Section
3: Earned income and Net Profits Tax
Under Pennsylvania law, municipalities and school districts are authorized to impose taxes on the earned income of their residents. Municipalities other than school districts also are permitted to levy the tax on non-residents employed within the municipality.
As a general
matter, with exceptions for the Pittsburgh School District and City of
Philadelphia (more specifically discussed below), municipalities of residence
have priority in the collection of the EIT/NPT paid by their residents,
irrespective of place of employment, up to the amount of tax imposed by the
“home” municipality. The EIT/NPT is imposed upon both “earned income” and the
“net profits” of taxpayers. Corporations (both “C” corporations and
non-wage/salary/compensation payments to shareholders of Sub-Chapter S
corporations) are exempt from the EIT/NPT.
The
exception to the general rule of credit being given to the “home” municipality
of most interest to the Township is that imposed by the “Sterling Act” (53 P.S.
15971) which is the principal statute addressing the Philadelphia wage tax as
it applies to non-residents. The Pennsylvania Department of Community and Economic
Development (“DCED”) Local Tax Manual states,
By far the most extensive grant of nonreal estate taxing power to any political subdivision in Pennsylvania, and the earliest of this type, was conveyed to Philadelphia by the Sterling Act of 1932. This act gives the city the authority to levy, assess and collect . . . such taxes on persons, transactions, occupations, privileges, subjects and personal property . . . as it shall determine....” [citing 53 P.S. 15971; 1932 (Ex. Sess.) P.L. 45] The city may not levy or collect a tax on any subject preempted by a state tax or license fee, but otherwise there are no limits on the kinds of taxes Philadelphia can impose, no limits on the rates of those taxes, and no limit on the aggregate amount of revenue that can be raised.
Under the broad authority of the Sterling Act, Philadelphia has enacted taxes on wages, earnings and net profits, admissions to amusements, real estate transfers, parking lot receipts, mechanical devices, bowling alleys and sound reproduction. The income tax imposed by the city applies not only to residents of the city wherever they may work, but also to nonresidents earning income within the city. A 1977 law limited increases in the rate levied on nonresidents. [citing 72 P.S. 7359, Tax Reform Code, Section 359(b); Leonard v. Thornburgh, 489 A.2d 1349, 507 Pa. 317, 1985] The split rate has been upheld by the Pennsylvania Supreme Court.
….
Municipalities are authorized to levy the earned income tax on nonresidents earning income within their jurisdiction. However, the Local Tax Enabling Act requires the place of employment to grant a credit for any earned income tax levied at the place of residence. [citing 53 P.S. 6914; Local Tax Enabling Act, Section 14; Neshannock Township School District v. City of New Castle, 13 D.&C. 2d 255, at 262, 1957, C.P. Lawrence Co.] In most cases, there will be a tax at the place of residence, so the ability to tax nonresidents does not constitute a significant source of revenue.
….
The exception to the priority given to the place of residence is persons subject to the Philadelphia wage tax. The Local Tax Enabling Act requires municipalities to credit their residents for taxes paid to Philadelphia on income earned within the city. This credit, like the other credits …, is a direct reduction against the liability for tax owed by the taxpayer. In a case where Norristown attorneys claimed a credit against liability for local taxes for taxes paid to Philadelphia on net profits earned within the city, the court upheld the taxpayers' interpretation. The Norristown tax collector had attempted to calculate local tax liability as one percent on income earned locally, but the court held the credit meant a direct reduction from liability for the tax owed. “Here, however, the Legislature said plainly that a tax paid to one taxing authority should be credited to the tax liability to the other taxing authority.” [citing Dunmire v. Applied Business Controls, Inc., 440 A.2d 638, 63 Pa.Cmwlth. 479, at 484, 1981.] The correct method of calculating the tax due was to take one percent of total taxable income then subtract the amount of tax paid to Philadelphia. [emphasis added].[i]
The Sterling Act often has been cited as a significant impediment to the imposition of an earned income tax by municipalities located in proximity to the City of Philadelphia, but over recent years more municipalities and school districts in southeastern Pennsylvania have decided to impose the tax.
Imposition
of the Earned Income Tax and Net Profits Tax
While there are details which pertain to both taxes, the following general standards apply with respect to the EIT/NPT:
Calculation of the Yield to the Township from the EIT/NPT
The collection of the EIT/NPT requires assessment of the various items of income and expenses which are proper deductions. However, the structure of the tax and the way it is collected makes it difficult to estimate revenues with precision.
