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Pennsylvania Act 32 - Implementation Alert

Tax

By Martin DiGiovine

Recently, we have received many inquiries requesting clarification of a statement made in an informational brochure by the Pennsylvania Institute of Certified Public Accountants (“PICPA”) titled, Act 32: Guide for Employers. One of the bullet points included in the brochure states:

At the time of payment to an employee, an employer will be required to deduct the local earned income tax from the employee’s paycheck. The applicable tax rate is the greater of the tax rate where the employee is employed or the tax rate in effect where the employee lives...

Most of the inquiries we have received have been from employers located in the City of Pittsburgh that are interpreting the statement to mean they would be required withhold a combined total of 3% city and school district tax from non-resident (of Pittsburgh) employees. The PICPA brochure is paraphrasing the requirement of Section 512 of Pennsylvania Act 32 of 2008, which says:

Every employer. . . shall, at the time of payment, deduct from the compensation due each employee...the greater of the employee's resident tax or the employee's nonresident tax...

While seemingly saying the same thing, the two paragraphs produce different results when applied to non-resident employees working in the City of Pittsburgh. This is currently causing confusion to employers, practitioners and others as they prepare to implement Act 32 at the start of next year. Here’s the reason for the confusion:

With the exception of Philadelphia, Pennsylvania local taxes are generally authorized by Act 511 of 1965, the Local Tax Enabling Act. The tax is levied on wages, salaries, commissions, net profits or other compensation of people subject to the jurisdiction of the taxing body.

With some exceptions, municipalities and school districts subject to Act 511 may, by ordinance or resolution, enact an earned income tax limited to 1%. Where both a municipality and a school district impose the tax on the same wage earner, the 1% maximum rate is divided evenly between the two taxing districts unless they agree otherwise. Municipalities may also impose a tax on nonresidents employed in their municipality; however, they must grant a credit for any earned income tax levied at the place of residence.

Example 1 - Al is a resident of Municipality A (with a 1% EIT rate), and is employed in Municipality B ( with a non resident EIT rate of 1%). Al is liable to both Municipality A and Municipality B for a tax equal to 1% of his wages. However, because Al receives a credit for taxes paid to Municipality A, he will owe no net tax to Municipality B. Under Act 32, Al’s employer will be required to withhold 1% of Al’s wages for local earned income taxes. The Tax Officer in the TCD where A1 is employed is required to transfer the tax to the TCD where A1 is domiciled. A1 must file a Final return with the Tax Officer in the community where they are domiciled to pay any balance of tax or file for a refund.

There are seven exceptions contained in Act 511 that permit the earned income tax rate to be raised to over 1%.1

Example 2 - Beth is a resident of Municipality A (with a 1% EIT rate), and is employed in Municipality C (with a 1.6% EIT rate imposed on residents and non-residents, due to their financially distressed pension plan). Beth is liable to Municipality A for EIT of 1% and to Municipality C for EIT equal to 1.6% of her wages. However because she receives a credit from Municipality C for the 1% tax paid to Municipality A, she pays a net nonresident tax equal to 0.6% of wages to Municipality C. Under Act 32, Beth’s employer will be required to withhold 1.6% of Beth’s wages for local earned income taxes. The 1% of Beth’s tax will be transferred to her home community TCD. Beth will be required to file a Final Tax Return.

If that were the end of the analysis of local earned income tax, both the paragraph contained in the PICPA brochure and the applicable paragraph of Act 32 would be accurate. However, the way the City of Pittsburgh and Pittsburgh School District earned income taxes are levied is causing confusion.

Under the authority Act 511 of 1965, the City of Pittsburgh levies a 1% earned income tax on residents and non residents. The City of Pittsburgh does not split this 1% with the Pittsburgh School District.

The Pittsburgh School District earned income tax is not levied under the authority of Act 511. Rather, Section 652.1 of Act 14 of 1949, also known as the Public School Code of 1949 (24 P.S. §1-101 et. seq.), specifically authorizes the Pittsburgh School District to levy a 2% earned income tax on residents. The statute specifically prohibits the School District from splitting the money with the City, and also prohibits the tax from being levied on non-residents. Therefore the Pittsburgh School District has no “non-resident” tax.

Example 3 - Charlie is a resident of Municipality A (with a 1% EIT rate), and is employed in the City of Pittsburgh ( with a non-resident EIT rate of 1% and a school district resident EIT of 2%). Charlie is liable to both Municipality A and the City of Pittsburgh for a tax equal to 1% of his wages. However, because Charlie receives a credit from the City of Pittsburgh for taxes paid to Municipality A, he will owe no net tax to the City of Pittsburgh. Additionally, because the 2% school district tax is levied only on those who reside within the Pittsburgh School District, it does not apply to Charlie. Under Act 32, Charlie’s employer will be required to withhold 1% of Charlie’s wages for local earned income taxes. Contrary to current procedure for the City of Pittsburgh, Charlie’s tax will be transferred to his home community. Charlie is required to file a Final Return with his community TCD Tax Officer.

