Last week, Pennsylvania Governor, Tom Corbett, signed several significant Pennsylvania tax changes into law as part of the Fiscal 2014 budget, which affect both business and personal income taxes. Below is a brief summary of the highlights of the provisions in the bill.
Intangible Expense Addback
In an effort to close the "Delaware loophole", Pennsylvania has adopted an addback for intangible expenses, such as royalties or licenses, and interest expenses paid to an affiliated entity for all tax years beginning after December 31, 2014. Prior to the creation of this addback, corporations were able to escape state taxation on a portion of revenues by setting up an affiliated holding company in another state, such as Delaware, which would collect royalties and/or interest from the operating company doing business in Pennsylvania. This addback eliminates the benefit received by using this planning technique. The adjustment only applies to transactions between affiliated entities, but will not apply to those involving certain foreign-based affiliated entities. It should be noted that no addback would be required if it can be shown that the transaction was entered into with a valid business purpose and established at arm's length terms and rates. Additionally, a credit will be available if the affiliate receiving the income pays tax to Pennsylvania or another state on the income received under these agreements.
Apportionment for Service Providers: Shift to Market-Based Sourcing
For tax years after December 31, 2013, Pennsylvania has modified its rules regarding the sourcing of sales of services for purposes of computing state apportionment. Under current law, sales of services are sourced to the state in which the costs of the performance of these services are greatest. The new law requires these sales of services to be sourced to the state in which the customer receiving the benefit is located. In other words, if a Pennsylvania company performs a service for a customer located in New Jersey, that sale will excluded from the company's Pennsylvania sales factor. An out-of-state company performing services for customers located in Pennsylvania will be required to include those sales in its Pennsylvania sales factor, assuming that the out-of-state company has nexus in Pennsylvania. Pennsylvania now joins the growing list of states which have adopted Market Based Sourcing provisions for service providers.
The new law increases the limits imposed on the utilization of net operating losses for corporations. For tax years beginning after December 31, 2013, net operating losses will be limited to the greater of 25% of taxable income or $4 million. Furthermore, for all tax years beginning after December 31, 2014, this limit will be increased to the greater of 35% of taxable income, or $5 million.
2 Year Extension of Capital Stock Tax
The capital stock tax, which was previously set to expire after the 2013 tax year, is now scheduled to expire for tax years beginning after December 31, 2015. The tax rate for 2014 tax years will be .67 mills, and it will decrease to .45 mills for 2015 tax years.
Pass-Through Entity Compliance Initiatives
Estates and trusts will be required to withhold tax for nonresident beneficiaries for all tax years beginning after December 31, 2013. Additionally, pass-through entities are now required to provide Forms RK-1 and NRK-1 to all beneficiaries, partners, or shareholders. Finally, Pennsylvania may now assess tax at the entity level for certain pass-through entities that have underreported income.
Personal Income Tax
Pennsylvania made several changes to the Personal Income Tax, effective for tax years beginning after December 31, 2013. First, the credit for taxes paid to foreign countries has been eliminated. Taxpayers can now only claim credit for taxes paid to other states within the U.S. Additionally, Pennsylvania will now allow taxpayers to deduct start-up costs up to the amount deducted on their federal tax return. Taxpayers must also capitalize intangible drilling costs unless an election is made on the federal tax return to expense up to one third of the costs in the year incurred and capitalize the remaining two thirds. In either case, the capitalized amount is recovered over 10 years.
Pennsylvania enacted several new credits and changed or extended several existing credits. Any purchaser or assignee of a Film Production Tax Credit in 2013 or 2014 may now carry that credit forward to 2014 (if acquired in 2013) or 2015 (if acquired in 2014). The Mobile Telecommunications Broadband Investment tax credit was established for 5% of the available qualified broadband equipment placed into service in tax years beginning January 1, 2014 and ending December 31, 2023. The Innovate in PA Tax Credit was also enacted for insurance companies who invest in certain tech investment entities. Up to $100 million in tax credits can be sold to taxpayers to be applied against the insurance premiums tax liability. The Keystone Special Development Zone tax credit was extended permanently. Finally, the Job Creation Tax Credit was amended to allow the full amount of a multi-year tax credit to be awarded in the first year in which the new job is created.