By David A. Caplan, CPA, and Matthew D. Melinson, CPA
The Local Tax Enabling Act (LTEA), or Act 511, is now more than 40 years old. The law provides localities with the ability to levy certain types of tax, including, but not limited to, earned income, gross receipts, occupation, local services, and per capita taxes. While local taxes generally are not significant enough to be the determining issue in a business’s decision regarding location,1 these taxes are among the many factors considered. At minimum, Pennsylvania’s antiquated local tax structure negatively affects the state’s desire to be perceived as business-friendly. Many attempts have been made over the past four decades to amend the law, but most have been unsuccessful at simplifying the tax burden on businesses and individuals.
Earned Income Taxes
Act 1, a proposal to reduce school property taxes by increasing or implementing either a local earned or personal income tax, was voted on in 498 of the 501 school districts in Pennsylvania.2 It passed in only eight. Pennsylvania residents are not keen on local income taxes; in fact, local income taxes are somewhat of an anomaly in the United States. Besides Pennsylvania, only 11 other states have a local income tax; and five of those have the tax collected by the state, not the municipalities. By contrast, Pennsylvania has nearly 2,900 jurisdictions that levy the tax, double the number of all other states combined, with approximately 560 different collectors.3
Act 166 of 2002, a PICPA legislative initiative sponsored by Rep. John A. Maher, CPA (R-Allegheny), defined earned income and net profits for local purposes, following state-level rules under the personal income tax code. This improved uniformity, but different interpretations on certain issues still exist. Additionally, some residents live in areas where the municipality and the school district have different tax collectors. The tax also features a convoluted collection and distribution system, in which required taxes are collected at work but owed to the home jurisdiction. Both of these result in difficulties related to the timely remission of the required dollars to the resident jurisdiction. One recent proposal calls for consolidation of collection at the school district level.4 While this could lead to improvements, centralization of collection at the state or county level would be much better in terms of streamlining and efficiency.
Gross Receipts Taxes
Also subject to much controversy are the business privilege and mercantile taxes, collectively referred to as gross receipts taxes. The Pennsylvania Supreme Court decision in Northwood vs. Upper Moreland ruled that a construction company’s receipts earned on jobs outside of Pennsylvania could not be taxed by the municipality.5 The result has led to inconsistent interpretations among jurisdictions, as some continue to attempt to impose tax on all or part of out-of-state receipts under various methodologies. Another area of conflict is whether credit is permitted for gross receipts tax paid as part of Philadelphia’s business privilege tax. Some collectors disallow the credit under the premise that Philadelphia’s business privilege tax was enacted by different enabling legislation than the LTEA. This is technically true, but Pennsylvania legislators probably did not intend to permit the exact same receipts to be taxed by two different jurisdictions. Localities also differ in interpreting subjectivity to business privilege tax, though Pennsylvania courts consistently rule that there must be a base of operations physically present for a jurisdiction to impose tax.
Nuisance Taxes
A nuisance tax is a minor tax that may cost more to administer, withhold, collect, and legislate than it brings in to support the community. Act 222 of 2004, for instance, introduced the Emergency and Municipal Services Tax, which allowed jurisdictions to convert occupational privilege taxes into this new tax and increase the maximum from $10 to $52 per year. The law, however, did not address specific collection terms, refund procedures, low-income exemption process, and a host of other administrative requirements. The rapid initiation of this tax caused confusion, surprised employees, and resulted in time-consuming paperwork by employers. The situation was corrected by Act 7, which was passed in June 2007 and becomes effective Jan. 1, 2008. Renamed the Local Services Tax, the revisions require a uniform exemption amount of $12,000, require Department of Community and Economic Development to create uniform forms, and mandate pro-rata withholding as opposed to one-time lump sum payments.
There are other nuisance taxes in addition to the Local Services Tax. Per Capita Taxes are imposed on residents at a maximum rate of $10; and some localities impose an Occupation Tax, distinguished from the tax previously known as the Occupational Privilege Tax. The Occupation Tax is a flat tax based upon the specific occupation of the resident. The LTEA provides no maximum for this tax, and hence the tax can differ among jurisdictions, along with amounts per occupation being subjective.
Additional Considerations
As you can see, and have probably experienced first-hand, Pennsylvania’s local taxes are a tangled mess. So, where does Pennsylvania go from here? There are two broad options: fix the current system or repeal Act 511. For the LTEA to be repealed, a substitute form of funding would need to be recommended so municipalities and school districts could balance their budgets without property taxes skyrocketing. A possible solution may be increasing the state personal income tax rate, with the extra funds being earmarked for local funding.
If repeal is deemed undesirable, the current system most certainly needs substantial improvement. The collection process for earned income taxes is cumbersome and inefficient, resulting in lost revenue and inequality throughout the state. School district consolidation for earned income taxes is a step in the right direction, but state- or county-level collection would be better. Gross receipts taxes require increased clarification and uniformity. Local "nuisance taxes" should be repealed, or, at minimum, should not be used as the upside of the seesaw in future tax shifts.
PICPA members can help by contacting their legislators and stressing that local taxes are an important issue. Only through your advocacy and expert testimony can we hope to achieve local tax reform.
1 An exception is gross receipts taxes, which occasionally drive decisions regarding location.
2 Jurisdictions excluded from a voting requirement were Philadelphia, Pittsburgh, and Scranton.
3 Pennsylvania’s Earned Income Tax Collection System, An Analysis with Recommendations, Pennsylvania Department of Community and Economic Development, August 2004.
4 House Bill 1458.
5 Northwood Construction Co. vs. Township of Upper Moreland, 579 Pa. 463, 802 A.2d 1269 (2004).
David A. Caplan, CPA, is a sole practitioner in Lafayette Hill, and is a member of the PICPA State Taxation Committee. He can be reached at dactyl@caplancpa.com.
Matthew D. Melinson, CPA, is a director in the state and local tax practice of SMART Business Advisory and Consulting LLC, and is a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at mmelinson@smartgrp.com.
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