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Legislative Update

Week Ending June 16, 2006

• Week in Review
• Political News & Notes
• Property Tax Relief Passes House
• EMS Bill Clears Another Hurdle
• Graham Packaging Bill Goes to House
• Committee Approves Bill to Ease School AFRs Requirements
• House Passes Bill Providing Tax Incentive to Save for College
• Businesses with Employees - Single Member Limited Liability Companies
• Business Income and the Tax Gap
• New Breach Notification Requirements Become Law

Week in Review

This week, the House of Representatives reviewed and passed the highly debated legislation drafted by the House and Senate Conference Committee to address property tax reform. Despite attempts by Republicans to provide further assistance in the form of a marginal increase in the state sales tax, House Bill 39 - the Conference Committee report - will alone be placed on the governor's desk for his signature.

In addition to this significant vote, Senate Bill 1134, legislation that would overturn the Commonwealth Court's decision to subject prewritten computer software to sales and use tax - a case commonly referred to as Graham Packaging - has successfully passed through the Senate. The bill has now moved to the House, where it will first be considered by the House Finance Committee.

Political News & Notes

The Numbers Are In. Despite the massive statewide television advertisement campaign, Gov. Ed Rendell still has more than four times as much in the campaign coffers as his gubernatorial challenger, Republican Lynn Swann. In reports filed earlier this month, Rendell had raised $13.8 million - $2.53 million since May 1 - to Swann's $3.25 million. Hoping to jump-start their fundraising efforts, the Swann campaign has scheduled a major event for August featuring President Bush.

Another Candidate. will attempt to join the race for unseated Senate Majority Leader David Brightbill's Lebanon County seat, according to the Lebanon Daily Times. Mt. Gretna businessman Bray Brunkhurst has confirmed that he is planning to run as a Green Party candidate against Republican Mike Folmer and Democrat John Liss. In order to do so, Brunkhurst will have to gather the requisite 1,000 petition signatures.

Death and Taxes. Rep. Dennis Leh, although defeated in the primary, has taken another shot at the "Death Tax."  This week, he has proposed two amendments to House Bill 906, which would expedite a proposed phase-out of state inheritance and death taxes, completely eliminating them by 2010. HB 906 passed the House Finance Committee and is now being considered by House Rules.

Property Tax Relief Passes House

On Wednesday night, June 13, the state House passed Special Session House Bill 39 by a vote of 137-61.

Almost 3 weeks prior to the May primary elections, House Republicans, led by House Majority Leader Sam Smith, walked out on a vote to pass or reject HB 39 - a report drafted by the Conference Committee of six House and Senate members formed to solve the escalating problem of Pennsylvania's property taxes.

A month and a half later, and following a massacre at the polls for the Republican caucus, members returned to the House floor to consider a number of reform proposals, many of which centered around modifying the state sales tax in order to generate new revenues to be put toward reducing - and in some cases, eventually eliminating - property taxes.

Among those was an amendment made to House Bill 859, which would have increased the sales tax from 6 percent to 7 percent, the revenue from which would be placed in an account exclusively devoted to reduce property taxes. Rep. Pyle, sponsor of HB 859, referred to the amended bill as companion legislation to HB 39, which uses gaming monies to provide rebates for senior and low income households, among other provisions. Please click here for a complete outline of the components of the conference committee report.

Although there was bipartisan support of HB 859, objections to the bill ranged from those fearing its economic impact on businesses like car dealerships, to others who pointed out the possibility that the bill would be rejected by the Senate, which has voiced consistent opposition of the tax shift. The amendment ultimately failed by a vote of 91-106, leaving the House to consider - and ultimately pass - HB 39 on its own merits. A final attempt to include a half percent hike in sales taxes for additional relief to more Pennsylvanians following the bill's passage also failed.

Having approval of the House, it only remains for Gov. Rendell to sign HB 39 into law, which he has promised to do - fulfilling, he says, one of his most major campaign promises: property tax relief.

EMS Bill Clears Another Hurdle

The Emergency Municipal Services Tax (EMS) was first established in 2004 as a means for local municipalities to collect up to $52 per employee to pay for emergency services, property tax reductions and road construction.

Almost immediately there were problems - many of which were identified by PICPA members to legislators - with the law. The General Assembly has been working to correct the flaws in how the tax is imposed almost since before it was enacted.

The state House took action to correct the EMS problem on June 13 with the passage of Senate Bill 157. As amended and approved by the House, the legislation would:

• Rename the Emergency and Municipal Services Tax, the Local Services Tax.
• Exempt from the tax those whose total earned income from all sources is less than $12,000.
• Limit the total levy for individuals to $52 annually.
• Require employers to withhold the tax on a pro-rated basis determined by the number of payroll periods which the employer has established for the year.
• Limit the tax to just one municipality during each payroll period.
• Require a municipality to use at least 25 percent of the revenues for police, fire and emergency services, road construction and/or maintenance or property tax reductions.

The bill now moves back to the Senate for a concurrence vote.

