Corporate Net Income and Capital Stock Franchise Tax

In Pennsylvania, REITs and QRSs formed as corporations under the laws of any state are subject to both the corporate net income tax (“CNI”) and capital stock franchise tax (“CSFT”).  However a REIT or QRS formed as a business trust (including a Real Estate Investment Trust formed under Title 8 of the Maryland General Corporation Law, a “Maryland REIT”) is exempt from both of these taxes.  However, a business trust REIT is subject to CNI if the REIT is closely held by a corporation that is not a REIT or a QRS.

Planning note:  a QRS is an entity treated as a corporation for federal income tax purposes that is wholly owned by a REIT.  This means that a business trust QRS qualifies for the exemption from these taxes ONLY if it checks the box to be treated as a corporation for federal income tax purposes.  A business trust that is wholly owned by a REIT that is merely disregarded, but is not a QRS, is subject to these taxes.  As a result, make sure that you check the box for federal income tax purposes for any business trust wholly owned by a REIT if you want to claim this exemption. 

CNI

CNI is imposed at a rate of 9.99% on corporations and entities that check the box to be treated as corporations for federal income tax purposes.  CNI is not imposed on a REIT or QRS formed as a business trust (including a Maryland REIT).  However, CNI is imposed on a business trust REIT that is closely held by a corporation that is not a REIT or a QRS.

For CNI purposes, net income is based on taxable income for Federal income tax purposes, with adjustments.  As a result, a corporate REIT is entitled to a dividends paid deduction.  Notwithstanding that a corporate QRS is not itself a REIT, the policy in Pennsylvania is to permit a corporate QRS to take a dividends paid deduction.

A taxpayer also subject to tax in other jurisdictions may apportion its CNI tax base.  Apportionment is based on a three factor apportionment that is phasing into a single sales factor.  Currently, the factors are weighted 90% sales factor, 5% payroll factor; and 5% property factor.  Any factor with a denominator of zero is thrown out.

CSFT

CSFT is imposed on certain state law entities, including business trusts, LLCs, and corporations.  Importantly, LLCs and business trusts, even those treated as disregarded entities or partnerships for federal income tax purposes, are subject to CSFT.  However, CSFT is not imposed on (1) a REIT or QRS formed as a business trust (including a Maryland REIT) or (2) a state law partnership.  If an entity subject to CSFT is a partner, directly or through another state law partnership, in a state law partnership that does business in Pennsylvania, the partner is subject to CSFT.

CSFT is phasing out and is scheduled to be eliminated for tax years beginning January 1, 2014.  The tax rate is scheduled to be 1.89 mills in 2012, 0.89 mills in 2013 and -0- in 2014.

The CSFT tax base is based on a statutory formula [(A + B) / 2] - $160,000, where A = average net income, if any, capitalized at 9.5% and B = 75% of positive book net worth (or 0.5 * ( (average net income) / (0.095) + (0.75 * net worth)) - $160,000).  Average net income is the sum of the net income reported on the company’s financial books for the current year and the preceding 4 years divided by 5.  If an entity subject to CSFT has been in business for less than 5 years, average net income is calculated using only the years the entity has been in business.  For a single-member LLC or business trust that is owned by a partnership or corporation and treated as a disregarded entitiy for federal income tax purposes, the net income or loss is determined as though the LLC or business trust itself filed a federal income tax return.

A taxpayer also subject to tax in other jurisdictions may apportion its CSFT tax base.  Apportionment is based on the three factor apportionment – property, payroll, and sales, equally weighed.  Any factor with a denominator of zero is thrown out.  Alternatively, a taxpayer may elect to use a single factor, based on the property factor, to determine apportionment.

Planning Tips

Corporate REITS

If a REIT formed as a corporation intends to own property in Pennsylvania through:

  • a QRS, then the QRS should be formed as a business trust (including a Maryland REIT); 
  • an entity owned by its OP, and if the OP is a state law partnership, then the property owning entity should be a highly leveraged LLC so that its book net income and book net worth is minimized; or
  • an entity owned by its OP, and if the OP is an LLC, then the property owning entity should be a highly leveraged LLC so that its book net income and book net worth is minimized.

Business Trust REITS

If a REIT formed as a business trust (including a Maryland REIT) intends to own property in Pennsylvania through:

  • a QRS, then the QRS should be formed as a business trust (including a Maryland REIT); 
  • an entity owned by its OP, and if the OP is a state law partnership, then the property owning entity should be a state law partnership; or
  • an entity owned by its OP, and if the OP is an LLC, then the property owning entity should be a highly leveraged LLC so that its book net income and book net worth is minimized.

Realty Transfer Tax

Transfers of real estate are subject to a state level and local level realty transfer tax.  The state rate is 1% and the local rates vary from 1% to 5% (the rate in Philadelphia and Pittsburgh is 3%).  This tax is complicated and nuanced.  Structuring opportunities are available to minimize or eliminate the tax, at least upon a disposition if implemented at inception.

Transfers to and from entities (even wholly owned entities) are subject to tax except in very narrow circumstances.  Also, there is a controlling interest transfer tax imposed on a “real estate company” (as defined in the statute) that experiences a 90% or more change in ownership over a three year period.  For Pennsylvania realty transfer tax purposes, there is no concept of a disregarded entity; all state law entities must be considered.  For Pennsylvania and local realty transfer tax purposes everywhere except Philadelphia, a company that owns an interest in a “real estate company,” but which does not itself own real estate, is not a “real estate company.”  As a result, the use of tiered entities often can eliminate realty transfer tax on a disposition, other than in Philadelphia.

This article is intended as general information only and is not intended to constitute legal advice or a legal opinion on any specific facts or circumstances.

Related Practice

Tax