenses to related entities. These states require that such payments be added back when computing taxable income. The effect of these disallowances is to increase the effective state income tax rates in these jurisdictions.

Pennsylvania does not impose a "throwback" or "throw out" rule in calculating Pennsylvania receipts. The "throwback" rule refers to the fact that some states capture not only sales destined for their state, but also sales made from their state to other states in which the company is not taxed. Imposition of a throwback sales rule can greatly increase a company's apportionment factor and consequently, its tax burden. NOTE: Similar to the throwback rule is the "throw out rule" applied by New Jersey. This concept requires the company to exclude from the denominator sales made to states in which the company is not taxed.

Income is apportioned to Pennsylvania using a three-factor formula consisting of payroll (15 percent), property (15 percent) and receipts/sales (70 percent) for taxable years beginning after December 31, 2006. The importance of weighing the sales factor more heavily is that it reduces some of the tax detriments of increasing a company's property and payroll in the state.  It also favors in-state companies that are selling out of state.

Net operating losses may be deducted to reduce state income tax. For taxable years beginning after December 31, 2006, the deduction for net operating loss is the greater of 12.5 percent of taxable income or $3 million. This is an increase from the prior limit of $2 million. Net operating losses incurred in years 1998 and thereafter may be carried forward for 20 years.

State tax credits and/or abatements may be applied to reduce state corporate net income tax. Credits include:
• Job Creation Tax Credit;
• Educational Improvement Tax Credit;
• Neighborhood Assistance Tax Credit;
• Enterprise Zone Tax Credit;
• Tax credits, abatements,  and exemptions for investment in a Keystone Opportunity Zone (KOZ);
• Research and Development Tax Credit;
• Resource Enhancement and Protection Tax Credit.

The Research and Development Tax Credit for businesses has been expanded to provide that credits may be approved in an amount not to exceed $40 million in any fiscal year with $8 million allocated exclusively for small businesses. Taxpayers can now sell or assign a research and development tax credit within one year from the date that the credit was approved.

Pass-through entities are now eligible for the Neighborhood Assistance Tax Credit. If the entity cannot use this credit, the entity may elect, in writing, to transfer the credit to its shareholders, members or partners in proportion to the share of the entity's distributive income to which the shareholder, member or partner is entitled.  This credit may now be sold or assigned.

 The effect of apportionment on the corporate net income (CNI) tax rate:
Although the base rate for Pennsylvania's corporate net income tax is 9.99 percent, the effective rate can vary greatly, depending on a number of factors, particularly on how a company's property, payroll, and sales are apportioned. For example, with Pennsylvania's apportionment formula (15 percent payroll, 15 percent property, and 70 percent sales), a company operating in Pennsylvania with 40 percent in-state property, 50 percent in-state payroll, and 5 percent in-state sales would have an effective rate of 1.70 percent. Thus, a company may have a lower effective CNI rate in Pennsylvania than in a state that has a lower base rate.

Capital stock/foreign franchise tax:
This tax is based on a corporation's capital stock value apportioned to Pennsylvania. For capital stock/foreign franchise tax purposes, limited liability companies are treated as separate "corporations" and are taxed as separate entities. The capital stock value is based on a fixed statutory formula expressed as:

[.5  x  (average net income / .095 + (.75)(net worth))] - $125,000

 
For taxable years beginning after December 31, 2006, the exclusion exemption is increased from $125,000 to $150,000. Thus, for tax years beginning January 1, 2007, the formula is:

[.5  x  (average net income / .095 + (.75)(net worth))] - $150,000

Average net income equals the preceding four years of book income plus the current year divided by 5 (average net income is capitalized by dividing by .095).

Net worth is generally the value of outstanding stock, surplus and retained earnings on the last day of the tax year, but may be computed as an average if the ending value is more than twice or less than half of the beginning value. In the case of a parent entity, this value is based on the consolidated values of the parent and subsidiaries.

The capital stock value is apportioned based on one of two apportionment methods. The first is an equally weighted three-factor apportionment formula, consisting of payroll (33.33 percent), property (33.33 percent) and receipts (33.33 percent). Manufacturing entities utilizing this apportionment method may exclude from the property and payroll numerators the Pennsylvania property and payroll utilized in manufacturing activities.

The second apportionment formula is a single factor exempt asset formula (i.e., taxable assets divided by total assets).

