On Feb. 4, Gov. Tom  Wolf announced his proposed budget for 2020-21. The budget calls for a few key changes to the commonwealth's tax system. The top three proposed changes will be discussed below. However, the proposed changes are not new; the governor has unsuccessfully attempted to pass all three of the proposed changes in previous years. For various reasons, each has been met with criticism, lobbying, and eventual defeat. While it is likely the proposed changes will see the same fate in 2020, each is worth discussing and understanding.

• Lowering the Corporate Net Income Tax Rate

Pennsylvania has the second highest corporate net income tax (CNIT) rate nationwide, currently at 9.99%. Pennsylvania is outdone only by Iowa, which imposes its CNIT at a rate of 12%. The fear with a high comparative CNIT rate is that Pennsylvania is not competitive in attracting businesses. When companies consider where to locate, such a high tax rate is a deterrent to investment in the commonwealth.

Pennsylvania's CNIT rate is particularly important when considered in conjunction with the Department of Revenue's 2019 bulletin that created a presumption of nexus for purposes of Pennsylvania's CNIT for out-of-state companies with sales of $500,000 or more into the commonwealth, beginning with tax year 2020. Previously, companies without a physical presence in Pennsylvania did not have a filing requirement for purposes of the CNIT. The change necessarily draws more companies into Pennsylvania's taxing system, thereby subjecting more companies to a comparatively high CNIT rate.

The governor's proposed budget would gradually lower the CNIT rate to arrive at a rate of 5.99% by 2025. In order to impose a lower CNIT rate, the governor's proposed budget would implement combined reporting.

• Combined Reporting

Pennsylvania's history with combined reporting dates back to 2004 when then-Gov. Ed Rendell appointed a business tax reform commission to study the state's economic competitiveness.  Presently, Pennsylvania is a separate company filing state—whereby each corporation includes only its income on its Pennsylvania corporate net income tax return; separate corporations of a commonly controlled group each file individually. Conversely, combined reporting requires that all members of a commonly controlled, unitary group file one return. Where a unitary relationship exists, all separate-company income and losses are added together.

The drive for combined reporting is the belief that separate company reporting allows corporations to shift income to affiliated corporations that do not file in Pennsylvania.  However, as with any change in tax policy, there are winners and losers. For instance, a combined group with a Pennsylvania company operating at a loss, but with highly profitable out-of-state subsidiaries would see a tax increase. Meanwhile, a highly profitable Pennsylvania company with subsidiaries with significant losses out-of-state would see a tax decrease with combined reporting. If combined reporting is adopted in Pennsylvania, the department should expect to see increased controversy over what constitutes a "unitary" business.

Over the years, a number of proposals to change the corporate filing method from separate reporting to combined reporting have been introduced and debated, including by Wolf in previous years. Each time combined reporting has been proposed, it has swiftly been defeated.  The governor's proposed budget again calls for the adoption of combined reporting in Pennsylvania—again with the carrot of the lower CNIT rate.

• Marcellus Shale

Finally, Wolf is again seeking approval of a tax on Marcellus Shale natural gas production in order to fund a $4.5 billion "Restore Pennsylvania" infrastructure program. The tax is not officially incorporated into the budget proposal; instead, the governor is seeking to fund it separately, as he did in 2019. Prior to 2019, the governor incorporated a shale tax into all of his previous budget proposals. Republican legislative leaders have successfully blocked all of the governor's past efforts to impose the tax.

Drillers pay an "impact fee" in Pennsylvania, but do not pay a tax on the amount extracted. The governor's proposed severance tax would be added to the impact fee. Many critics of the proposed tax point to the fact that drillers already pay the impact fee. The impact fee is levied on a per-well basis. As such, every time a driller drills a hole into the ground, the driller pays the impact fee.

Conversely, the proposed severance tax would be applied when resources are "severed" from the earth and would be based upon the amount of gas extracted. Because severance taxes are tied to the amount extracted, their revenue stream is volatile and, therefore, they are not a reliable source of revenue. Republicans and lobbyists of the oil and gas industry argue that the tax would weaken the industry. Proponents point to the fact that all other large gas-producing states impose a severance tax (and maintain a viable oil and gas industry).

Wolf's proposed budget contains many of the same key provisions of his previous proposed budgets. While the governor's efforts are laudable, if history is any indication, he will have a difficult time getting his proposed state tax changes adopted by the legislature.

Jennifer Weidler Karpchuk is a partner at the law firm Cozen O'Connor in Philadelphia. She focuses her practice on state and local tax compliance and litigation, and represents clients in a range of taxation matters, with an emphasis on the minimization of state and local tax obligations. Contact her at [email protected].