Governor Wolf and the Pennsylvania State Legislature have passed the 2022-2023 Pennsylvania state budget, which contains several tax provisions including a corporate net income (CNI) tax rate reduction.
CNIT Rate Reduction
For tax years beginning on, or after, January 1, 2023, the CNI, which is currently one of the highest in the country at 9.99%, will gradually be cut in half to 4.99% over nine years. It will be reduced to 8.99% for tax year 2023 and will drop by 0.5% every year through 2031. Following are the rate reductions by year:
Market-based sourcing changes
For tax years beginning after December 31, 2022, the cost of performance sourcing methodology for intangibles is repealed and replaced with market-based sourcing based on the following rules:
- Gross receipts from the lease or license of intangible property, including sales or exchange of property where the receipts from the sale or exchange derive from payments that are contingent on the productivity, use or disposition of the property, are sourced to Pennsylvania if, and to the extent that, the property is used in the state.
- Gross receipts from the sale of intangible property where the property sold is a contract right, government license or similar property that authorizes the holder to conduct a business activity in a specific geographic area, are sourced to Pennsylvania if, and to the extent that, the property is used in, or otherwise associated with, the state.
- Gross receipts from the sale, redemption, maturity, or exchange of securities (held by the taxpayer primarily for sale to customers in the ordinary course of its trade or business) are sourced to customer location.
- In general, gross receipts received by a corporation that regularly lends funds to unaffiliated entities or to individuals from interest, fees, or penalties imposed in connection with loans secured by real property, are sourced based on the location of the real property.
- In general, if the loan is secured by tangible personal property, gross receipts are sourced to the state where the property is delivered or shipped to a purchaser. Gross receipts relating to transportation property are sourced “to the extent the property is used” in a state. An aircraft’s “use” is measured by aircraft landings. A motor vehicle’s “use” is where it is registered. If use cannot be determined, use is deemed to be where the property was delivered or shipped to the customer.
- For all other loans to unaffiliated entities or to individuals not described above (i.e., for loans not in connection with real property or tangible personal property), gross receipts are sourced to location of the borrower.
- Receipts from interest not otherwise described in the statute are sourced based on the lender’s state of commercial domicile, which is generally defined as the principal place from which the trade or business of the taxpayer is directed or managed.
- Gross receipts from intangible property not otherwise described in the statute are excluded from the numerator and denominator of the sales factor.
For tax years beginning after December 31, 2022, the legislation provides that “having substantial nexus” is included in the list of activities that require a corporation to file a PA CNI tax return.
Under the new rules, having a substantial nexus means “a direct or indirect business activity that is sufficient to grant the Commonwealth authority under the Constitution of the United States to impose” the CNI tax. Business activity includes, but is not limited to:
- The leasing or licensing of intangible property that is utilized in Pennsylvania;
- Regularly engaging in transactions with customers in Pennsylvania involving intangible property, including loans made by a corporation that regularly lends funds to unaffiliated entities or individuals; or
- Sales of intangible property that was utilized by the corporation within Pennsylvania.
Included in the economic nexus provision is a rebuttable presumption that a corporation with $500,000 or more of sales sourced in the current tax year to Pennsylvania has substantial nexus in Pennsylvania without regard to physical presence in Pennsylvania. This section codifies the Pennsylvania Corporation Tax Bulletin 2019-04, which established a similar $500,000 gross receipts threshold. It is not clear whether the applicable date of 2023 for substantial nexus will impact the enforcement of Tax Bulletin 2019-04 guidance for tax years prior to 2023.
There is an exception that is applicable to affiliated entities domiciled in a foreign nation that has in force a comprehensive income tax treaty with the United States providing for the allocation of all categories of income subject to taxation, or the withholding of tax, on royalties, licenses, fees and interest for the prevention of double taxation of the respective nations’ residents and the sharing of information.
Personal income tax changes
Pennsylvania will now conform with both IRC Section 179 and IRC Section 1031.
For property placed in service in tax years beginning after December 31, 2022, the cost of Section 179 property may be deducted to the extent allowed under IRC Section 179 in effect at the time the property is placed in service. The 2022 limit for federal purposes is $1,080,000. Prior to this change, for Pennsylvania purposes the deduction for Section 179 property was limited to the rules under the Internal Revenue Code of 1986 which limited the expense to $25,000.
For transactions that occur in tax years beginning after December 31, 2022, Pennsylvania now conforms to IRC Section 1031. Previously, the nonrecognition rules of Section 1031 were not applicable for purposes of Pennsylvania personal income tax.
The CNI tax rate reduction is the first in over 20 years and is an important achievement in helping Pennsylvania become a more competitive, business friendly state. Notably, the Pennsylvania legislature failed to enact a pass-through entity tax (PTE), which 28 other states have already done. It will be interesting to see whether this legislation will be introduced again over the next year.
Please contact your Mazars professional for additional information.
Authored by: Harold Hecht and Harry Johnson