Pennsylvania Corporation Tax Audit Manual

Corporation Tax Audit Manual
Corporate Net Income Tax Audit Manual
Published: 10/7/2025

CORPORATE NET INCOME TAX
AUDIT MANUAL

BUREAU OF AUDITS
PA DEPARTMENT OF REVENUE

CORPORATE NET INCOME TAX AUDIT MANUAL

BUREAU OF AUDITS

Introduction .......................................................................................................................................... 3
Section I: Imposition of Tax .................................................................................................................... 4
Overview ............................................................................................................................................ 4
Subjectivity ........................................................................................................................................ 4
Tax Rate ............................................................................................................................................. 4
Nexus ................................................................................................................................................ 5
Economic Presence ........................................................................................................................... 5
Public Law 86-272 .............................................................................................................................. 5
Section II: Reports & Statutes of Limitations ........................................................................................... 7
Pennsylvania Corporate Net Income Tax Report (RCT-101) .................................................................. 7
Reports of Change (RCT-128C) ........................................................................................................... 7
Amended Reports (RCT-101) .............................................................................................................. 8
Extensions of Statute of Limitations .................................................................................................... 8
Section III: Taxable Income .................................................................................................................... 9
Pennsylvania Taxable Income ............................................................................................................. 9
Charitable Contribution Expense ........................................................................................................ 9
Capital Losses ................................................................................................................................. 10
Adjustments for IRC 163(j) - “Limitation on Business Interest” ........................................................... 10
Sham Transaction Adjustments ........................................................................................................ 12
Gain/Loss Sale Subsidiary Stock ....................................................................................................... 14
Calculation for Federal S Corporations Filing as Pennsylvania C-Corp ............................................... 14
Extraterritorial Income Deduction ..................................................................................................... 15
Section IV: Statutory Deductions .......................................................................................................... 16
Dividends......................................................................................................................................... 16
Interest on US Securities .................................................................................................................. 17
Current Year Additional Pennsylvania Depreciation ........................................................................... 17
Intangible Income or Related Interest Income ................................................................................... 19
Other Deductions ............................................................................................................................. 20
Section V: Statutory Additions .............................................................................................................. 21
Taxes Imposed on or Measured by Net Income .................................................................................. 21
Current Year Bonus Depreciation ...................................................................................................... 22
Intangible Expense or Related Interest Expense ................................................................................. 23
Other Additions ................................................................................................................................ 25
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Section VI: Business & Non-Business Income or Loss ........................................................................... 26
Section VII: Apportionment .................................................................................................................. 27
Overview .......................................................................................................................................... 27
Jurisdiction to Subject ...................................................................................................................... 27
Apportionment Calculation .............................................................................................................. 27
Sales Factor Receipt Types ............................................................................................................... 28
Sales (Net of Returns and Allowances) .......................................................................................... 28
Interest, Rents, and Royalties ........................................................................................................ 28
Gross Receipts from the Sales of Other Business Assets ................................................................ 29
Other Sales (Receipts Only) .......................................................................................................... 30
Partner’s Share of Sales from Partnerships .................................................................................... 30
Rules of Apportionment .................................................................................................................... 31
Sales of Tangible Personal Property ............................................................................................... 31
Sales from the Sale, Lease, Rental or Other Use of Real Property .................................................... 32
Sale of Services ............................................................................................................................ 32
Sales Other Than Tangible Personal Property and Services ............................................................. 32
Special Apportionment ................................................................................................................. 34
Audit Procedures ............................................................................................................................. 36
Everywhere Receipts (Inside and Outside PA) ................................................................................ 36
Pennsylvania Receipts (Inside PA) ................................................................................................. 37
Section VIII: Net Loss Deduction .......................................................................................................... 38
Overview .......................................................................................................................................... 38
Application of Losses ....................................................................................................................... 38
Federal Audits and Net Losses .......................................................................................................... 38
Changes in Ownership ..................................................................................................................... 39

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Introduction
The primary objective of this manual is to provide instructions on the performance of a Pennsylvania corporation
tax compliance audit. Instructions are based on state tax statutes, department regulations, court cases,
departmental policies, previous audits, appeal decisions, and general accounting and auditing principles at the
time of this publication.
This manual is intended as guidance to the audit staff. Auditing methods and techniques suggested in the manual
may not be necessary or applicable for every audit. This manual is not authoritative and may neither be cited to
support an audit position nor relied on by the taxpayer. This manual and its auditing procedures will be
continuously evolving as it is impacted by changes in tax statutes, regulations, court cases and departmental
policies.

