In a major set back for Pennsylvania businesses and their employees, Governor Rendell has vetoed legislation that would have adopted the federal constructive receipt rule for purposes of applying Pennsylvania's personal income tax to nonqualified deferred compensation plans.  While the governor's veto has likely put an end to any further developments on this matter for 2004, it very likely that Pennsylvania's General Assembly will revisit this issue when it reconvenes in 2005.

Nonqualified Deferred Compensation in Pennsylvania

In applying Pennsylvania's personal income tax law to nonqualified deferred compensation plans, the PA Department of Revenue has determined that voluntary employee contributions to an unfunded, nonqualified deferred compensation plan are constructively received in the year deferred (not the year in which the amounts are ultimately paid). While this position is inconsistent with a well-developed body of federal income tax law, the Commonwealth Court of Pennsylvania recently upheld the Department of Revenue's position. See Ignatz v. Commonwealth of Pennsylvania, 2004 WL 1057453 (Pa. Commw. May 12, 2004) (No. 136 F.R. 2003, 397 F.R. 2003). The Ignatz decision caught the attention of many employers due to its potential application to a broad range of nonqualified elective deferral arrangements. Currently, the parties to the Ignatz decision have filed exceptions with the court regarding its decision and oral arguments are scheduled for February 2005.

Governor's Veto

Governor Rendell vetoed House Bill 176 citing uncertainties regarding its application and the potential for a significant loss of revenue to the commonwealth. In particular, the governor was concerned that the provisions of the House Bill could be interpreted to apply to voluntary deferrals into qualified retirement plans, such as 401(k) plans. Based on this interpretation, the governor stated that the loss of revenue to Pennsylvania would be in excess of $220 million annually. The governor also reaffirmed his intent to enforce a "pay as you go budget process" and indicated that the House Bill would have reduced the commonwealth's revenue without compensation for the loss through additional sources of revenues and/or expense reductions. 

THE ABOVE ADVICE WAS NOT INTENDED OR WRITTEN TO BE USED, AND IT CANNOT BE USED, BY YOU FOR THE PURPOSE OF (1) AVOIDING ANY PENALTY THAT MAY BE IMPOSED BY THE INTERNAL REVENUE SERVICE OR (2) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY TRANSACTION OR MATTER ADDRESSED HEREIN.  IF YOU DESIRE SUCH AN OPINION, PLEASE SO ADVISE.