PA Tax Law News – September 2015
September 10, 2015
In this issue: PA Budget Watch Continues | Pass-Through Business Tax Alert | The Noose Tightens: Charitable Exemptions Again Under Attack | Department Recommences Responsible Party Assessments | IFTA Compliance More Important Than Ever
PA Budget Watch Continues
As this issue of our newsletter went to the printer, a final Pennsylvania budget, with related tax provisions for FY 2015-16 still seemed far off. As soon as there is something substantive to report, we will issue an email update. If you are not signed up yet for electronic delivery, please visit www.mwn.com and sign up at the “Newsroom/Newsletter SignUp” tab.
Pass-Through Business Tax Alert
The Pennsylvania Department of Revenue has announced that it will soon begin identifying pass-through business entities that have under-reported income, failed to file PA-20S/PA-65 Information Returns, and failed to maintain accurate lists of owner information for tax years beginning on or after January 1, 2014.
Through Act 52 of 2013, the Pennsylvania General Assembly gave the Department the muscle in the following three new enforcement provisions related to pass-through business entities, and the Department fully intends to start flexing it:
The Department may now assess partnerships and PA S corporations at the entity level for understating income by more than $1 million. Excluding publicly traded partnerships, this provision applies to partnerships with eleven or more partners; partnerships with at least one partner that is a corporation, limited liability company, partnership, S corporation, or trust; PA S corporations with eleven or more shareholders; and any partnership or PA S corporation that elects to be subject to the provision.
Please note that appeals involving a deficiency assessed against a partnership may only be pursued by the partnership, and a reassessment of tax liability will be binding on the partners. Likewise, appeals involving the deficiency assessed against a PA S corporation may be filed only by the PA S corporation, and a reassessment of tax liability will bind the shareholders.
A $250 failure-to-file penalty applies when a partnership, S-corporation, or limited liability company classified as a partnership or S corporation for federal tax purposes does not file a PA-20S/PA-65 Information Return. The $250 penalty also applies to any trust or estate that fails to file a PA-41 Fiduciary Income Tax Return and provide RK-1s and NRK-1s to all beneficiaries. Additionally, the penalty applies for each missing PA Schedule RK-1 or NRK-1.
Every estate, trust, Pennsylvania S corporation, or partnership (other than a publicly traded partnership) that fails to maintain an accurate list at the end of the entity’s taxable year, including the name, current address, and tax identification number of all existing partners, members, beneficiaries, or shareholders and all of the partners, members, beneficiaries, or shareholders who were admitted or who withdrew during the taxable year, including the date of withdrawal and admittance, will subject the general partner, tax matters partner, corporate officer, and/or trustee of the partnership, S corporation, trust, or estate to responsible party assessments holding them individually liable for the tax, penalty, and interest owed by the entity.
The Noose Tightens: Charitable Exemptions Again Under Attack
For decades, charities in Pennsylvania have enjoyed an exemption from real estate taxation and sales and use taxes. Recently, several Pennsylvania appellate decisions have tightened that exemption. As a result, charities across the state need to be aware that some taxing jurisdictions are becoming very aggressive in their approach to exemptions. This aggression, in turn, has spurred a constitutional amendment push in the General Assembly. While this article will focus on the recent cases and what charities can do in this new environment, it is helpful to back up and understand the genesis of the exemption.
