The City of Philadelphia has been busy formulating its tax positions in response to both the South Dakota v. Wayfair Inc. decision and Tax Cuts and Jobs Act of 2017 (TCJA). This column summarizes the changes affecting the city’s Business
Income and Receipts Tax (BIRT) and Net Profits Tax (NPT).
BIRT Economic Nexus
In January 2019, the Philadelphia Department of Revenue released amended BIRT regulations to update the city’s nexus standard in response to the U.S. Supreme Court’s ruling in South Dakota v. Wayfair Inc., in which the court rejected
the physical presence requirement for purposes of sales and use tax nexus. Effective for tax years beginning on or after Jan. 1, 2019, Philadelphia will no longer adhere to an “active presence” standard for purposes of determining whether
a person is “doing business” in the city.1 The department announced that the “economic and virtual connections” of a business to Philadelphia are now sufficient to create constitutional nexus. The amended regulations
clarify that taxpayers will not be subject to the net income portion of the BIRT if their activities in Philadelphia are strictly limited to the solicitation of orders for sales of tangible personal property. Such businesses may still be subject to
the gross receipts portion of the BIRT. The amended regulations provide that a business with no physical presence in Philadelphia is considered to have nexus if it has generated at least $100,000 in Philadelphia gross receipts during any 12-month
period ending in the current calendar year, and has sufficient connection to establish nexus under the U.S. Constitution.2
Responses to Federal Tax Reform
Under the TCJA, Internal Revenue Code Section 965 treats unrepatriated foreign earnings from most subsidiaries as Subpart F income subject to a one-time transition tax in 2017 of 15.5 percent for cash and cash equivalents, and 8 percent for other assets.
Taxpayers may elect to pay the resulting federal income tax over an eight-year period.
In a recent advisory notice,3 the Philadelphia Department of Revenue announced that both the deemed repatriation income and deduction are reflected in the BIRT income tax base for BIRT Method II taxpayers. Treated as a dividend for BIRT purposes,
the net deemed repatriation income will be eligible for deduction either as dividends received from another corporation of the same affiliated group or dividends received from a corporation that is a 20-percent-or-greater-owned subsidiary.4
Beginning in 2018, U.S. shareholders are required to include as income the global intangible low-taxed income (GILTI) of controlled foreign corporations (CFCs), with a corresponding 50 percent deduction of the GILTI inclusion amount. The TCJA also added
a new incentive for domestic C corporations earning foreign-derived intangible income (FDII) that provides a deduction of 37.5 percent of the sum of a taxpayer’s FDII plus 50 percent of its GILTI.5
This past February, the Philadelphia Department of Revenue announced that it will treat GILTI income as dividend income includable in the BIRT income tax base of Method II taxpayers.6 Philadelphia will not conform to the 50 percent deduction for
GILTI income provided by the TCJA. The department also announced that BIRT Method II taxpayers will include FDII in the BIRT income tax base. When applicable, a corporation may deduct all other receipts received from another corporation that is a
member of the same affiliated group. Similar to its stance on GILTI, Philadelphia will not conform to the FDII deduction as provided by the TCJA.
Section 199A of the TCJA provides a 20 percent deduction on qualified business income (QBI) for owners of certain pass-through businesses. The Philadelphia Department of Revenue recently released an FAQ in which it explained that BIRT filers may not take
the 20 percent federal deduction on QBI.7 The federal deduction does not apply because pass-through entities file and pay the BIRT at the entity level. Similarly, NPT return filers may not take the 20 percent deduction before arriving at the
net profits subject to tax because the NPT is based on books and records rather than federal taxable income.8
Extended NOL Carryforward
A city ordinance enacted on Jan. 24, 2019, extends the period that net operating losses (NOLs) may be carried forward for the BIRT. The ordinance, however, does not become effective until authorizing legislation is passed by the Pennsylvania General Assembly.
If enacted, NOLs may be carried forward for 20 tax years following the year they were incurred.