3

Section I: Imposition of Tax
Overview

Corporate net income tax is imposed under Article IV of the Tax Reform Code. Corporate net income tax is paid
by all domestic and foreign corporations for the privilege of doing business, carrying on activities, employing or
owning capital or property, or having substantial nexus in Pennsylvania. The tax is levied on federal taxable
income without the federal net operating loss deduction and special deductions, on a separate company basis
with Pennsylvania modifications. Corporate taxpayers with activity in multiple states may be able to apportion
taxable income. To apportion income, a corporation must be subject to tax in another state. Corporations report
their corporate net income tax liability on the Pennsylvania Corporate Net Income Tax Report (RCT-101).

Subjectivity

Domestic and foreign corporations, as well as limited liability companies, partnerships, and business trusts that
are classified as corporations for Federal income tax purposes and are doing business in the Commonwealth are
subject to the tax. Corporations are subject to Pennsylvania Corporate Net Income Tax for conducting any of the
following activities:
•
•
•
•
•

Doing business in this Commonwealth
Carrying on activities in this Commonwealth, including solicitation
Having capital or property employed or used in this Commonwealth
Owning property in this Commonwealth
Having substantial nexus in this Commonwealth

State Reference - 72 P.S. § 7402(a)

Tax Rate

The CNIT rate was 9.99% for tax years 1995 through 2022. Act 53-2022 set a schedule of rate reductions for tax
years beginning in 2023.
Year

Rate

1995-2022

9.99%

2023

8.99%

2024

8.49%

2025

7.99%

2026

7.49%

2027

6.99%

2028

6.49%

2029

5.99%

2030

5.49%

2031 and thereafter

4.99%

State Reference - 72 P.S. § 7402(b)

4

Nexus

Corporations having either economic presence or a physical presence in Pennsylvania are considered to have
nexus for corporate net income tax purposes.
Business activities creating nexus include, but are not limited to, the following:
•
•
•
•
•
•
•
•
•
•
•
•
•
•

Owning or leasing property
Maintaining inventory within the Commonwealth
Having employees or others soliciting sales or referring customers
Delivering property into the Commonwealth
Maintaining a fixed location
Installing or repairing of property by employees, independent contractors, or others
Employee leasing services or personnel services
Approving or accepting purchase orders
Performing services, managerial or research activities
Repossessing property
Having one or more employees performing business activities in Pennsylvania, even occasionally
Conducting training or seminars
Providing transportation services
Hiring, training or supervising personnel

State Reference - 72 P.S. § 7402(a)

Economic Presence

Economic presence applies when out of state corporations are considered to be doing business in this
Commonwealth to the extent they are taking advantage of the economic marketplace of the Commonwealth
regardless of whether they are physically present in Pennsylvania. As a result, the department will require such
taxpayers to begin filing Corporate Tax Reports (Form RCT-101) so long as they meet the minimum thresholds for
nexus.
The department will deem that there is a rebuttable presumption that corporations without physical presence in
Pennsylvania, but having $500,000 or more of direct or indirect gross receipts from any combination of the
following, sourced to Pennsylvania per year, have a corporate net income tax filing requirement with the
Commonwealth:
•
•
•

Gross receipts from the sale, rental, lease, or licensing of tangible personal property;
Gross receipts from the sale of services; and/or
Gross receipts from the sale or licensing of intangibles, including franchise agreements.

State Reference - 72 P.S. § 7402(a) & Corporation Tax Bulletin 2019-04

Public Law 86-272

Public Law 86-272 (15 USC § 381) is a federal law enacted in 1959 to limit the states' ability to tax interstate
commerce. It provides that a state cannot impose a net income tax on a business if the business activities within
the state are limited to the solicitation of sales of tangible personal property, orders for which are accepted
outside the state and delivery of property is made from outside the state.
Generally, taxpayer's that claim the P.L. 86-272 exemption still have nexus with Pennsylvania. If a taxpayer
qualifies for protection under the provisions of P.L. 86-272, it is entitled to such protection regardless of whether
or not it has Pennsylvania sourced sales in excess of $500,000.
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To the extent protection under this federal law is claimed, taxpayers should continue to file a Pennsylvania
Corporate Tax Report (RCT-101) and complete the schedule (Form Rev-986) to claim this exemption from tax.