The Consolidated County Assessment Law, 53 Pa.C.S. § 8812, et seq., specifically exempts from taxation property of “[a]ll institutions of… charity. . .endowed and maintained by public or private charity…” 53 Pa.C.S. § 8812(a)(3). The Constitution of the Commonwealth of Pennsylvania provides the basis for this exemption in Article VIII, § 2(a)(v) which provides, “[t]he General Assembly may by law exempt from taxation…[i]nstitutions of purely public charity …” Determining what exactly constituted a “purely public charity” for purposes of the constitutional provision provided a challenge to courts over the years. Finally, in 1985, the Pennsylvania Supreme Court in Hospital Utilization Project v. Commonwealth, 487 A.2d 1307 (Pa. 1985), articulated a five-pronged test to be used in determining whether an entity was an “institution of purely public charity” for constitutional purposes. This test, widely referred to as the “HUP Test,” provided some long-awaited guidance from the highest court, but by no means ended the confusion. Partly in response to the ambiguities present in the HUP Test, and in an effort to define “purely public charity,” the General Assembly enacted The Institutions of Purely Public Charity Act, Act of November 26, 1997, P.L. 508, 10 P.S. § 371 et seq.(“Act”). Also consisting of five prongs that closely mirror the HUP test, the Act sets forth objective criteria to evaluate whether an entity is a “purely public charity.”
The HUP Test
Under the HUP Test, in order to meet the constitutional threshold of a “purely public charity,” an institution must: (a) advance a charitable purpose; (b) donate or render gratuitously a substantial part of its services; (c) benefit a substantial and indefinite class of persons who are legitimate subjects of charity; (d) relieve the government from some of its burden; and (e) operate entirely free from private profit motive.
Under the Act, an institution must advance a charitable purpose, 10 P.S. § 375(b); have no private profit motive, 10 P.S. § 375(c); provide community service, 10 P.S. § 375(d); provide charity to persons, 10 P.S. § 375(e); and provide government service by relieving the government of some of its burden, 10 P.S. § 375(f).
The Chicken or the Egg?
Does one test take precedence over the other? Are the tests the same? These questions have frustrated charities, advocates, and judges over the years. Since adoption of the Act in 1997, Pennsylvania courts had been clear that, since the exemption is rooted in the constitution, the HUP Test must be met before reaching the five prongs of the Act. Despite this settled case law, the Pennsylvania Supreme Court case of Mesivtah Eitz Chaim of Bobov, Inc. v. Pike County Board of Assessment Appeals, 44 A.3d 3 (Pa. 2012), which once again confirmed that the HUP Test must be passed before the Act’s test is reached, was greeted with banner point headlines in the press and breathless commentary that it was somehow a “game-changer” in the exemption world. There was absolutely nothing landmark about the holding in Mesivtah.
As a practical matter, the tests are nearly identical, so, if an entity can meet a prong of one test, it generally can meet the corresponding prong of the other. The Act does have some objective criteria in the form of financial tests that rely on calculations, so it is not unimaginable that an entity could meet the HUP Test and fail the corresponding prong of the Act due to the inability to meet the objective test. This situation, however, would be rare. Importantly, when Mesivtah was decided, there had never been a case of a Pennsylvania court finding that an institution had failed a prong of the HUP Test after meeting the corresponding prong of the Act.
The Post-Mesivtah Landscape
Whether rational or not, the activity in the aftermath of Mesivtah has seen taxing jurisdictions become emboldened in their willingness to challenge charitable exemptions and has motivated the General Assembly to begin the process of enacting a constitutional amendment that would grant the General Assembly the sole power to define what “institution of purely public charity” means for purposes of the exemption. Currently, that effort needs only to pass the House of Representatives this session, followed by approval in a statewide referendum, in order to take effect.
With respect to how courts are looking at exemption cases, they continue to note that each case turns on the particular, specific facts of the case. Recently, in Fayette Resources, Inc. v. Fayette County Board of Assessment Appeals, 107 A.3d 839 (Pa. Cmwlth. 2015), the court held that an institution operating group homes for the mentally disabled, usually a charitable activity that qualifies an institution for exemption, failed to meet the HUP Test because it had failed to offer evidence as to how it donated or rendered gratuitously a substantial part of its services. On its face, this holding is unremarkable because courts often have found that an institution seeking exemption failed to offer the appropriate evidence to pass a particular prong. What is noteworthy about this holding, however, is the fact that the court noted that the institution appears to have satisfied all five prongs of the Act. While courts have danced around this issue before, this is the first time that a court has expressly stated that a charity has passed a prong of the Act, while failing the corresponding prong of the HUP Test. This holding is much more noteworthy and impactful than anything that was decided in Mesivtah. The Fayette court’s decoupling of the two tests may have the effect of making charitable exemption issues even more inconsistent, ambiguous, and unclear than they are now. While not perfect in its mission of calming the exemption waters, the Act did serve to impose discipline on the process by providing objective criteria to help institutions, advocates, and judges in the analysis of exemption issues.
