Gov. Tom Ridge signed Senate bill 557, which made numerous changes to the Pennsylvania tax statues, into law May 12.
For the third consecutive year, the commonwealth has an operating surplus, and, therefore, has enacted tax law changes, the majority of which affect the business sector.
The following is a brief overview of the changes:
Corporate income tax provisions
1. Effective for tax years beginning on or after Jan. 1, 1999, companies may now deduct up to $2 million of net operating losses during a tax year. Under prior law, the maximum amount that could be deducted was $1 million.
2. Generally, when a company conducts business inside and outside of Pennsylvania, a calculation known as apportionment must be performed to determine the amount of income attributable to Pennsylvania and, therefore, subject to Pennsylvania income tax. Apportionment is performed by dividing the companys payroll, property and sales within Pennsylvania by its payroll, property and sales everywhere.
Under prior law, the sales factor was double-weighted. For tax years beginning on or after Jan. 1, 1999, the apportionment formula has been revised to provide for a triple-weighted sales factor. This change is intended to reduce the amount of Pennsylvania corporate net income tax paid by Pennsylvania companies that sell products in other states and increase the Pennsylvania corporate net income tax paid by foreign companies. The apportionment formula for the capital stock tax is unaffected by the new legislation.
Capital stock tax provisions
Pennsylvania imposes a capital stock tax on corporations and limited liability companies that operate within the commonwealth. The capital stock tax is calculated through the use of a formula (taxable value) based on the earnings of the company during the five most recent tax years and the companys net worth. The changes are as follows:
1. The tax rate applied to a corporations taxable value is reduced for tax years beginning on or after Jan. 1, 1999, from 11.99 mills to 10.99 mills.
2. Inactive companies and businesses with nominal net worth and a minimal history of income also receive additional relief. The minimum capital stock tax is reduced from $300 to $200 for taxable years beginning on or after Jan. 1, 1999.
3. Pennsylvania tax law provides an exclusion from capital stock tax for the value of assets used by the company in manufacturing or processing operations within the commonwealth. The processing exemption has been expanded to include the cleaning, cutting, coring, peeling or chopping of fruits for tax years beginning after Jan. 1, 1999. Assets used in these activities will be exempt from capital stock tax.
4. The new legislation provides that corporations engaged in exploring for and refining, blasting, mining and quarrying limestone, sand, gravel or slag from the earth or from waste or stock piles are exempt from capital stock tax.
Exempt processes also include the cleaning, crushing, grinding, pulverizing, sizing or screening of limestone, sand, gravel or slag, including blast furnace slag. This new exemption is available for tax years beginning on or after Jan. 1, 1999.
Personal income tax provisions
1. Effective Jan. 1, 2000, resident and nonresident individuals, estates and trusts will not be required to make estimated tax payments unless their noncompensation income (interest, dividends, rents, etc.) is more than $8,000. Under prior law, estimated tax payments were required if noncompensation income exceeded $2,500.
2. Pennsylvania provides special tax relief provisions, known as Pennsylvania tax forgiveness, for low-income taxpayers. The new law provides an exemption of $6,500 for each dependent of the taxpayer for tax years beginning on or after Jan. 1, 1999. Previously, the dependents exemption was $6,000.
Sales tax provisions
1. The definition of processing for the purpose of the sales tax exemption has been expanded to include the cleaning, cutting, coring, peeling or chopping of fruits effective July 1, 1999.
2. It has always been the Department of Revenues position that sales tax was due on credit sales. However, the new legislation formally provides that any sales tax due on credit sales must be remitted to the Department of Revenue with the companys next required sales tax return, whether or not payment is received from the purchaser. This provision is effective for tax years beginning on or after Janu. 1, 1999.
3. A new provision has been added that provides for a partial refund of sales tax attributable to bad debts effective for tax years beginning on or after Jan. 1, 1999. Most other states have previously enacted laws permitting the refund of sales tax related to bad debts. A vendor may file a petition for a refund of sales tax paid that is attributable to a bad debt if all the following apply:
1. The purchaser fails to pay the vendor the total purchase price;
2. The purchase price is written off, either in whole or in part, as a bad debt on the vendors books and records; and
3. The bad debt has been deducted for federal income tax purposes.
The amount of the refund is limited to one-third of the sales tax paid, less any discount received when payment was made. If $20,000 of taxable sales are written off as bad debts, the vendor would be entitled to a refund of $396.
Partial payments made by the purchaser are to be prorated between the original purchase price and the sales tax due on the sale. Partial payments received on a sale that includes both taxable and nontaxable items are to be allocated proportionately between the taxable and nontaxable items.
The amendment further provides that the Department of Revenue will not grant a refund for interest, finance charges or expenses incurred in collecting the outstanding receivable. Regulations are to be issued by the Department of Revenue to clarify the procedures for refund applications.
A major obstacle to electing and maintaining Pennsylvania S corporation status, the passive investment income limitations, has been repealed. These limitations generally required that a corporation could not derive more than 25 percent of its gross receipts from passive sources such as rents, royalties, interest and dividends.
If the company earned more than 25 percent of its gross receipts from passive sources, it would lose its status as an S corporation and be subject to the Pennsylvania corporate net income tax. This would result in a net tax increase of 7.1 percent (9.9 percent corporate tax rate less 2.8 percent individual tax rate). As a result of Pennsylvanias restrictive investment rules, a corporation could be an S corporation for federal purposes and a C corporation for Pennsylvania purposes.
Under the new law, any corporation that has lost its Pennsylvania S corporation status due to the passive investment income limitations may re-elect S status for 1999 by filing an S election before Sept. 16, 1999.
Jeffrey A. Wlahofsky is a shareholder of Pittsburgh-based certified public accounting firm Schneider Downs & Co. in its tax advisory services department. John C. Jennings is with the firms tax advisory services department. Reach Schneider Downs & Co. at (412) 261-4876.