January 7, 2011

Philadelphia Tax Reform – Will It Ever Happen?

Philadelphia Tax Reform – Will It Ever Happen? Tax & Business

Over the years since its inception, the Philadelphia Business Privilege Tax has seen its share of detractors. Proponents for change have cited the inequality of those who bear the burden of the tax and a confusing system, resulting in businesses choosing not to do business in the city. City Council members Bill Green and Maria Quinones Sanchez have recently introduced legislation (Bill #100635) that, while currently on hold and pending changes, may just be the solution many have been waiting for.

Current Structure
Currently, the Business Privilege Tax is a two-pronged system: a 6.45% tax on net income and a 0.1415% tax on gross receipts. Any receipts that are sourced to Philadelphia are subject to the gross receipts portion of the tax; this would subject any company to tax on Philadelphia-sourced sales, whether it be a corner store, a suburban consulting firm or a nationwide wholesaler. However, the net income portion of the tax is imposed on net income that is apportioned to Philadelphia using a three-factor apportionment formula. Consequently, the companies that bear the majority of the net income tax burden are those located within the city and those with Philadelphia employees.

The result is a potential disincentive for profitable businesses to headquarter within city limits; after all, why pay an extra layer of tax on your profits when you can move a few blocks away and reach the same market?

Proposed Legislation
The proposed legislation (as of January 5, 2011) is intended to encourage economic growth in Philadelphia and remove this disincentive to businesses located in the city. The bill seeks to accomplish this by eliminating the net income portion of the tax and increasing the rate of the gross receipts tax from 0.1415% to 0.53% of Philadelphia sales. The changes to both the net income and gross receipts taxes will phase in over the next 5 years, fully implemented in 2015.

This change would shift the tax burden, spreading it over a much wider base. Much of the incentive to locate outside of the city would therefore be removed because a company will pay the same amount of gross receipts tax on its Philadelphia receipts no matter where the company is located. Additionally, companies may be more willing to employ workers in Philadelphia with the potential danger of increasing their payroll apportioned to the city eliminated.

In order to ensure that the new structure is not a burden to small companies that have yet to turn a profit, the proposal exempts from the gross receipts tax the first $100,000 of a company’s annual sales. This would result in an estimated 50,000 Philadelphia-based small businesses that would pay no tax.

Effects on Taxpayers
While the proposal does its best to spread the tax burden evenly, there will be taxpayers who will benefit from the changes more than others. Professional firms such as attorneys, accountants and management consultants would potentially benefit from a shift to a gross receipts-only tax, particularly Philadelphia-based firms who earn a substantial portion of their receipts by performing their services at client locations outside of Philadelphia. On the other end of the spectrum, industries with generally high receipts and low profit margins, such as hotels and retailers, are likely to be hurt by the change. However, even those industries which may shoulder a somewhat higher tax burden stand to make a greater overall profit, as they too would benefit from a thriving city economy.

Where Do We Go From Here?
While there are always winners and losers to any tax law change, the overall benefits of a broader tax base, a more active economy and a simpler tax system seem worth pursuing. Representatives of certain industries have expressed concerns over the bill as it is currently written; and while the current version of the bill was tabled by City Council, at a December 15, 2010 press conference Mayor Michael Nutter has stated that a final bill may be completed as early as February 2011. For those interested in seeing how the bill may affect their company’s tax liability, the City has published a website where taxpayers can calculate an estimate of their taxes under the proposed system. If you have any questions about how the bill may affect you or about the status of the bill, please contact your dedicated Marcum professional.

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