Given the state of affairs, in the short term, charities holding exemptions should reexamine their compliance with both the HUP Test and the Act. While it is possible that the constitutional amendment will resolve some of the thornier and confusing issues, there is no assurance that the amendment will be enacted. Even if the amendment passes, issues will still exist and taxing jurisdictions will continue their efforts to lop off exemptions in their never ending search for revenue. Therefore, it is worth being prepared. Our team has substantial experience with charitable exemptions, having both worked on the language of the Act as well as successfully having litigated charitable exemption cases.
Please feel free to contact one of our Group members if you have any questions regarding Pennsylvania’s charitable exemptions.
Department Recommences Responsible Party Assessments
When the Department of Revenue transitioned trust fund taxes to its “new” integrated computerized tax system last November, it temporarily suspended the issuance of responsible party assessments. In its most recent PA Tax Update, the Department announced that it would be resuming the issuance of responsible party assessments. It is imperative that officers and other persons in control of a business make sure that trust fund taxes (employer withholding taxes and sales taxes collected from customers) are paid when due, even when a business is having financial difficulties, to avoid potential personal liability for such taxes through a responsible party assessment.
A responsible party assessment must be timely appealed even if the business has appealed the underlying tax liability or the recipient may lose the right to contest personal liability for the unpaid taxes. As reflected in decisions recently published in the Board of Finance and Revenue’s decision database, untimely appeals are generally dismissed, even when an individual thinks he or she has a compelling reason for not filing a timely appeal.
Under Pennsylvania law, there are important exceptions to the general rule that officers, employees and owners of a corporation or limited liability company have no personal liability for the business’s unpaid tax liabilities. The Pennsylvania Department of Revenue has statutory authority to collect unremitted sales tax, employer withholding tax and fuel tax from “responsible parties” when those taxes have been collected from customers or withheld from the compensation of employees. See 72 P.S. § 7225; 72 P.S. § 7320; 75 Pa. C.S. § 9014. The basis for this type of assessment is that the collected taxes constitute a “trust fund” in favor of the Commonwealth. That is, in each of these situations, the business has collected taxes from third parties on behalf of the Commonwealth. The applicable statutes generally provide that the collected, but unpaid, taxes are enforceable against “representatives” of the business that collected the taxes.
When there is an unpaid “trust fund” liability, the Department of Revenue is likely to issue a responsible party assessment against the chief operating and financial officers of the business and possibly against owners and other employees who have been identified on tax filings or registration documents as having responsibility for the reporting of these taxes. It is therefore critical that such persons file the appropriate forms to have their names removed from the records maintained by the Department when they are no longer an officer or owner of a business or otherwise no longer have responsibility for the operation of the business or for tax filings.
Since the Department often has limited information as to which individuals were actually in control of a business’s operations and/or responsible for the remittance of trust fund taxes, assessments are commonly issued against individuals who were not actually “responsible parties,” as that term has been construed by the Pennsylvania courts. For example, the courts have generally restricted personal liability for unpaid trust fund taxes to individuals who actively control the operations of a business. See, e.g., Brown v. Commonwealth, 670 A.2d 1222 (Pa. Cmwlth. 1996).