Data Collection and Methodology - Municipalities in Berks, Bucks, Chester, Delaware, Montgomery and Philadelphia Counties identified by DCED as imposing an earned income tax collect the tax on their own, or through multi-jurisdiction cooperative arrangements or commercial tax collection services. Inquiries were made over a two-week period to tax collectors for each municipality in the 6-county region as to the number of Lower Merion residents employed in their jurisdiction levying the taxes.
The survey collected information on over 200 Pennsylvania municipalities which levy an EIT/NPT on non-residents, as well as 69 other jurisdictions. 63 municipalities were unable to respond, generally because the collectors do not distinguish among jurisdictions which do not impose an EIT/NPT, and those for which the municipality has no repayment obligation. The substantial majority of jurisdictions which were unable to respond are in Berks County. It should be noted that persons who work in more than one jurisdiction over the course of a year (whether due to locational changes for their employment or as a result of income and/or net profits being generated from several employers or clients in different areas) may produce some double counting, resulting in incremental over-reporting of the number of taxpayers. That factor is discussed in more detail below.
The imposition of the EIT/NPT on both residents and non-residents creates a universe of possible taxpayers of a Lower Merion Township-imposed EIT/NPT, which may be divided into categories of persons who:
With information for each category, it is possible to make an estimate of the return to Lower Merion Township from each.
Of the several categories, the allocation to the City of Philadelphia (#2) is the most problematic, in light of the absence of detailed current information from the taxing authorities in Philadelphia as to the specifics of non-resident wage tax collections from Lower Merion residents. While the data would become available as those persons notify the Township of payments to Philadelphia incident to claiming credit for the Township EIT/NPT, the information is not now available for estimation purposes.
Of some difficulty, but of substantially less financial significance, is the calculation of revenue which would be lost as a result of persons working in Lower Merion whose municipality of residence imposes an EIT/NPT. As the number of jurisdictions not assessing the EIT/NPT shrinks, the likelihood of the Township’s prospect for counting on being able to retain large amounts declines as well. Item 3, which pertains to those who work out of state, is most likely not statistically significant, and the 1990 census data indicates that to be the case. As well, the availability of credits in some cases makes this category a less reliable source of revenue.
Several
approaches were taken to develop and support estimates, in addition to review
of prior studies and estimates prepared by and for the Township,
generally-available published materials, calculations received from two
for-profit tax collection agencies: Berkheimer Associates, Inc. (“Berkheimer”)
and Central Tax Bureau of Pennsylvania, Inc. (“Central”), and the survey noted
above:
IRS Information - Data was secured from the United States Internal Revenue Service
for calendar years 1997 and 1998 on a zip code basis, dividing taxpayers and
their returns on Form 1040 into several categories, among them:
Census Information – Population and Income - Information was obtained from
the Bureau of the Census for both 1990 and 2000, for both the Township and zip
codes which overlap it. The availability of 1990 data, by both zip code and
municipality, permitted development of a ratio of Township population and
self-reported earned income to that found in the collected zip codes, thereby
facilitating a comparison between the zip code-based IRS data. Attention also
was directed to census tract maps and other supporting information.
Census Information – Employment - Given that the Census Bureau
has not yet reported detailed employment data for 2000 in terms of minor civil
division level information listing where persons are employed, examination was made
of journey to work and place of
employment data from the 1990 census, including information gleaned from the
1990 Census Transportation Planning Package, published by the Bureau of
Transportation Statistics of the United States Department of Transportation
(the “1990 CTPP”). Using the 1990 CTPP, it is possible to ascertain commuting
patterns, and although 2000 data would be preferable, aggregate Township
population and resident employment figures have not changed substantially over
the last decade. This information also permitted development of imputed values
for employment in Philadelphia and for municipalities which were unable to
provide detailed data.
Bureau of Labor Statistics – CPI and Employment - Periodically issued information by the Bureau of Labor Statistics
relates both to such topics as employment and unemployment, and the rate of
inflation within the Philadelphia area. That information is of great value in
assigning values to some types of financial data with respect to which an
effort is being made to impute current and/or prior value(s).