State Reference - Corporation Tax Bulletin 2004-01 & Corporation Tax Bulletin 2019-04
Audit Procedures

1) Request a detailed description of business activities conducted in Pennsylvania and have the taxpayer
complete a Business Activities Questionnaire (Rev-203D).
2) Additional requests for information may be necessary to verify the accuracy of the initial responses. These
records may include, but are not limited to:
•
•
•
•
•

Job descriptions for employees conducting activities in PA
Expense reports for employees traveling to PA for business
Company policy or procedures manuals regarding sales activities and/or telework
Apportionment schedules
Sales invoices/contracts

3) If nexus with Pennsylvania is established during the audit period:
•

The auditor must request completed Pennsylvania Corporate Net Income Tax Reports (RCT-101s) for
the periods under audit, along with the supporting documentation that is typically request in any
corporate income tax audit.

•

If documentation is not provided during the audit, an assessment may be calculated using the best
information available to the Department.

•

Auditors should consult with their regional specialist to discuss the facts and circumstances of the
audit to determine if any additional procedures are necessary.

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Section II: Reports & Statutes of Limitations
Pennsylvania Corporate Net Income Tax Report (RCT-101)

Corporations subject to Pennsylvania Corporate Net Income Tax report their tax liability on the Pennsylvania
Corporate Net Income Tax Report (RCT-101). Reports must be filed using the same taxable year as reported to
the federal government. All corporations incorporated in Pennsylvania are required to file annual reports even if
no business activity was conducted during the taxable period. Corporations that have nexus with Pennsylvania
are required to file reports even if there was no physical presence within the commonwealth during the tax year.

Filing Deadlines

The RCT-101 is due on or before the 15th day of the month following the due date of the return to the Federal
Government for both calendar and fiscal year filers.

Statute of Limitations for Assessment

Tax may be assessed within three (3) years after the date the report is filed or the due date of the return, whichever
is later. Tax may be assessed at any time if a taxpayer fails to file a report required by law or if the taxpayer is
determined to have filed a fraudulent return.

State Reference - 72 P.S. § 7403 & 72 P.S. § 7407.3

Reports of Change (RCT-128C)

A Report of Change (RCT-128C) is used to report changes to an entity’s income as result of a federal audit; or
report changes to an entity’s income as a result of an amended Federal income tax return filed by the entity. If the
changes are the result of a federal IRS audit, the taxpayer must attach a copy of the Revenue Agent Report Income Tax Examination Changes (RAR). If the changes are a result of an amended Federal income tax return
(FF1120X) filed by the entity, the amended Federal income tax return must be provided with proof of acceptance
by the IRS. When a Report of Change is filed for a period under audit, the report must be reviewed by the auditor
for compliance with Pennsylvania law.
Important Note: A Report of Change should only be filed when there are changes to an entity’s Federal Taxable
Income i.e. RCT-101, Line 1. Generally speaking, Amended Reports (RCT-101) are filed to report changes to
Pennsylvania additions/deductions or Pennsylvania apportionment; however, in certain circumstances federal
adjustments could trigger changes to Pennsylvania additions/deductions/apportionment.

Filing Deadlines

For tax years beginning prior to January 1, 2013, changes in federal taxable income must be reported to the
Department within 30 days of the change. This has been extended to six months for tax years beginning after
December 31, 2012.

Statute of Limitations for Assessment

Tax may be assessed within three (3) years after the date the report is filed.

State Reference - 72 P.S. § 7406.1 & 72 P.S. § 7407.3

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Amended Reports (RCT-101)

Amended reports are filed when a taxpayer is requesting that the Department adjust the corporate net income
taxes for a correction to the original report for a particular tax year. Amended reports are filed by using a check
box on Page 1 of RCT-101 and including Rev-1175 – Schedule AR, which includes an explanation for filing the
amended report. Amended reports cannot be filed for the following reasons:
•
•
•
•

Challenges to PA Statute or regulations
Challenges to department policy or interpretation of statutes or regulations
For the sole purpose of claiming the report is a final report
To change the end of the tax year

When an Amended Report is filed for a period under audit, the report must be reviewed by the auditor for
compliance with Pennsylvania law.
Important Note: A Report of Change should only be filed when there are changes to an entity’s Federal Taxable
Income i.e. RCT-101, Line 1. Amended Reports (RCT-101) are filed to report changes to Pennsylvania
additions/deductions or Pennsylvania apportionment.

Filing Deadlines

A taxpayer has three (3) years after the due date of the original report to file an amended report. If the original
report was properly extended, then the taxpayer has three (3) years after the extended due date to file an amended
report.

Statute of Limitations for Assessment

Tax may be assessed within one (1) year from the date of the filing of the amended report or three years from the
due date of the original report, whichever period expires later.