Individuals who were, in fact, actively engaged in the management and control of the business generally do have personal responsibility for unpaid trust fund taxes. Persons in control of a business should make sure that all trust fund taxes are paid when due, even when a business encounters cash flow problems. The volume of responsible party assessments issued by the Department reflects how common it is for businesses with financial problems to use trust fund taxes to pay other financial obligations. Lack of intent to “defraud” the Commonwealth is no defense to a responsible party assessment. Similarly, the fact that a “responsible party” may have received no financial benefit from the failure to remit trust fund taxes does not shield him or her from personal liability for the unpaid taxes.
It is sometimes possible for an individual to obtain relief from a responsible party assessment at the administrative appeal levels, but only if the individual can adequately demonstrate that he or she was not responsible for the operations of the business during the period when the trust fund taxes were collected. Even individuals who were “active and controlling” agents of a business may have grounds to appeal certain portions of a responsible party assessment, such as interest and penalties, or taxes assessed for periods when they were no longer in control of the business. We also have seen cases where a “responsible party” was erroneously assessed for tax liabilities of a business which did not constitute “trust fund” taxes because they were not taxes that had been collected from customers.
If an assessment is issued, and the recipient does not file a timely appeal, the Department will file a lien against the individual and may take other collection action. The circumstances under which an untimely appeal from a responsible party assessment will be considered are very limited. For example, in decisions recently issued by the Board of Finance and Revenue, the Board declined to consider untimely appeals filed by, among others, an individual who “was preoccupied with caring for his father who subsequently passed away,” and who had served as the corporation’s accountant during his illness, and by an individual who claimed that “the appeal was filed late at the Board of Appeals because an employee she was working with was fatally electrocuted on the job site” and she was “dealing with the legal setbacks and the emotional toll of the fatality.”
For assistance in dealing with a responsible party assessment, please contact a member of the McNees SALT Group.
Jim Fritz Again Named to Best Lawyers in America©
Jim Fritz has been listed in the 2016 edition of The Best Lawyers in America©, in the category “Litigation & Controversy – Tax.”
Best Lawyers® lists are compiled based on exhaustive peer-review evaluation, and Best Lawyers’ lists have become recognized as the most reliable, unbiased source of legal referrals in the country. Jim has been listed in Best Lawyers® since 2008.
IFTA Compliance More Important Than Ever
Several Pennsylvania appellate court decisions in recent years have made it more important than ever for IFTA licensees to strictly comply with IFTA documentation requirements. The fact that a company actually pays taxes on all of the fuel that it purchases at retail stations and/or dispenses from bulk fuel tank(s) will not preclude a substantial audit liability if proper records are not maintained. While there are still some arguments available to contest an IFTA audit determination, it has become more difficult to obtain favorable settlements of IFTA audit liabilities through the appeals process for companies with less than stellar records since these decisions were issued.
In R & R Express v. Commonwealth, 37 A.3d 46 (Pa. Cmwlth. 2012), aff’d per curiam, 65 A.3d 900 (Pa. 2013), the court upheld an IFTA audit liability of over $300,000, plus interest, against a brokerage company that failed to strictly comply with IFTA documentation requirements, in part because its owner/operators did not consistently turn in trip reports and fuel receipts for their activity. In addition to disallowing credit for tax paid on all fuel purchases that were not properly documented, the auditor imposed the statutory 4.0 m.p.g. factor for vehicles with incomplete records. The court rejected the company’s argument that the audit deficiency should be stricken because it had already paid tax on all fuel used in its motor carrier operations at the time of purchase. The court also rejected the company’s request to have its tax for the audit period recomputed based on data for reporting periods subsequent to the audit period because its recordkeeping procedures had improved after the audit. While the court expressed “sympathy” for the taxpayer’s plight, it ruled that strict compliance with IFTA reporting standards is required.