Graham Packaging Bill Goes to House

Legislation that will address last year's Commonwealth Court decision to subject all prewritten or "canned" computer software to sales and use tax was approved by the state Senate on June 14 by a vote of 29 to 19.

Senate Bill 1134 will amend the Tax Reform Code by codifying definitions related to computer software and its delivery, and by creating an exclusion from tax for prewritten software and digital products that are delivered electronically. The bill would also exclude from tax the renewal of licenses to use computer software.

Graham Packaging Company, L.P. v. Commonwealth overturned a long-standing Department of Revenue policy that held canned computer software transferred to a purchaser by electronic means not to be subject to sales and use tax.

The bill goes to the House for consideration.

Committee Approves Bill to Ease School AFRs Requirements

The House Education Committee unanimously approved a bill on June 14 that would permit an alternative accounting standard for annual reports filed by school districts and intermediate units. The PICPA Committee on Local Government Auditing and Accounting reviewed the bill and supports the concept but is working on an amendment to clarify the intent of the proposal.

House Bill 2629 amends the Public School Code to require annual financial reports to be completed on an "other comprehensive basis of accounting" rather than generally accepted accounting principles so as to prevent duplication with the annual audit filing by local education agencies. The increased accounting requirements of GASB 34 have created duplication and complexity in completion of the annual financial report (AFR) that are not necessary.

The bill now goes to the full House for consideration.

House Passes Bill Providing Tax Incentive to Save for College

The House passed legislation on June 13 that would provide a new tax incentive to families who save for their child's college education. House Bill 2096 would allow for a state Personal Income Tax (PIT) deduction of up to $10,000 per contribution made to any 529 college savings plan. By providing this tax incentive for contributions to any 529 college savings plan, families can choose the savings plan that best meets their individual needs.

The bill now goes to the Senate for consideration.

Businesses with Employees - Single Member Limited Liability Companies

Thanks to a suggestion from the PICPA listserv, the IRS has released an article on single member limited liability companies (SMLLC) with respect to tax identification numbers. While there are some changes coming to this regime in the future, this recent information should be helpful.

Over the years, there has been confusion regarding SMLLCs in general and specifically, how they can report and pay employment taxes. An LLC is a new entity created by state statute. The IRS did not create a new tax classification for the LLC when it was created by the states; instead IRS uses the tax entity classifications it has always had for business taxpayers: corporation, partnership, or sole proprietor. An LLC is always classified by the IRS as one of these types of taxable entities.

Business Income and the Tax Gap

The IRS recently completed a National Research Program (NRP) reporting compliance study of individual taxpayers for tax year 2001. The study involved random selection of about 46,000 returns for review. The examinations generally concluded in the fall of 2004.

IRS designed the NRP to measure reporting compliance and determine the tax gap. The tax gap is the difference between the amount of tax that taxpayers should pay for a given year and the amount that is paid voluntarily and timely. The tax gap represents, in dollar terms, the annual amount of noncompliance with the tax laws.

The largest component of the tax gap comes from unreported and underreported income. Non-filing and underpayment of tax comprise the rest of the tax gap. NRP data suggest that well over half ($109 billion) of the individual underreporting gap came from understated net business income - underreported receipts and overstated expenses.

While the NRP data tell IRS quite a bit about the tax gap there is one critical unknown piece. The data do not reveal how much of the gap is attributable to willful non-compliance or carelessness and how much is the result of a lack of understanding by the taxpayer of his or her full tax obligation.

In an effort to assist small businesses and self-employed taxpayers to better understand their reporting, filing and payment obligations, the IRS designed a series of fact sheets to identify issues discovered during the NRP process and provide detailed educational information.

This first fact sheet addresses the issue of income and how to determine gross income for a small business or self-employed taxpayer. A later fact sheet will provide information about a factor contributing to underreported income -- overstated expenses.

New Breach Notification Requirements Become Law

Next week, Pennsylvania will join thirty other states in implementing a law requiring companies to notify state residents if their sensitive personal data has been lost or stolen. The Breach of Personal Information Act - Senate Bill 712 - will go into effect June 22, and is aimed at providing citizens with an early warning that they have been exposed to the risk of identity theft. This would allow them an opportunity to monitor their financial records for irregular transactions and to take preemptive measures to safeguard their accounts and records.

Under the law, businesses could notify consumers about a security breach by letter, telephone, or - if there is an established relationship with the company - via e-mail correspondence. E-mail is also acceptable if more than 175,000 people were affected, or if notification would cost more than $100,000. In such a case, however, the company would also have to inform major statewide media and post a notice on its Web site. If more than 1,000 people were affected, the business would have to inform national credit reporting agencies, as well.

Companies that fail to notify citizens of the breach would be subject to penalty by the attorney general's office for violation of Pennsylvania's consumer protection laws. The obvious hindrance in doing so, however, is the open invitation notification provides lawyers to file negligence suits against the offending companies.

The federal government is also currently debating a number of consumer protection proposals, including those addressing breach notifications.