Employment Calculations
There
are several factors which come into play with respect to determination of the
possible revenue yield to the Township due to imposition of an EIT/NPT. As
noted above, critical to the analysis is a determination of where Township
residents work, and particularly the number who work in the City of
Philadelphia and other jurisdictions which have enacted an EIT/NPT. Another is
weighing the impact of known changes of significance in regional workplace
location since 1990, notably in the Malvern/202/422 corridors and
Conshohocken/West Conshohocken areas.
There have been insubstantial changes in the population of the Township and in the number of Township residents who are employed since the 1990 census, with a 3.18% increase in total population (1,847), and a decrease of 3.93% (1,149) in the number of Township residents employed in the civilian workforce. The 1990 Census also revealed that of the 29,219 Township’s residents who are employed, 9,011 (30.84%) worked in Lower Merion Township and 20,208 (69.16%) worked elsewhere.[iv]
A
distinction should be made between Philadelphia’s wage tax claim in terms of
percentage of wages versus percentage of employees, particularly given the
significant difference between Lower Merion’s average earned income per
household ($130,322) and that amount in Philadelphia ($44,963). According to
research conducted for the Pennsylvania Economy League, 37.7% of the wages of
Lower Merion Township’s residents were earned in Philadelphia in 1999.[v]
Township staff has estimated that 31% of its residents’ wages would be
allocable to Philadelphia, and in information provided to the Township in July,
2002 Berkheimer estimated that figure to be 40%.
In
a projection provided to the Township in 1991, Berkheimer used a similar factor
for Philadelphia, and in 1992 the Pennsylvania Department of Revenue reported a
Philadelphia employment percentage of 35%. The 1990 CTPP reported that 37.58%
of employed Lower Merion residents worked in Philadelphia, but did not make a
judgment as to earned income. While Philadelphia is estimated to have lost
approximately 50,000 jobs in the aggregate from 1990 to 1997, employment levels
in Center City, West Philadelphia and Southwest Philadelphia (thought to be
likely employment locations for Township residents) is essentially flat, with
less than .6% loss in employment.[vi]
Using the range of estimates from those sources, from the 31% developed by the Township to the figure used by others, an estimate of revenue loss due to Philadelphia employment has been made at 32% of earned income. An allocation of IRS-developed data (with adjustment for 1998-2001 inflation) using that percentage of income share shows that Lower Merion residents earned $952.2 million in Philadelphia in 2000, resulting in an estimate of 8,982 Township residents working in Philadelphia.
Table 3.1 – Locations of Employment of Lower Merion Residents
|
||
|
Of 28,070 Employed Township Residents… |
Number |
% |
|
Worked in Lower Merion |
8,657 |
30.84 |
|
Worked outside Lower Merion |
19,432 |
69.16 |
|
Philadelphia |
8,982 |
32.00 |
|
Non-Philadelphia |
10,450 |
37.16 |
|
Source: From 2000 Census with
1990 Census allocation Table P046. Place of Work --- Minor Civil Division
Level, 1990 Summary Tape File 3 (STF 3) – Sample Data as to % employed in
Township. |
||
The
1990 CTPP reported that in 1990 Lower Merion Township residents worked in 117
different municipalities in Pennsylvania (other than the Township), and in 69
jurisdictions outside the Commonwealth. Of the Pennsylvania municipalities
where Township residents were employed, 73 (69%) impose an EIT/NPT. Based on
1990 CTPP figures, 28.3% of employed
Township residents worked in jurisdictions which do not impose an EIT/NPT on
non-residents.
The
1990 CTPP data also show that in 1990 Lower Merion was the workplace of 26,038
persons, of whom 18,184 were residents of other Pennsylvania municipalities.
Although data are not presently available as to the number of persons from
outside the Commonwealth who are working in Lower Merion Township, if the same
figure as to Lower Merion residents working outside of Pennsylvania (4.64%) is
applied to the total of Pennsylvania residents working in the Township, the
result would be an aggregate employment figure of 27,246.
The
EIT/NPT survey data is at variance with both the 1990 CTPP information and the
results produced by application of the percentage allocation in Table 3.2, and
while the variance is not material in terms of which EIT/NPT municipalities are
currently collecting tax from Lower Merion residents, it is of significance in
terms of those localities which are not imposing an EIT/NPT, and for whom the
Township’s enactment of an EIT/NPT would create a new tax burden.
