For businesses operating in Philadelphia, it is critical to be aware of certain aspects of Philadelphia’s onerous business tax regime, particularly the Business Income and Receipts Tax (“BIRT”) and Net Profits Tax (“NPT”).
The City of Brotherly Love is not too affectionate when it comes to business taxes. In fact, Philadelphia’s business tax rates are among the highest of any major U.S. city— largely due to the BIRT, the driving component of the city’s onerous tax burden. According to one tax study, only 11 of the country’s 30 largest cities impose a tax on corporate profits or revenue, but only Philadelphia does so on both through the BIRT. In addition to this tax, Philadelphia also levies the NPT on many unincorporated businesses operating within the city’s limits. Read on for important highlights of the BIRT and NPT and how these taxes may impact your Philadelphia business.
Every individual, partnership and corporation engaged in business or other activities for profit within the city of Philadelphia is subject to this dual tax. However, there is an exclusion for the first $100,000 in gross receipts and the proportionate share of net income. Note that real estate rental activities are also subject to the BIRT.
BIRT Rate and Base
The BIRT is comprised of two components: a gross receipts tax and an income tax. The tax rate on gross receipts is 0.1415%, while the income tax rate is 6.45%. Accordingly, a federal C corporation operating in Philadelphia is subjected to an astonishing cumulative income tax rate of over 50% (Federal: 35%, Pennsylvania: 9.9%, Philadelphia: 6.45% = 51.35%).
The BIRT’s income tax portion is imposed based on a single sales factor apportionment methodology. Additionally, for service providers services are sourced to Philadelphia based on the cost of performance. The city recently instituted an exception for software companies, which must use market-based sourcing rules when assigning income to customers’ locations.
Credits and Exemptions
Certain credits allow taxpayers to reduce the BIRT owed to Philadelphia. These credits include:
- Community Development Credit,
- Economic Development District Tax Credit,
- Jobs Creation Tax Credit,
- Green Roof Tax Credit, and
- Veterans Tax Credit.
Moreover, certain organizations, such as nonprofits, religious organizations and public utilities, are exempt from the BIRT.
For many years, large companies have significantly avoided the income tax portion of the BIRT by employing the so-called “Delaware Loophole.” This essentially allows Pennsylvania taxpayers to exploit a state law that permits them to establish holding companies in Delaware. By transferring all profits and trademarks to the Delaware holding companies, they are not subject to any Delaware corporate tax and are exempt from Pennsylvania taxes— including the income tax component of the BIRT. Recently, however, the Pennsylvania legislature has started taking steps to introduce a phase-in of combined tax reporting which would effectively close the Delaware loophole and expose more taxpayers to the income tax portion of the BIRT.
Net Profits Tax
In addition to the BIRT, Philadelphia also levies its NPT on (1) residents conducting business operations outside the city, and (2) nonresidents doing business within the city. Those subject to the NPT include individuals, partnerships, limited liability companies and trusts and estates. However, corporations are exempt.
The NPT rate for residents is 3.8907%, but the rate is reduced for nonresidents to 3.4654%. Interestingly, unlike the BIRT, the NPT uses a three factor (sales, property and payroll) apportionment formula, but like the BIRT sources services to Philadelphia based on the cost of performance.
The NPT does not supersede the BIRT, but to provide relief from the same income being taxed by both the NPT and the BIRT, there is a credit mechanism that provides an NPT credit of up to 60% of the income tax portion of the BIRT. In some situations this credit can eliminate a taxpayer’s NPT liability entirely. The NPT can sometimes be mitigated with tax planning, such as by employing a management company outside the city.
Enforcing the BIRT and NPT
Philadelphia’s Department of Revenue (“Department”) has a robust Audit Division with respect to the BIRT and NPT. The Department routinely audits large taxpayers to ensure proper compliance with these taxes. The Department also has a Discovery Unit tasked with finding businesses that are operating in Philadelphia, but not filing and paying taxes.
For assistance navigating Philadelphia’s business tax regime and ensuring compliance with BIRT and NPT, please contact Alan Goldenberg, Senior Manager of State and Local Taxation and Tax Controversy, at firstname.lastname@example.org or 212-897-6421, or your Friedman LLP tax professional.