BIRT Revised Estimated Payments
BIRT regulations were amended to clarify the due dates for filing BIRT returns and for the payments of estimated taxes. Effective July 1, 2019, new businesses are no longer required to make estimated tax payments when filing a BIRT return for their first
tax year of business operations.9 These changes apply only to taxpayers starting business activity in Philadelphia in the 2019 calendar year, and in subsequent years for taxpayers whose first BIRT return filing due date is after the regulation’s
Taxpayers commencing business activity in Philadelphia during 2019 will no longer be required to make estimated tax payments toward their second-year tax return with the filing of the first-year tax return.10 With the filing of the second-year
tax return, the taxpayer will either make a 100 percent estimated tax payment toward the third-year tax return, or elect to make quarterly estimated tax payments. The taxpayer will be required to make an estimated payment beginning with the third-year
return toward the estimated tax for the subsequent year return.
Philadelphia is one of the first jurisdictions to apply an economic nexus standard to an income or gross receipts tax after the Wayfair decision. The city’s economic nexus standard departs from the standard in Wayfair by establishing
a $100,000 annual gross receipts threshold without imposing a separate transaction threshold. Based on this regulatory adoption, Philadelphia may seek to apply an economic nexus standard to other taxes.
Philadelphia largely follows Pennsylvania’s corporate net income tax with respect to the treatment of Section 965 income, GILTI, and FDII. Both types of income are treated as dividend income, and thus are included in the BIRT income tax base of
Method II taxpayers. Both types of income are eligible for a dividends-received deduction with respect to dividends received from affiliated corporations.
Philadelphia’s extension of the NOL carryover period from three to 20 years comes after efforts in City Council to improve Philadelphia’s overall business tax structure and to attract and retain start-up businesses. Likewise, the change in
the method by which businesses that are new to Philadelphia make estimated tax payments, at least for the first two tax-filing seasons, will provide these new businesses with a reasonable amount of time to adapt to the 100 percent estimated tax payment
requirement. This change could be especially helpful for businesses that will become new BIRT taxpayers in light of the regulatory adoption of Wayfair-style standards.
Many of these tax changes may have a substantial impact on taxpayers doing business in Philadelphia, particularly those that may now have nexus in Philadelphia under the new BIRT economic nexus standard, despite having never been required to file in the
1 “Active presence” was defined as purposeful, regular, and continuous efforts in Philadelphia in the pursuit of profit or gain and the performance of activities essential to those pursuits. (Phila. BIRT Reg. Section 103(B).)
2 Phila. BIRT Reg. Section 103(C).
3 Advisory Notice – Repatriation Transition Tax Policy Update, Philadelphia Department of Revenue (Jan. 31, 2019).
4 Phila. BIRT Reg. Section 404. For the net income portion of the BIRT, taxpayers elect to calculate net income using one of two methods. Method I taxpayers calculate net income using the books and records of the business. Phila. BIRT Reg. Section 403. Method II taxpayers calculate net income using federal taxable income as a base. Phila. BIRT Reg. Section 404.
5 IRC Section 250.
6 Advisory Notice – Global Intangible Low-Taxed Income (GILTI) and Foreign-Derived Intangible Income Deduction (FDII) Tax Policy Update, Philadelphia Department of Revenue (Feb. 11, 2019).
IRC 199A Deduction: Frequently Asked Questions, Philadelphia Department of Revenue (Jan. 17, 2019).
8 Phila. Code Section 19-1501(6).
9 Bill No. 1800770-A (enacted Oct. 3, 2018), amending Phila. Code Section 19-2610.
10 Phila. BIRT Reg. Section 202(B)(1)-(3).
Vito A. Cosmo Jr., CPA, CGMA, is managing director, state and local tax, at Grant Thornton in Philadelphia. He can be reached at firstname.lastname@example.org.
Matthew D. Melinson, CPA, is a partner at Grant Thornton, leader of the Atlantic Coast region state and local tax practice, and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at email@example.com.
Katherine M. Piazza, JD, is a state and local tax associate at Grant Thornton. She can be reached at firstname.lastname@example.org.
Patrick K. Skeehan, JD, is manager, state and local tax, at Grant Thornton. He can be reached at email@example.com.