The
survey showed that 7,084 residents of the Township paid EIT/NPT to
municipalities other than Philadelphia in 2001. Notwithstanding the relatively
large numbers of reported taxpayers, however, on the basis of IRS data the
EIT/NPT tax revenue collected by non-Philadelphia municipalities was well below
what would have been expected on the basis of aggregate wage and salary income
per employed Merion Township resident. Employed Township residents earned
$96,922 in 2000 on a per capita basis, and the local EIT/NPT tax collectors saw
earned income of only $44,805. In an effort to reconcile the disparate data,
and deal with part-time workers, persons working in more than one place and
those who were employed in an EIT/NPT area for only a portion of the year, a
“full-time equivalent” calculation based on per capita income was performed,
producing a figure of 3,298 employees.
While
many of the non-responding municipalities were geographically distant and for
the most part not major employment centers, several (notably Conshohocken
Borough, East Whiteland Township, and Plymouth Township) are known to be the
workplace of large numbers of Lower Merion residents, and have had employment
growth in recent years. The Delaware Valley Regional Planning Commission
estimates 2000 employment levels for those jurisdictions to be 11.2% larger
than in 1990,[vii] and the
addition of that factor to the three jurisdictions noted above brings the total
to 3,490. There also is a margin for intervening changes and statistical
deficiencies built in to this calculation, in that the 1990 CTPP figures for
Lower Merion Township residents working elsewhere totaled 2,532, a difference
of almost 38%.
While
1990 CTPP information noted 5,322 Lower Merion residents working in
municipalities not imposing the EIT/NPT on nonresidents, an adjustment of
approximately 6% was made (to a total of 5,644) to take possible data
inadequacies into account due to the length of time that has passed since the
information was compiled and changes in the regional employment market.
Figures for
residents of other areas working in Lower Merion are somewhat speculative. The
1990 CTPP reported that over 18,000 persons worked in the Township who lived
elsewhere in Pennsylvania, but current figures are not available for
non-Pennsylvania persons. The 1990 CTPP reported 11,536 persons with non-Lower
Merion residency working in the Township, (8,354 of whom are from Philadelphia)
who would not be liable for the Lower Merion EIT/NPT, and 6,648 persons were
reported to be employed in Lower Merion from jurisdictions not imposing the
tax. The final group would be liable to the Township for EIT/NPT. Table 3.2
provides an updated estimate of the distribution of employment among the seven
categories on the basis of currently available information
|
Table 3.2 – Lower Merion Township
Residents and Others Who are Employed in
Lower Merion Township |
|
|
Persons who…. |
Number |
|
Live and work in the Township |
8,650 |
|
Live in the Township, but work in Philadelphia |
8,982 |
|
Live in the Township, but work out of state |
1,304 |
|
Live in the Township, but work in a jurisdiction which
either does not impose an EIT/NPT, or which does not impose it on
non-residents |
5,644
|
|
Live in the Township, but work in a jurisdiction which
imposes an EIT/NPT on non-residents (other than in the City of Philadelphia) |
3,490
|
|
Live in a jurisdiction which imposes an EIT/NPT and work
in the Township |
11,536 |
|
Live in a jurisdiction which does not impose an EIT/NPT
and work in the Township. |
6,648 |
Total
|
46,254 |
Wage and Salary and Net Profit Calculations
Wage
and salary figures are not regularly reported on a municipality level, which
complicates the process of developing estimates of income for a locality which
does not already have an income-based tax in place. Several alternatives were
followed to determine an income level for Lower Merion Township.
Census
Data – The Census Bureau
compiles data from respondents to the decennial census as to income, which
includes self-reporting on earned income on a household basis. In the 2000
Census, respondents in 18,454 households in the Township with mean earnings of
$130,322 reported $2,404,962,188 in earnings.
IRS
Information – As noted
above, the Internal Revenue Service has made information available as to wage
and salary income reported on Form 1040 for 1998, by zip code. Four zip codes
are located wholly within Lower Merion, and eight others are shared with other
municipalities (three have fewer than ten addresses in Township). Census
information from 2000, by zip code, was compared with the boundaries of Lower
Merion, and that in turn was compared with the IRS-supplied information and
Census 2000 self-reported data to calculate that Lower Merion Township makes up
33.93% of the population of all zip codes which cover even a portion of the
Township, and 48.35% of the wage and salary income. With that as a base, it was
estimated that $2,558,820,000
was earned by Lower Merion residents from wages and salaries during 1998, and
that figure is estimated to have risen to $2,720,618,000 at the end of 2001 due
to inflation.
