Governor Wolf and other Pennsylvania lawmakers recently passed the state budget for FY22-23 (the “Budget”). Coming in at $45.2 billion, the negotiations entailed to finalize the Budget appear to be worth the effort by having the best of both worlds- increased revenue placing Pennsylvania in a strong fiscal position without having to increase any taxes.
In fact, as part of the Budget’s tax policy, Pennsylvania is lowering its corporate net income tax (“CNIT”) rate from 9.99% to 8.99% for the 2023 tax year. From there, the CNIT rate will continue to decrease by 0.5% each year until the CNIT reaches a baseline 4.99% rate in 2031.
This phased reduction is a change welcomed by both sides of the aisle, with the hope that Pennsylvania will become more attractive for businesses. Comparatively, the current 9.99% CNIT is one of the highest in the country. Set against Pennsylvania’s neighboring states- except for Ohio since it has no corporate income tax- New York, New Jersey, and Maryland, have current corporate tax rates of 7.25%, 11.5% and 8.25%, respectively. It stands to reason that the 4.99% rate by 2031 has the potential to incentivize more commercial activity in Pennsylvania.
By increasing revenue for Pennsylvania while simultaneously lowering the CNIT and not increasing individual income taxes or the sales and use tax, the Budget’s tax reforms might seem almost magical at first glance. However, this is not the case, for two reasons.
First, Pennsylvania is widening the scope of income sourced to Pennsylvania via intangible assets. The Commonwealth will now cast a wider net on intangibles in general by pivoting from the current Cost-of-Performance method sourcing, to Market-based sourcing for tax years beginning after January 1, 2023. The implications of this transition are too numerous to discuss at length here and the DOR has been specifically instructed to draft new regulations to implement this new tax base. Essentially, the difference between the two methods is implied in the names. Cost-of-Performance looks to where the services are performed whereas the Market method looks to the location of the customers.
Second, even though the CNIT rate is lower, the threshold for corporations becoming subject to the CNIT and creating nexus within Pennsylvania has become easier. Bolstered by the U.S. Supreme Court’s Wayfair decision, corporations with sales in Pennsylvania exceeding a $500,000 threshold are now subject to the CNIT, irrespective of whether or not the corporation has any physical presence within the Commonwealth.
It is easy to see how the two prongs work hand-in-hand together to expand the tax base- customers purchasing intangible assets for customers within Pennsylvania as opposed to intangibles created in Pennsylvania casts a wider net, pulling non-Pennsylvania based corporations in closer to establish nexus with a lower dollar benchmark.