We have spoken to many employers who are interpreting the guidance issued by the PICPA to mean that they must withhold the entire 3% of wages from non-resident employees who work within the City of Pittsburgh. As the preceding example illustrates, that is not the case.

Under Act 32, Pennsylvania’s earned income tax collection mechanism was re-structured to create 69 countywide Tax Collection Districts (TCD’s). Philadelphia, which is subject to the Sterling Act of 1932, is exempt from the requirements of Act 32. Allegheny County is segmented into 4 TCD’s under Act 32.

Tax Collection Committee’s (TCC’s) are the governing body for each TCD. The TCC is comprised of one delegate from each municipality and school district within the TCD. It is the responsibility of the TCC to appoint a tax officer or they may create a tax bureau and appoint a director and employees to provide for its operation.

Beginning in January of 2012, for TCD’s that did not elect early implementation, employers will be required to withhold EIT from all residents and non residents. The employer must withhold the tax at the rate in the employee’s home jurisdiction or at the rate at the work site location in order to accommodate certain other authorized levies. They must remit all withholdings to the TCD where they are located within 30 days of the end of each quarter. Prior to April of 2013, TCD’s will remit the taxes to the appropriate taxing jurisdiction within 60 days. After April of 2013, all taxes must be remitted to the appropriate taxing jurisdiction within 30 days.

Employers with multiple worksites within the Commonwealth of Pennsylvania will have the option of selecting one TCD to remit all of their withholdings to. Also, businesses with headquarters located in Pennsylvania also have the option to remit their withholdings to the TCD in which the headquarters is located. It will be the responsibility of each TCD Tax Officer to forward the withholdings to the appropriate TCD that each employee resides in. Under the current tax collection law, the tax officer is required to transfer the tax to the political subdivision where the employee is domiciled. Some jurisdictions, like the City of Pittsburgh require the non resident employee to file an exemption certificate (WTEX) with the employer to exclude the non resident employee from withholding. If the employee withholds the tax due to the absence of the exemption form the employee is required to seek a refund of the taxes. This does not apply to out of state residents or persons on work visas.

As Act 32 implementation continues to approach, it is certain that even more confusion will arise as to how to implement its requirements. Therefore, Eric Wright of Schneider Downs Technology Advisors recommends that employers assess their technological resources and system capabilities to collect, store and transmit the data to their third party payroll processor and general ledger systems as soon as possible. Schneider Downs would be pleased to assist you in this process.

Update – A sample Certificate of Residency Form, required for every employee of an employer having a factory, workshop, branch, warehouse or other place of business within the Commonwealth of Pennsylvania, can be found at: http://newpa.com/webfm_send/1566. Every employee must file this certificate with the employer at the same time the Federal form W-4 is filed and on each occasion a change of address or domicile occurs. The employer must verify the tax rate of the employee by accessing the appropriate state site. If the work site has authorization to impose a rate of tax upon non residents then the work site tax rate must be withheld from each employee as shown in Example 2. 

 Bob Villella, President of Central Tax Bureau of Pennsylvania, also contributed to this Insight.

Footnotes:

1. Earned income taxes also are subject to the overall limits on taxes enacted under Section 320 of Act 511. Not all taxing jurisdictions are limited to the 1 percent limit on the rate of the earned income tax. Other laws and provisions allow the Act 511 limit for earned income taxes to be exceeded under seven circumstances:
1.Home rule municipalities. 
2. Financially distressed municipalities. 
3. Municipalities with financially distressed pension systems. 
4. Municipalities that purchase open space. 
5. School districts that have adopted increased earned income taxes under Act 50 of 1998 (53 Pa.C.S. § 8581 et seq.) prior to the repeal of Act 50’s provisions addressing the levy of earned income taxes by Act 72 of 2004 (53 P.S. § 6925.101 et seq.), which itself was subsequently repealed by Special Session Act 1 of 2006. 
6. Municipalities and school districts that adopt the provisions of Chapter 4 of Act 511. 
7. School districts that adopt Act 1’s provisions to levy or increase earned income taxes.

Schneider Downs provides accountingtax, wealth management, technology and business advisory services through innovative thought leaders who deliver the expertise to meet the individual needs of each client. Our offices are located in Pittsburgh, PA and Columbus, OH. 

This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.

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