Other Data Sources – Investigations were made of other data
sources, with varying utility. The Bureau of Labor Statistics of the United
States Department of Labor publishes an “average annual pay” figure, by county.
The BLS calculated that to be $44,336 for 2001 for Montgomery County, which
seems to be too low for residents of Lower Merion Township in light of what is
known about Lower Merion’s demographics in comparison with those of the County
as a whole, even taking into account two-wage earner families as a surrogate
for the IRS data (e.g.,
reflected in joint tax returns), in light of IRS and census data. The
Pennsylvania Economy League – Eastern Division has done extensive research on
local tax matters, as has Professor Robert Inman of the Wharton School of the
University of Pennsylvania, and their work was drawn upon as well.
Calculation of Estimated Revenue from Imposition of an Earned
Income and Net Profits Tax
As
has been noted before, it is difficult to make a totally reliable estimate of
the yield from a new EIT/NPT. Current, comprehensive and consistent information
is lacking, and the diversity of taxing jurisdictions and the approaches they
take tends to obscure rather than illuminate. Facts pertaining to such matters
as deductions on the net profits side of the EIT/NPT are not available. With
that in mind, three different approaches were taken to estimate EIT/NPT yield,
disregarding questions of collection efficiency and/or cost, and a comparison
was made to Township staff-generated estimates. In each case, the calculation included
neither Township residents who work in Philadelphia (because of the Sterling
Act), nor residents of other areas which impose a resident EIT/NPT (in light of
the crediting of tax to home jurisdictions), and indicates that 22,246 persons
not now paying EIT/NPT will become subject to the tax (based upon the
percentage allocation of approach #1, below):
1.
Using
the information provided by the tax collection agencies, adjusted per capita
tax liability was used to determine how the composite rate would translate
into a .5% EIT/NPT paid to the Township by residents of other areas which
do not impose the EIT/NPT. Receipts from Lower Merion residents working in
EIT/NPT jurisdictions were calculated by use of the survey data and the imputed
collections from the principal municipalities from which EIT/NPT survey information
was not obtained, all for 2001. Other estimates (for persons who are Township
residents and who do not now pay EIT/NPT) were based on per capita income
figures derived from the IRS zip code data for 1998 (indexed to 2001).
A
mixed approach was taken for the other efforts. In each case, the composite per
capita income number derived from the EIT/NPT survey was used to calculate the
prospective tax liability for Lower Merion-employed persons who are not
residents of the Township:
2.
The 2000 Census
data as to earned income per household were used to determine aggregate and
per-household earned income for all Lower Merion residents, exclusive only
of those who are employed in Philadelphia. The .5% tax rate was applied to that income number.
3. The .5% tax rate
was applied to the wage and salary income number from the analysis which inter-relates
IRS zip code figures with allocated
Township population and income numbers derived from the Census for the persons
noted in Number 2., above. An inflation-based variation was added, taking
into account wage inflation in the
Philadelphia area since 1998.
[viii]
Table 3.3 summarizes the
results of the several approaches.
Table
3.3 – Alternative Approaches to EIT/NPT Revenue Estimates
|
|||
Taxpayer Group |
#1 Tax Collectors (2001
Basis) |
#2 2000 Census and Tax Collectors 1 |
#3 Inflation-Indexed Allocated IRS
Zip Code Data and Tax Collectors1 |
|
Live and work in the Township |
$ 4,191,904 |
$ 8,274,994 |
$ 9,250,103 |
|
Live in the Township - work out of state |
631,936 |
n/a |
n/a |
|
Live in the Township - work in a jurisdiction which
imposes EIT/NPT on non-residents (other than Philadelphia) |
1,493,941 |
n/a |
n/a |
|
Live in the Township - work in a jurisdiction which does
not impose EIT/NPT, or which does not impose it on non-residents |
2,735,157 |
n/a |
n/a |
|
Live in a jurisdiction which does not impose EIT/NPT - work in the Township |
1,363,836 |
1,363,836 |
1,363,836 |
Estimated Yield
|
$ 10,416,773 |
$ 9,638,830 |
$ 10,613,938 |
|
1Note: Amounts
in “Live and work in the Township” are inclusive of amounts allocable to the
three categories which follow. |
|||
Berkheimer in July of 2002 estimated that a 1.0% EIT/NPT would produce $12 million when fully implemented (thereby producing about half of that amount were Lower Merion Township to impose a .5% EIT/NPT), and Township staff has estimated $8.7 million as the likely yield. On the basis of the four approaches noted above, which average to $10,183,341, it is estimated that upon full implementation (assuming that no municipalities not now imposing an EIT/NPT decide to do so and current employment patterns) the Township would realize $10,100,000. approximately 87% of that amount would be paid by Township residents. Using this approach should provide enough latitude to deal with presently unknown factors.
