Pennsylvania Tax
DECEMBER 2004
Be Ready To Get What You Wanted:
Massive Pennsylvania Business Tax Changes On the Horizon*
When you ask for something, you better be prepared to
get it. For years business leaders have bemoaned
Pennsylvania’s high corporate tax rates. In response to
the perceived unfriendly, outdated and anticompetitive business tax environment in
Pennsylvania, Governor Rendell established the
Pennsylvania Business Tax Reform Commission
earlier this year. The Commission’s mandate was to
recommend ways to fix the perceived business tax
problems without sacrificing overall revenue for the
Commonwealth. The Commission released its final
report on November 30 in which it made seven
recommendations, the cornerstone of which is to cut
the corporate net income tax rate by almost one-third
(an estimated $634 million tax cut for 2005). These
proposals are expected to be on the legislative agenda
in early 2005, backed by the Rendell administration.
Sound like good news? It will be for some, but for the
unprepared it could be a new disease that is worse than
the last one. Five of the Commission’s seven
recommendations will be a welcome tonic for what ails
scores of Pennsylvania businesses. These helpful
recommendations basically would loosen restrictions
on corporations’ ability to utilize net operating losses,
modify the manner in which multi-state businesses
apportion their income to Pennsylvania, and simplify
the business tax appeals process. Because the
Commission’s proposals had to be revenue neutral,
however, the Commission recommended two sweeping
reforms that, notwithstanding the large corporate tax
cut, would cause many businesses to see an increase in
their overall Pennsylvania tax burden.
First, businesses formed as pass-through entities
(limited partnerships, LLCs, LLPs, business trusts and
S corporations) and their owners would suffer a greater
than 30% tax hike. This proposal is estimated to raise
$175 million in 2005 alone and arguably would hit
small businesses disproportionately (which tend to be
organized as pass-throughs), but also would be an
unwelcome blow to service-based businesses (such as
law firms, accounting firms, management consulting
firms, information technology consultants, investment
management firms, etc.), which are a growing segment
of the Pittsburgh-area economy. The proposal would
not exclude from this tax increase any pass-through
businesses (either by industry or size) other than
general partnerships. Accordingly, pass-through
businesses should evaluate how this proposal will
affect them and explore opportunities with their tax
advisors for legitimate tax planning that are invited by
this proposal.
Second, in what would be a “sea change,” the
Commission proposed for Pennsylvania to join a
growing minority of states that require so-called
“combined” tax reporting for “unitary” businesses.
Under this proposal, companies doing business in
Pennsylvania would be required to include the
financial results of affiliated companies that are part of
the same “unitary” group when they calculate their
income subject to Pennsylvania tax. Currently,
Pennsylvania’s tax regime requires each corporation
subject to tax in Pennsylvania to calculate its income
on a “separate-company” basis.
* This article also appeared in the Pittsburgh Business Times, December 17, 2004.
Kirkpatrick & Lockhart LLP
The Commission noted that Pennsylvania’s separatecompany reporting regime invites overly aggressive tax
planning. Admittedly, there have been widely reported
abuses across the country spawned by separatecompany reporting regimes (including WorldCom’s
now-infamous royalty charge of more than $20
billion for “executive foresight”). While it is true
that a combined reporting regime minimizes the
opportunities for untenable tax hijinks, the result of
moving to a combined reporting system may
overwhelm the benefits resulting from the lower tax
rate even for companies that have not taken
aggressive positions. Although no absolute
generalizations can be made, corporations engaged
in manufacturing and trading are most likely to
experience the worst results.
of their unitary group. Moreover, moving from a
separate company reporting regime to combined
reporting presents a window of opportunity for wellprepared taxpayers to adapt their structures before
legislation is enacted and achieve efficiencies that will
not be available later.
Businesses that know how these significant changes
will affect them and who have identified changes
that they can make in order to plan for the new
regime will be more likely to embrace change. Those
businesses that do not may wonder why they ever
asked for tax reform.
Because this proposal is expected to be considered
carefully by the legislature early next year,
corporations need to determine now how they would
be affected by combined reporting. Among the most
critical aspects of that determination will be which
affiliates are “in” and “out” of the unitary group. The
ultimate legal standards for this determination will be
among the most hotly debated topics as the proposal
progresses. Additionally, businesses that pay careful
attention to operating details can influence the scope
J. STEPHEN BARGE
sbarge@kl.com
412.355.8330
FOR FURTHER INFORMATION, please contact one of the
following K&L lawyers:
J. Stephen Barge
Peter A. Gleason
Raymond P. Pepe
Andrew B. Pullman
W. Henry Snyder
sbarge@kl.com
pgleason@kl.com
rpepe@kl.com
apullman@kl.com
hsnyder@kl.com
412.355.8330
717.231.2892
717.231.5988
412.355.8369
412.355.6720
The attorneys resident in all offices, unless otherwise indicated,
are not certified by the Texas Board of Legal Specialization.
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This bulletin is for informational purposes and does not contain or convey legal advice. The information herein
should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.
© 2004 KIRKPATRICK & LOCKHART LLP.
ALL RIGHTS RESERVED.