Enacted on July 8, PA House Bill 1342 (H.B. 1342) makes significant changes to the corporate net income tax laws, including a nine year phase-in of a corporate net income tax (CNIT) tax rate reduction. It also enacts personal income tax (PIT) law changes including IRC Section 179 expense deduction and IRC Section 1031 like-kind exchange treatment. Following is an overview of the law changes.
Corporate income tax changes:
CNIT rate reduction
The CNIT rate for the 2022 tax year (including fiscal years beginning in 2022) will remain at 9.99%. H.B. 1342 reduces the tax rate to 8.99% for tax years beginning on or after January 1, 2023. The rate is then reduced by 0.5% annually until it reaches 4.99% for the 2031 tax year.
Market sourcing for sales of intangible property
For multi-state businesses, how revenue is sourced (or not) to Pennsylvania impacts tax exposure. Numerous changes are being proposed.
Prior to H.B. 1342, specific customer-based sourcing rules applied to (1) sales of tangible personal property or (2) sales of services for CNIT purposes. All other receipts were sourced based on the statutory income-producing activity test and included in the sales factor numerator if the income-producing activity (or if a greater proportion of the income-producing activity) was performed within Pennsylvania.
Applicable to tax years beginning after December 31, 2022, Pennsylvania repeals the cost of performance treatment for CNIT and has adopted a comprehensive customer-based sourcing method that generally applies the following sourcing rules:
Gross receipts from the lease or license of intangible property are sourced to Pennsylvania “if and to the extent the property is used” within the state.
Gross receipts from the sale of intangible property involving activity in a specified geographic area are sourced to Pennsylvania “if and to the extent the property is used in or otherwise associated with” the state.
Gross receipts from the sale, redemption, maturity, or exchange of securities are sourced to customer location if the securities are held by the taxpayer primarily for sale to customers in the ordinary course of business.
Gross receipts from interest, fees, and penalties from credit card receivables are sourced to the cardholder’s billing address.
Gross receipts from interest, fees, penalties from unaffiliated entities or individuals received by a taxpayer that regularly lends funds to unaffiliated entities or individuals are generally sourced:
• To the location of the real property, if the loan is secured by real property.
• To the state where the property is delivered or shipped to a purchaser if the loan is secured by tangible personal property. Such gross receipts relating to transportation property are sourced “to the extent the property is used” in a state.
• To location of the borrower 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 from other interest not otherwise described in the statute are sourced to the lender’s commercial state of domicile.
Gross receipts from other intangible property not otherwise described in the statute are excluded from the numerator and denominator of the sales factor.
Effective for tax years beginning after December 31, 2022, H.B. 1342 codifies Corporation Tax Bulletin 2019-04 subjecting a corporation to the CNIT as having substantial nexus, despite the lack of physical presence within Pennsylvania. Note that this merely creates a rebuttable presumption of substantial nexus. Substantial nexus is defined as “a direct or indirect business activity that is sufficient to grant the Commonwealth authority under the Constitution of the United States to impose.” H.B. 1342 provides that substantial nexus exists when a corporation has $500,000 or more Pennsylvania-sourced sales regardless of physical presence. Such business activities include:
Leasing or licensing intangible property utilized in Pennsylvania.
Regularly engaging in transactions with Pennsylvania customers involving intangible property, including lending to unaffiliated entities or individuals.
Selling intangible property that was used by the corporation in Pennsylvania.
However, an exception applies to an affiliated entity “domiciled in a foreign nation that has in force a comprehensive income tax treaty with the U.S. 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.”
As a reminder, Public Law 86-272 prohibits the imposition of an income tax on the sale of tangible personal property when activity in the state is limited to mere solicitation (among other requirements).
Personal income tax changes:
Conformity to IRC Section 179 expense deduction
Effective for tax years beginning after December 31, 2022, property placed in service and depreciated under Section 179 of the Internal Revenue Code may be deducted consistent with IRC Section 179 “in effect at the time the property is placed in service.” The federal 2022 tax year limit is $1,080,000. This limit is adjusted annually for inflation and will likely increase substantially for 2023. Prior to H.B. 1342, such property generally was limited to a deduction of $25,000. In addition, the annual limit phases out at a rate of $1 for every dollar that a taxpayer’s total Section 179 purchases placed in service during the year exceed a threshold amount. For 2022, that threshold is $2,700,000 (likely to be adjusted higher for inflation in 2023). Previously, in Pennsylvania, that threshold was $200,000 .
Conformity to IRC Section 1031 like-kind exchange treatment
Applicable to transactions occurring in tax years beginning after December 31, 2022, Pennsylvania provides that Section 1031 of the Internal Revenue Code is applicable.
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