This article is reprinted with permission from the June 2006 issue of Practical US/Domestic Tax Strategies.
On Saturday, July 1, the Pennsylvania General Assembly passed a number of bills, including Senate Bill 300, House Bill 859, House Bill 801, that contain significant Pennsylvania tax changes. The following are the most significant of those changes:
Corporate Net Income Tax
For tax years beginning on or after January 2007, the sales factor has increased from 60 to 70 percent. Pennsylvania uses a three factor apportionment formula that takes into account a corporation's sales, property and payroll within and outside of Pennsylvania to apportion a corporation's business income among the states in which the corporation does business. The increase in the weight of the sales factor has the effect of reducing a corporation's Pennsylvania corporate net income tax liability for those corporations that have significant property and payroll in Pennsylvania and that have significant out-of-state sales. Conversely, out-of-state corporations with less property and payroll in Pennsylvania will have an increased Pennsylvania corporate net income tax liability.
- Net Operating Loss
The current cap on net operating losses will increase from $2 million to the greater of $3 million or 12.5 percent of taxable income effective for tax years beginning on or after January 1, 2007.
- Research and Development Credit
The aggregate annual amount of available research and development tax credit has increased from $30 million to $40 million with $8 million of that amount set aside for small business. The amount of research and development expenses that may be used in calculating the tax credit for a small business has increased from 10 to 20 percent.
Capital Stock and Franchise Tax
- The phase out of the capital stock/franchise tax was accelerated by reducing the rate by an additional .010 mill to 4.89 mills for the 2006 year. In each year thereafter, the rate will be reduced by 1 mill so that the tax will be completely eliminated for tax year 2011 and thereafter.
- The definition of book income was amended effective January 1, 2006, to clarify that a limited liability company that is "a disregarded entity of a natural person" may deduct from book income distributions made to a natural person. Presumably this change was made to clarify that a single member LLC may deduct from book income distributions made to its sole member. The language of the statute appears to be broader. Indeed, the report of the Senate Appropriations Committee states that "the net income of a limited liability company not subject to taxation for federal income tax purposes is reduced by the amount of distributions made to any member who is a natural person." (Emphasis added)
- Single member Restricted Professional Companies will be exempt from capital stock/franchise tax for the 2006 tax year and thereafter.
- The fixed formula deduction used to calculate a taxable entity's capital stock tax value has increased from $125,000 to $150,000.
- A corporation that elects to be treated as an S corporation for federal tax purposes will automatically be treated as an S corporation for Pennsylvania tax purposes unless 100 percent of its shareholders elect otherwise. This provision, effective January 1, 2006, has the effect of addressing a common problem where corporations that elected to be treated as an S corporation for federal tax purposes inadvertently failed to file a Pennsylvania S election and thus were not treated as S corporations for Pennsylvania tax purposes.
- The maximum number of shareholders allowed in a Pennsylvania S corporation has increased form 75 to 100 to conform to federal law.
Personal Income Tax
Effective January 1, 2006, contributions to health savings accounts are not subject to Pennsylvania personal income tax, consistent with federal tax law.
What Didn't Pass
- The General Assembly did not act to legislatively reverse the Commonwealth Court's egregious and questionable holding in Graham Packaging that the electronic delivery of software is subject to Pennsylvania sales and use tax.
- The General Assembly also did not pass Senate Bill 993 which provides for substantial changes to Pennsylvania's administrative tax procedure and appeals system.
These issues may be reconsidered by the General Assembly in the fall.