A business owner who avoids paying the state sales or employer withholding taxes can get in big trouble.
A business owner who avoids the state corporate net income tax can get away with it.
Behind this distinction is "the Delaware Loophole," a misnamed tax law quirk that state officials say costs Pennsylvania $450 million a year in corporate net income taxes and forces it to rely more on taxpayers and small business owners who earn far less than multibillion-dollar, multinational corporations.
The difference between the two business owners is not lost on Gov. Ed Rendell, whose administration has vigorously chased delinquent taxpayers while fruitlessly pleading to amend state tax laws to ensure more companies pay the corporate tax.
For most of the last eight years, Mr. Rendell has tried to close the loophole only to have Republicans in the General Assembly thwart him.
But state Senate Republican Leader Dominick Pileggi, R-9, Chester, said the governor's proposal went from a revenue neutral one - a swap of closing the loophole for a lower corporate tax rate - to one intended to raise additional money for the state.
Mr. Pileggi and other loophole supporters say it is necessary to allow companies to avoid an onerous corporate net income tax of 9.9 percent, the second highest in the nation.
"It reduces a company's taxable income and makes it competitive and financially viable for it to stay in the state," said Mike Cortez, an official for the convenience store chain, Sheetz, and a member of the state commission that studied Pennsylvania's business taxes.
That $450 million would fit nicely into the $472 million gap that Mr. Rendell is trying to fill in funding for road and bridge construction and mass transit.
As he pushes for more funding, the governor rails against the seven major oil companies that account for 95 percent of all the gasoline sold in Pennsylvania, and pay only $70 million in state taxes combined.
One of the seven, with headquarters in Pennsylvania, pays about $35 million, Mr. Rendell said. He did not identify the company, but Sunoco is based in Philadelphia. Mr. Rendell identified ExxonMobil and BP as two of the other six.
"One of those ... is ExxonMobil, which made $52 billion in profit last year," he said.
He declined to identify the other four.
In fact, Mr. Rendell and state officials refused to provide a list of all the companies that use the Delaware Loophole to reduce their exposure to the corporate net income tax.
"I would love to do it," Mr. Rendell said of providing the list. But the confidentiality of tax returns prohibits him from doing that, he said.
The governor said he named ExxonMobil and BP only because he did not say what they pay. Asked to release a list without saying what the companies pay, the governor said he would consider it.
"I think I'm banned, but I'll take a look at it," he said. Gary Tuma, his press secretary, said later the state would not release the list, though it might if the governor follows through with a more thorough legal review. Still later, Mr. Tuma said the state would stick to its refusal to release the list.
"Anything coming to the Department of Revenue in a tax return is confidential," department spokeswoman Stephanie Weyant said.
The Times-Tribune has filed a Right-To-Know request with the state Department of Revenue in an effort to obtain the list. The department has yet to respond to the request.
The confidentiality issue sets up an ironic contrast.
The names of companies that use the loophole are a state secret. The names of companies that avoid paying sales or withholding taxes long enough end up published on the state Department of Revenue website if they owe at least $5,000, are still in business and have had a state tax lien filed against them.
"If you're talking about the Delaware Loophole, it's a tax policy we're not fond of, but it is a completely legal tax strategy," revenue spokeswoman Elizabeth Brassell said.
The sales tax is 6 percent; the withholding tax is the 3.07 percent earned income tax charged to employees and collected by employers, who forward it to Harrisburg. Tax liens, filed most often in county courthouses by all levels of tax-collecting governments, protect a government's ability to collect unpaid taxes. Liens allow agencies to get paid what they are owed if a business is sold and allow tax collectors to force the sale of property to cover the unpaid taxes.
The department posts the names of the tax-delinquent companies to embarrass them into paying.
Later this year, the department will begin posting the names of all businesses and individuals who face liens of any amount and regardless of the tax owed or whether a business exists or is bankrupt, Mrs. Brassell said. That means even companies liened for not paying the corporate net income tax will be subject to Internet ridicule.
Except those that use the Delaware Loophole, of course.
Using the loophole
Delaware actually has a corporate net income tax of 8.87 percent. Companies based there pay it on profits earned there. No state tax revenue earned in other states.
But Delaware also does not impose the tax on income earned from trademarks, patents, stocks, bond or other investments or intangible assets.
So companies from outside of Delaware, especially large retail chains, set up holding companies there. The holding companies, commonly known as passive investment companies, are allowed to control the trademarks, patents or other investments.
Then, they charge a parent company operating in another state, like Pennsylvania, a royalty for using the trademarked name, for example.
That allows the Pennsylvania-based company to treat that royalty payment as a business expense, which it may deduct from its income in the Keystone State, reducing its tax burden here.
Sheetz Inc., is one of many that does this, but one of the few that publicly says it does. Mr. Cortez, Sheetz's vice president and general counsel, said companies must have a way around corporate net income tax because it is so high.
For years, he said, state economic development officials encouraged companies moving into Pennsylvania and concerned about its corporate tax to set up passive investment companies in Delaware.
This happens to other states, too.
