Earned Income Tax
Local income taxes in Pennsylvania are variously termed earned income taxes, wage taxes or net profits taxes or a combination of these terms.
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- Current EIT/PIT/LST Tax Registers
- Withholding the Earned Income Tax
- Definitions of Earned Income and Net Profits in the Local Tax Enabling Act
- Summary - Definitions of Earned Income and Net Profits
The earned income tax is a tax levied as a percent of earned income. The Local Tax Enabling Act requires every employer having a factory, workshop, branch, warehouse or other place of business within the taxing jurisdiction to register with the earned income tax officer of that district. All employers with work sites within the taxing jurisdiction are required by law to deduct the earned income tax from their employees at that site if the tax is listed in the Local Tax Register. If the municipality and/or school district’s tax rates are not listed in the Register, employers are not required to withhold earned income taxes from employee wages. Except for the City of Philadelphia and the Pittsburgh School District, employers have no legal responsibility to withhold taxes levied by jurisdictions where they have no worksites.
If an ordinance contains a provision imposing the earned income tax on nonresidents, the employer is required to withhold from all employees regardless of their place of residence and remit the money to the tax officer. Responsibility for transmitting withheld taxes of nonresidents to the employees’ place of residence rests with the tax officer, not with the employer.
Where the ordinance taxes residents of the taxing district only, the employer is required to withhold only from resident employees. Any other withholding under a resident-only taxing ordinance is voluntary on the part of the employer, usually done for the convenience of the employee. If the ordinance levies taxes on residents only, the municipal earned income tax officer may refuse to accept withholdings for any nonresidents. In such a case the employer is left with the choice of refunding the withholdings or transmitting them directly to the nonresident’s tax officer. Some employers with work locations in resident-only jurisdictions withhold from all employees as a matter of company policy, deciding to shoulder the additional filing costs as a benefit to their employees.
The exception to this rule is the earned income tax levied by the Pittsburgh School District. The district may require withholding of its tax from any nonresident employer who is believed to employ any resident of the district. Pennsylvania employers are required to withhold the Philadelphia wage tax from all employees who are Philadelphia residents regardless of where they work.
From Section 13 of the Local Tax Enabling Act, Act 511 of 1965 (53 P.S. §6913), as amended through December 20, 2005
"Earned income." Compensation as determined under section 303 of the act of March 4, 1971 (P.L.6, No.2), known as the "Tax Reform Code of 1971," and regulations in 61 Pa. Code Pt. I Subpt. B Art. V (relating to personal income tax), not including, however, wages or compensation paid to individuals on active military service. Employee business expenses are allowable deductions as determined under Article III of the "Tax Reform Code of 1971." The amount of any housing allowance provided to a member of the clergy shall not be taxable as earned income.
"Net profits." The net income from the operation of a business, profession, or other activity, except corporations, determined under section 303 of the act of March 4, 1971 (P.L.6, No.2), known as the "Tax Reform Code of 1971," and regulations in 61 Pa. Code Pt. I Subpt. B Art. V (relating to personal income tax). The term does not include income which is not paid for services provided and which is in the nature of earnings from an investment. For taxpayers engaged in the business, profession or activity of farming, the term shall not include:
Any interest earnings generated from any monetary accounts or investment instruments of the
- Any gain on the sale of farm machinery;
- Any gain on the sale of livestock held twelve months or more for draft, breeding or dairy purposes; and
- Any gain on the sale of other capital assets of the farm.
Act 166 of 2002 and Act 24 of 2004 changed the definitions of “earned income” and “net profits” for purposes of the earned income tax imposed under the Local Tax Enabling Act, Act 511 of 1965, 53 P.S. §6901 et seq., to adopt, with certain exceptions, the definitions of “compensation” and “net profits” for state personal income tax purposes. The changes to the definitions of earned income and net profits are not optional. They apply for tax years beginning on and after January 1, 2003.
The definitions of “earned income” and “net profits” in the Local Tax Enabling Act, now reference the definitions of “compensation” and “net profits” that are used for the personal income tax in state law and regulations. Local taxpayers are permitted to deduct from compensation the same employee business expenses that are deductible from compensation for state income tax purposes. Interest and dividends, which are taxable under the state personal income tax, are still not taxable at the local level.
Taxable compensation at the local level is almost identical to taxable compensation at the state level, except that housing allowances provided to a member of clergy and active-duty military pay are not taxable at the local level.
While the definition of “net profits” in the Local Tax Enabling Act includes net income from the operation of a business, profession or other activity, it does not include income from corporations. In addition, net profits do not include income that is “not paid for services provided” or that is in the nature of earnings from an investment. Most distributions passed through to a taxpayer by an S Corporation are considered investment income and not subject to the earned income tax, unless the distributions are based on services provided by the taxpayer. See May 24, 2004 from the Department of Revenue. Letter to Local Tax Collectors.
For taxpayers engaged in farming net profits do not include interest earned on the monetary accounts of the farming business and gains from the sale of farm machinery, most livestock and the capital assets of the farm.
The definitions of earned income and net profits in the Local Tax Enabling Act reference the definitions of compensation and net profits in 61 Pa. Code Pt. I Subpt. B Art. Art. V.
In addition, the Department of Revenue produces a Personal Income Tax Guide that provides more information than the regulations on what is considered compensation and net profits for state personal income tax purposes.
Disclaimer: The preceding summary is for informational purposes only, does not constitute legal advice and may not be legally relied upon by any person or organization. Local governmental organizations should consult their solicitors for legal advice concerning the effect of the amendments made to the Local Tax Enabling Act by Act 166 of 2002 and Act 24 of 2004.