As the deadline approaches to file a Pennsylvania corporate net income tax refund claim for the 2019 tax year (August 14 for calendar-year taxpayers), and the deadline approaches to file returns on extension for the 2022 tax year (November 15 for calendar-year taxpayers), companies should consider filing refund claims or taking return positions based on: (1) reducing their federal taxable income starting point for computing their Pennsylvania tax base, and (2) reducing their apportionment by including a property factor or a payroll factor, or both. We are making available a model refund claim that you can use to file a petition online to protect your rights based on these issues.

Tax Base

  • Immediately deduct research expenses notwithstanding mandatory federal amortization: Beginning in 2022, taxpayers are generally required amortize research and experimental expenses over 5 or 15 years for federal income tax purposes.1 Taxpayers may assume that means they must likewise amortize such expenses for Pennsylvania purposes, but that may be incorrect. Recent Pennsylvania caselaw developments may mean that the state's automatic conformity to mandatory federal amortization is unlawful. Based on those developments, a position exists to immediately deduct research and experimental expenses in Pennsylvania, notwithstanding mandatory federal amortization. Consider this issue when preparing your 2022 Pennsylvania return.

    Immediately deducting these expenses would create a permanent tax benefit because it would accelerate deductions into higher-tax-rate years. Pennsylvania's current 9.99% tax rate is set to gradually decrease until it reaches 4.99% in 2031. Accordingly, accelerating deductions—or claiming PA super-depreciation (see our prior alert)—would create a permanent tax benefit.
  • FDII deduction allowed in Pennsylvania: Under Pennsylvania law, federal taxable income is the starting point for computing the corporate net income tax, and there is no add-back or disallowance for the deduction for foreign-derived intangible income ("FDII").2 Therefore, if a taxpayer claimed a FDII deduction for federal income tax purposes, that deduction should be incorporated into its Pennsylvania corporate net income tax base. However, taxpayers that followed the Department's tax return instructions likely didn't get the benefit of the FDII deduction for Pennsylvania purposes. The Department's position is that the FDII deduction is not allowed for Pennsylvania purposes because it is a "special deduction" claimed after Line 28 on the federal income tax return.3 But that position is inconsistent with Pennsylvania statute, which states that federal taxable income (which is the amount reported on Line 30 of the federal income tax return and reflects the FDII deduction) is the starting point. Any taxpayer that claimed the FDII deduction on their federal return should consider this issue when preparing its 2022 Pennsylvania return. And if you had FDII that you didn't deduct for Pennsylvania purposes in prior years, you should consider filing a refund claim.

    Taxpayers may also be able to take the position that they are entitled to calculate their FDII without regard to the taxable income limitation of IRC § 250(a)(2).
  • IRC § 163(j) interest expense limitation does not apply in Pennsylvania: No taxpayer should apply the IRC § 163(j) interest expense limitation in computing its Pennsylvania tax base because applying that limitation violates multiple provisions of Pennsylvania's constitution. If you have a 163(j) limitation for 2022, consider this when preparing your 2022 Pennsylvania return. If you had a 163(j) limitation in prior years, consider filing a refund claim.

    Deducting interest without regard to 163(j) in Pennsylvania now—instead of carrying forward the disallowed interest to deduct in a future year—would also create a permanent tax benefit because of Pennsylvania's decreasing corporate net income tax rate, as discussed above.

Apportionment

  • Add a property factor or payroll factor, or both: Pennsylvania's statutory, sales-factor-only, apportionment formula does not fairly represent the extent of many taxpayers' activities in Pennsylvania, because the formula ignores major factors that contribute to the generation of income. For example, the statutory formula completely ignores all R&D and manufacturing activities, which, for many taxpayers, results in a distortive apportionment.

    The Department (and the Board of Finance and Revenue) have a long history of applying Pennsylvania's alternative apportionment statute—72 P.S. § 7401(3)2.(a)(18)—to add additional factors to the regular statutory formula when the regular formula does not fairly represent the extent of a taxpayer's activities in Pennsylvania. And the Pennsylvania Supreme Court has concluded that the three-factor formula is "a careful and equitable valuation of the various elements which contribute to and produce income."4 According to the Court, the inclusion of all three factors in the apportionment formula "allow[s] the interplay of the factors to average out the hardship which might arise by reliance upon any single one,"5 and this is precisely what makes it operate in a "fair and equitable manner."6

     Taxpayers with property and payroll concentrated outside Pennsylvania should consider requesting that the Department continue its prior practice of applying the alternative apportionment statute to add factors to the regular, sales-factor-only, formula. Any taxpayer with this profile should consider this when preparing its 2022 Pennsylvania return and should also consider filing a refund claim for prior years. They will simply be joining other taxpayers with claims pending on this issue.

Although Pennsylvania's refund deadline for calendar-year taxpayers is generally in May, such taxpayers have until August 14 to file refunds with respect to their 2019 tax year because of COVID-related extensions of the original filing due date in 2020.

We are making available a model refund claim that you can use to file a claim to protect your rights based on the above issues. Instructions for filing the refund claim are available on the Department's Board of Appeals website, in the Department of Revenue's regulations, and in Pennsylvania's statutes.

Footnotes

1. IRC § 174, as amended by Pub. L. No. 115-97, § 13206, 131 Stat. 2054 (2017) (applicable for tax years beginning after December 31, 2021).

2. 72 P.S. § 7401(3)1.

3. Pa. Corp. Tax Bulletin 2019-02 (Jan. 24, 2019).

4. Turco Paint & Varnish Co. v. Kalodner, 184 A. 37, 41 (Pa. 1936).

5. Commonwealth v. Columbia Gas & Elec. Corp., 8 A.2d 404, 411 (Pa. 1939).

6. Turco Paint, 184 A. at 41; see also Commonwealth v. Koppers Co., 156 A.2d 328, 334 (Pa. 1959) ("[I]t is precisely because one of the fractions may distort the allocation that three fractions are used.").

This article is presented for informational purposes only and is not intended to constitute legal advice.