The following are exempt from the capital stock and franchise tax:
• assets used in manufacturing, processing or research and development;
• tangible assets located outside of Pennsylvania;
• pollution control devices;
• certain government obligations;
• stock of Pennsylvania corporations;
• stock of majority-owned foreign corporations.

There is neither a minimum nor a maximum capital stock/foreign franchise tax.

The capital stock and franchise tax is being phased out and is currently scheduled to expire after 2010. In addition the rate will be reduced by one mil each year until the tax is eliminated.
 
Capital stock and franchise tax reduction schedule:

  Year                           Rate                 % Reduction Over Prior Year

2008                 2.89 mills (0.00289)              26
2009                  1.89 mills (0.00189)              36
2010                  0.89 mills (0.00089)              52
2011                  0 mills                                         100

State tax credits and/or abatements may be applied to reduce the capital stock and franchise tax. Credits include:
• Job Creation Tax Credit;
• Educational Improvement Tax Credit;
• Neighborhood Assistance Tax Credit;
• Enterprise Zone Tax Credit;
• Tax credits, abatements, and exemptions for investment in a Keystone Opportunity Zone (KOZ);
• Research and Development Tax Credit;
• Resource Enhancement and Protection Tax Credit.

Sales and use tax:
The sales tax is imposed on the sale at retail within Pennsylvania of tangible personal property and certain specifically-enumerated services.

The use tax is the complementary tax imposed on the use within Pennsylvania of tangible personal property and on taxable purchases within Pennsylvania upon which no sales tax has been paid. Additionally, certain specifically-enumerated services delivered within Pennsylvania are also subject to the use tax.

The state rate is 6 percent. Allegheny County (including the City of Pittsburgh) and Philadelphia County are the only municipalities that impose an additional 1 percent local sales and use tax. Taxability of transactions is consistent between Pennsylvania and these counties.

Purchases of materials to be consumed in manufacturing or those to be used directly in manufacturing (e.g., equipment, raw materials, etc.) are exempt from the sales and use tax.

The following specifically-enumerated services are subject to sales and use tax in Pennsylvania; all other services are excluded from sales and use tax:
• cleaning, inspecting, lubricating, polishing, washing, or waxing motor vehicles;
• applying or installing tangible personal property as a repair or replacement part of personal property other than clothing or shoes;
• altering, cleaning, dry-cleaning, dyeing, fitting, laundering, mending, pressing, or repairing tangible personal property other than clothing or shoes;
• imprinting or printing of tangible personal property of others;
• labor or service charges by a vendor for delivering, installing, or applying tangible personal property sold by the vendor;
• lobbying services;
• adjustment, collection, or credit reporting services;
• secretarial or editing services;
• disinfecting or pest control services, building maintenance or cleaning services;
• employment agency or help supply services;
• lawn care services;
• self-storage services.

It is important to note that purchases of custom computer software, as well as purchases of computer services (i.e., programming, customization, etc.) are not subject to Pennsylvania state or local sales and use tax.

Property tax:
Pennsylvania does not impose real property taxes at the state level. Real property taxes are imposed by counties, municipalities, and school districts. Real property taxes are imposed on the assessed value of the property as established by the local assessor. The assessed value is multiplied by the county's common level ratio (i.e., assessment ratio) and the tax rate (millage).

Unlike many other states, Pennsylvania and its counties do not impose a tax on personal property, whether tangible or intangible.

Realty transfer tax:
The realty transfer tax is based on the value of property transferred within Pennsylvania, and is imposed on any person, association, or corporation that makes such a transfer.  The rates are as follows: state level, 1 percent; county level, 1 percent; Philadelphia, 3 percent; Pittsburgh, 2.5 percent. The county and local taxes are imposed in addition to the 1 percent state tax.

Personal income tax:
The Pennsylvania personal income tax is imposed on eight classes of income, including wages/compensation. The tax is generally applicable to gross income and does not allow for broad deductions similar to those allowed when calculating the federal personal income tax. This tax is imposed at a 3.07 percent flat rate, which is low compared to other states, and particularly when compared to states in the Northeast.

State Contact Information:
Governor's Action Team
Commonwealth of Pennsylvania
400 North Street
Commonwealth Keystone Building
Harrisburg, PA  17120
(717) 787-8199
Fax: (717) 772-5419

Incentive and tax information is provided to Area Development by each state's economic development or commerce agency for information purposes only and is subject to revision at any time by the state government. Please contact the state agency directly for full requirements and offerings.

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