For example, in 1990, the Delaware holding company of Toys "R" Us earned $55 million in income by charging all the company's stores for using the Toys "R" Us name, trademarks such as its Geoffrey giraffe logo and "merchandising skills," according to the Center on Budget and Policy Priorities, a liberal think tank. The center found that out because of a lawsuit Geoffrey Inc., a Toys "R" Us subsidiary, filed to stop South Carolina's tax collection efforts.
But Sharon Ward, executive director of the Pennsylvania Budget and Policy Center, a liberal-leaning Harrisburg think tank, said critics overstate the corporate net income tax's effect. Citing a March 2010 study by the Council on State Taxation, a pro-business group, she said Pennsylvania's corporate tax burden is tied for 31st among the 50 states when all the taxes a company pays are added up.
Beyond that, 97 percent of all the large corporations in Pennsylvania already also operate in states that have closed the loophole, Ms. Ward said.
"It's unfair to other Pennsylvania businesses" unable to set up Delaware holding companies, she said.
States can combat the loophole through combined reporting - requiring parent companies to report the income of all their subsidiaries, including the passive investment companies, so a state taxing agency can evaluate how much of the revenue is earned in its state.
Twenty-three of 45 states with corporate net income taxes now require combined reporting. Pennsylvania does not.
Through lawsuits filed by various states, the Wall Street Journal, in 2002, identified almost 50 corporations using passive investment companies, not all of them in Delaware.
Some of the names are quite well known, and many do business in Northeast Pennsylvania: Budget Rent-A-Car, Burger King, Dress Barn, Gap Inc., Home Depot, Kmart, Kohl's, Long John Silver's, Payless Shoesource, Radio Shack and Staples.
State Rep. Ken Smith, D-112, Dunmore, whose closed restaurant faced state tax liens and heavy newspaper coverage about its tax problems, said the Delaware Loophole allows large corporations to avoid paying their fair share of taxes while small businesses that struggle to stay afloat end up facing state liens publicized on the Internet.
"When it came time to negotiate the (latest) budget, the Senate Republicans said, 'Don't even talk about it. We will not negotiate. It will not be part of the subject,'" Mr. Smith said. "Big business. You think they can identify with the guy that's here busting his tail trying to roll the dirt and bring in the backfill and pick up his lunchbox everyday and provide for his family? They don't understand that. It's a different world. And it's wrong, it's wrong, particularly during these tough economic times."
But Mr. Cortez said small business owners can set themselves up so they are subject to the state's far lower 3.07 percent personal income tax.
And Mr. Pileggi said all sides agree that closing the Delaware Loophole without reducing the corporate tax would increase the taxes paid by the most vulnerable corporations in Pennsylvania: manufacturers.
"Even if you were revenue neutral, there would be winners and losers," Mr. Pileggi said. "And everyone agrees, including the governor, that one in the category of losers in this change would be manufacturing ... At a time when we're trying to preserve manufacturing jobs, if we moved to combined reporting and increased the tax burden on manufacturers, what that would lead to is less manufacturing jobs in Pennsylvania."
He also said the Department of Revenue would also need several years to handle combined reporting because it would need to hire and/or train knowledgeable staff, eliminating that as a possibility for transportation funding.
Because states can close the loophole with combined reporting, Delaware Deputy Secretary of State Richard J. Geisenberger makes no apologies for it.
About 10,000 companies in Delaware are holding companies, and the loophole came into being decades ago to aid Delaware-based companies that earn income outside the state, Mr. Geisenberger said.
The name "Delaware Loophole" is a "misnomer," he said, because five other states also levy no corporate net income tax. They are Nevada, South Dakota, Texas, Washington and Wyoming. Theoretically, a company could incorporate in one of those states and use the same maneuver, he contends.
Delaware does not keep tabs on which holding companies are used to shift profits from Pennsylvania, and could not release their names anyway because of confidentiality laws, Mr. Geisenberger said.
Many of the holding companies exist only on paper and share corporate addresses in downtown Wilmington buildings with sometimes literally hundreds of other companies in one building.
Matthew J. Brouillette, president of the Commonwealth Foundation, a Harrisburg-based conservative think tank, questions the use of the term "Delaware Loophole" because he believes it connotes something nefarious when the tax shift is perfectly legal. He disagrees with publicizing the names of companies that use the loophole because that would amount to attempt to "pillory" the company.
The companies are avoiding paying the tax because it is "the highest in the world," he said. Iowa has a higher top rate, but on average its corporate tax is lower.
Groups that call for ending the loophole portray it as a way of avoiding paying taxes "as if that's a bad thing," he said. A lower tax burden creates more economic development, he argues.
Ms. Ward disputes that. There is no evidence the loophole produces economic development, she said.
"It's a giveaway," she said.
Unable to close the loophole, Mr. Rendell is proposing a separate oil and gasoline net profits tax to fund transportation because of the disparity in what the major oil companies pay. Republicans are again balking.
Mr. Rendell wishes the loophole was closed. He argues Pennsylvania business owners do not worry about the corporate net income tax. He once asked about 600 at a Greater Philadelphia Chamber of Commerce function two years ago whether their companies pay it.
"And only about four people raised their hands," he said. "It's pitiful."