In another recent decision, the court ruled that IFTA licensees are not entitled to interest on tax overpayments found during an audit for one or more jurisdictions, even though interest is owed to jurisdictions in which tax was underpaid. See Southern Pines Trucking v. Commonwealth, 42 A.3d 1222 (Pa. Cmwlth. 2012), affirmed per curiam, 69 A.3d 235 (Pa. 2013). Under IFTA, when a motor carrier’s base state conducts an audit, it is required to determine the carrier’s reporting compliance for every member jurisdiction in which the carrier travels. IFTA Article R1230 specifically mandates that the amount of interest due be calculated separately for each jurisdiction. Finally, in Senex Explosives, Inc. v. Commonwealth, 58 A.3d 131 (Pa. Cmwlth. 2012), aff’d per curiam, 91 A.3d 101 (Pa. 2014), the court extended the rationale of R & R Express to bulk fuel purchases. That is, credit for tax paid on purchases of bulk fuel was disallowed because the taxpayer did not maintain sufficient records to show the amount of fuel dispensed from its bulk tank(s) into individual vehicles.
In addition to keeping proper mileage and fuel records, IFTA licensees should notify the Department’s Bureau of Motor Fuel Taxes of any changes to their account. If the Department is not timely notified when a vehicle to which IFTA decals have been affixed is sold, traded or otherwise disposed of, or passes from the carrier’s control through a lease, the Department takes the position that tax liability remains with the licensee until the Bureau receives proper notification of disposition or loss of control of the licensed vehicle(s). Carriers are also advised to retain all purchased, but unused, decals for at least four years for auditing purposes. In the event of an IFTA audit, a company that disposes of unused IFTA decals will likely be assessed tax for each decal that is unaccounted for (e.g., based on the average activity of its fleet).
IFTA compliance requirements are set forth in the “PA International Fuel Tax Agreement and Motor Carriers Road Tax Compliance Manual” published by the Department of Revenue. Compliance requirements also are discussed in a white paper titled “International Fuel Tax Agreement Compliance Tips,” which is available on the McNees website.
The McNees SALT Group can provide advice on IFTA compliance procedures and assist with IFTA audits and appeals.
PA State & Local Taxes Seminar
October 30th in Lancaster
The McNees SALT Group will present its annual full-day seminar on Pennsylvania State & Local Tax Developments on Friday, October 30th, at the Eden Resort in Lancaster, PA. Legislative, administrative and court developments involving corporate, sales & use, personal income, fuel and other state and local taxes will be covered. Special speakers from the Department of Revenue and the Board of Finance and Revenue will address recent pass-through business developments and recent appeal procedure changes. Segments on Sales and Use Tax manufacturing exclusion and services issues also will be presented.
For additional information, click here.
PA Sales and Use Tax Update for Manufacturers
On October 1, 2015, Sharon Paxton and Randy Varner will co-present a live webinar discussing Pennsylvania Sales and Use Tax issues for manufacturers from 1:00 p.m. to 2:40 p.m. An agenda is available here. A substantial discount is available using priority code 15999 and discount code K7991259.
Sales and Use Tax in Pennsylvania
On October 7, 2015, Sharon Paxton and Randy Varner will be among the presenters at an all-day Pennsylvania Sales and Use Tax seminar in Harrisburg. An agenda and registration details are available here.
PA Sales and Use Tax Update
On November 17, 2015, Jim Fritz, Sharon Paxton and Paul Morcom will co-present a live webinar discussing hot Pennsylvania Sales and Use Tax issues and guidelines for dealing effectively with audits and appeals from 1:00 p.m. to 2:40 p.m. A substantial discount may be obtained here.
MACPA Advanced Tax Institute
Randy Varner will be speaking at the 2015 Advanced Tax Institute presented by the Maryland Association of Certified Public Accounts on November 4, 2015, in Baltimore, Maryland. Randy will be presenting the Pennsylvania Tax Update.
PA TAX LAW NEWS is presented with the understanding that the publisher does not render specific legal, accounting or other professional service to the reader. Due to the rapidly changing nature of the law, information contained in this publication may become outdated. Anyone using this material must always research original sources of authority and update this information to ensure accuracy and applicability to specific legal matters. In no event will the authors, the reviewers or the publisher be liable for any damage, whether direct, indirect or consequential, claimed to result from the use of this material.