Of the several approaches described above, #1 is calculated on a 2001 basis, and the others also take inflation into account, bringing the 1998 IRS data to the end of 2001. Wage inflation in the Philadelphia region has been low over the first six months of 2002, on a June 2001-June 2002 basis rising only 1.5%. The 23 forecasters who contribute to the Livingston Survey, published by the Federal Reserve Bank of Philadelphia, in June of this year forecasted a 10-year CPI-U price median inflation rate of 2.5%, a mean rate of 2.589%, and a rate of 4.7% during the 2001-2003 period (slightly more than 2.0% p.a.). If 2.0% is used as a conservative assumption, the cumulative impact would be 8.2% through 2005.[ix] Applying that factor to the estimate, the yield would increase to over $10.9 million.
Two additional factors could be taken into account were there a desire on the part of the Township to add some conservative assumptions into the mix. The first relates to Township residents who work out of state, and some of those persons may remit income-based taxes to other jurisdictions and may or may not be entitled to a credit on a Township-levied EIT/NPT. The second relates to the group of persons who live in jurisdictions which do not impose an EIT/NPT. Apart from anything which might occur to change the Sterling Act, there is some likelihood that more municipalities in Southeastern Pennsylvania will enact an EIT/NPT before 2005. While the Township could enjoy the benefits of not having to pay those amounts over to some “home” municipalities (as is the case now with jurisdictions which impose the EIT/NPT on Lower Merion citizens without having to pay anything over to the Township) for some time, a more conservative approach might be to assume that all remaining non-EIT/NPT municipalities will enact that tax prior to the Township’s EIT/NPT becoming effective.
With those two considerations factored in – the prospect of credits for Township residents working out of state causing a 50% reduction in anticipated revenue and the elimination of 100% of the EIT/NPT on nonresidents) the estimated revenue would drop to $5,894,000 in 2004 and $8,420,000 in the next year, without regard to inflation. Were the 8.2% inflation factor applied to the 2005 amount, the total would approximate $9,110,000.
[i]
Pennsylvania Department of
Community and Economic Development, Taxation Manual, Seventh Edition,
Harrisburg, May 1999, http://www.inventpa.com/docs/taxation.txt,
Jul 26, 2002 (the “DCED Tax Manual”).
[ii] DCED Tax Manual.
[iii] 53
P.S. 6913 and DCED Tax Manual.
[iv] 1990 Labor Force Location
Information, P048 Place of Work Minor Civil Division Level Universe Workers 16
Years and Over, Data Set: 1990 Summary Tape File 3 (STF 3), Sample data,
US Bureau of the Census.
[v] Pennsylvania Economy League
- Eastern Division; provided in May,
2002.
[vi] Regional Data Bulletin –
Population and Employment Forecasts, 2000-2025, 9-County DVRPC Region,
Delaware Valley Regional Planning Commission, March, 2002 (the “DVRPC
Forecast”).
[vii] DVRPC Forecast.
[viii] Bureau of Labor Statistics,
as per note 3., supra.
[ix] June 2001-June 2002 data
from Bureau of Labor Statistics, as per note 3., supra; Forecasts from Federal
Reserve Bank of Philadelphia, August 5, 2002. The “CPI-U” index relates to “all
urban consumers” in the Philadelphia area, whereas the “CPI-W” index focuses on
wage earners. Notwithstanding the differences which appear from time to time,
the aggregate change in the indices is within .4 percent since the 1982-84
benchmark period upon which the indices are based.