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March 25, 2015
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Financially Distressed Municipalities Obtain New Taxing Powers Under Act 47 Recovery Program

by Timothy J. Horstmann

Reprinted with permission from the March 25, 2015 issue of The Legal Intelligencer
© 2015 ALM Media Properties, LLC.
Further duplication without permission is prohibited. All rights reserved.

On October 31, 2014, Governor Tom Corbett signed House Bill 1773 into law, as Act 199. Act 199 represents the most significant reform in decades of the Commonwealth’s Financial Recovery Program – or Act 47 Program, as it is commonly known. Of the numerous changes made to the Act 47 Program by Act 199, are changes to the taxing powers granted to certain municipalities that enroll in the Act 47 Program. The changes give those municipalities that qualify greater flexibility in selecting the taxes that they impose, but will not result in additional tax revenue to the municipality when compared to what would have been obtained before the passage of Act 199.

Under the Act 47 Program, enrolled municipalities must petition their local court of common pleas for authorization to increase taxes beyond the maximum rates provided by law. Prior to the passage of Act 199, enrolled municipalities only were permitted to increase rates of taxation beyond those provided by law for earned income taxes and the property taxes. With the passage of Act 199, certain municipalities have two additional options when petitioning the court for a tax increase: an increase in the local services tax, and the imposition of a payroll preparation tax.

The local services tax is a tax with which most readers are familiar – it is the $52 flat tax imposed by a municipality pursuant to the Local Tax Enabling Act and in the jurisdiction where the person is employed. Under the Local Tax Enabling Act, the local services tax may actually be imposed at any rate, up to a maximum of $52, so long as the rate is uniform for all individuals. If the municipality charges a local services tax at a rate in excess of $10, it must exempt from the tax any person whose income is less than $12,000. Proceeds from this tax may be used by the municipality only for limited purposes, as follows: (1) emergency services, including emergency medical services, police services and fire services; (2) road construction and maintenance, (3) property tax reduction, and (4) homestead and farmstead property tax relief.

Under Act 199, municipalities enrolled in the Act 47 Program may petition the local court for an increase in the local services tax beyond the $52 limit mandated by the Local Tax Enabling Act, up to a maximum of $156. There are several limits associated with raising the rate beyond the $52 limit, however. First, the municipality must also increase the exemption threshold for certain individuals, from $12,000 to $15,600. Additionally, the option to request an increase in the local services tax is only available to those municipalities that are authorized to request the court for the imposition of an earned income tax on nonresidents.

Also, special rules apply to municipalities that have pension funds operating under a “moderate” or “severe” distress determination under the Municipal Pension Plan Funding Standard and Recovery Act, i.e., pension funds carrying a funding ratio of 69% or less. For such municipalities, the maximum local services tax rate permissible under Act 199 is reduced to $104, but only if the municipality is already levying an increased tax on earned income permitted by the Recovery Act for the purpose of shoring up the pension fund.

Finally, in keeping with Act 199’s purpose of providing additional flexibility, but not additional revenue, the option of raising the local services tax beyond the $52 limit is an alternative to raising the earned income tax. A municipality must therefore choose between requesting an increase in the earned income tax, or an increase in the local services tax.

Act 199 also extends to municipalities the option of requesting the local court to impose a payroll preparation tax in the manner prescribed in the Local Tax Enabling Act. Under that Act, a tax is imposed on all payroll generated by an employer from business activity within the municipality. Payroll includes all amounts paid by the employer as salaries, wages, commissions, bonuses, net earnings and incentive payments, whether based on profits or otherwise, fees and similar remuneration for services rendered, whether directly or through an agent and whether in cash, in property or the right to receive property.

However, in keeping with Act 199’s intended purpose of granting Act 47 municipalities additional flexibility, but not additional tax revenue, the option to request a payroll preparation tax is limited to municipalities that have imposed mercantile or business privilege taxes, and is in substitution for such taxes. Thus, a municipality that elects to replace their existing business privilege or mercantile tax with a payroll preparation tax must impose the new tax at the rate that is sufficient to produce the same amount of revenue produced by the existing business privilege or mercantile tax in the previous year.

A municipality considering switching from a business privilege or mercantile tax to a payroll preparation tax should not do so lightly, as the decision is binding even after the municipality exits the Act 47 Program. Once the decision has been made to switch to a payroll preparation tax, the municipality is locked into imposing that tax, and may not increase the rate of the tax beyond the rate initially approved by the court.

With Act 199 only going into effect earlier this year, it remains to be seen how effective the claimed additional flexibility will be in helping distressed municipalities craft recovery plans. Regardless of the taxing options chosen, municipalities seeking assistance through Act 47 will still face tough choices on their road to financial recovery.

Timothy J. Horstmann is an attorney with the law firm of McNees Wallace & Nurick LLC in Harrisburg, and practice in the Firm’s Municipal Recovery group. The group advises fiscally-challenged municipalities in Pennsylvania, and calls on the experience of its attorneys in public finance, business, tax, labor, energy and infrastructure in crafting novel solutions to a municipality’s financial problems. The group’s attorneys have advised municipalities enrolled or considering to enroll in the Commonwealth’s Financial Recovery Program. Tim can be reached at thorstmann@mwn.com.