State Reference - 72 P.S. § 7406 & 72 P.S. § 7407.3

Extensions of Statute of Limitations

Before the expiration of any limitation for assessment as described above, a taxpayer may consent, in writing,
that an open period be extended and the amount of tax due may be assessed at any time within the extended
period. The Consent to Extend Time Limit for Assessment/Determination of Tax and to Extend Period of Time for
Record Retention (waiver) form is used to extend the time limit for record retention and assessment of the specific
tax under audit.
The auditor should make every effort to complete the audit before the expiration of the initial statute of limitations.
When scheduling is delayed at the taxpayer’s request or the taxpayer is not providing records that allow for the
timely completion of the audit before statutory periods expire, a waiver must be obtained. A waiver should be
obtained at least six months prior to the original deadline date. It is recommended that the extended deadline be
at least eight (8) months prior to the supervisor review deadline of the audit to provide ample time for completion
of the audit and quality review.

State Reference - 72 P.S. § 7407.4

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Section III: Taxable Income
Pennsylvania Taxable Income

Taxable Income is partly defined as “taxable income as returned to and ascertained by the federal government
before the net operating loss deduction and special deductions.” Accordingly, Pennsylvania starts with Federal
Taxable Income on a separate company basis from the Federal Form 1120, Line 28.
If the taxpayer is part of a consolidated group, a pro-forma federal return must be filed on a separate company
basis. The amounts from the pro-forma federal return should match to the separate company breakdown of the
consolidated schedules. All elections made on the federal consolidated return are binding on the taxpayer for
Pennsylvania purposes. Additionally note that the adjustments to income made pursuant to the federal
consolidated return regulations are not applicable for purposes of calculating separate company taxable income
for Pennsylvania purposes.

State Reference - 72 P.S. § 7401.(3)1.(a) & 72 P.S. § 7406
Audit Procedures

1) Review pro-forma federal return and separate company elimination schedules of the consolidated federal
return.
2) Reconcile RCT-101, Line 1, Income or Loss on a separate-company basis to Federal Form 1120, Line 28. If
the primary taxpayer is not filing FF1120, contact headquarters for guidance.
3) Review Department records for any Reports of Change filed. When a Report of Change is filed for a period
under audit, the report must be reviewed by the auditor for compliance with Pennsylvania law.
4) Any differences should be noted and discussed with the taxpayer.

Charitable Contribution Expense

Pennsylvania follows the federal treatment of charitable contributions under IRC § 170. A charitable contribution
deduction is generally limited to 10% of the taxable income without regard to charitable contributions. For 2020,
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act, P.L. 116-136, 03/27/2020) temporarily
increased the typical 10% contribution deduction limitation to 25% of taxable income for qualified cash
contributions and 25% for food inventory contributions. These increases to the contribution limit were extended
by The Taxpayer Certainty and Disaster Tax Relief Act of 2020 to 2021 as well.
A taxpayer filing with the Federal government as a member of a consolidated group may be entitled, on a separate
company reporting basis, to a larger contribution deduction in arriving at Commonwealth taxable income.
Because consolidated reporting is not permitted for Commonwealth purposes, the taxpayer may reflect on a
separate company reporting basis the contribution deduction to which it would have been entitled had it filed a
separate return with the Federal government.
For Pennsylvania purposes, excess charitable contributions, to the extent they are allowed to be carried over,
may be carried forward up to five years until they are fully used. For a year where there is a loss, the contribution
loses its characteristics and becomes part of the federal net operating loss deduction. Therefore, there is no
charitable contribution deduction to be carried forward. Pennsylvania has not adopted the federal income tax
provisions relating to net operating losses. Accordingly, the Pennsylvania net operating loss statutes and
regulations do not provide for the conversion of excess charitable contributions into Pennsylvania Net Operating
Loss carryovers.

9

An IRC 163(j) adjustment restricting the amount of current year interest expense that can be deducted resulting
in changing a net loss to taxable income, may allow contributions made in the current year, or carryovers from
previous years that were not NOL years, to be deducted in arriving at federal taxable income.

State Reference- 72 P.S. § 7401.(3)1.(a) & 61 Pa. Code § 153.14.(2)
Federal Reference – IRC § 170
Audit Procedures

1) Review pro-forma federal return and separate company elimination schedules of the consolidated federal
return for charitable contributions, FF1120, Page 1, Line 19.
2) Verify that contributions are not in excess of allowable contributions on a separate company basis: (Federal
Taxable Income from Line 28 + Charitable Contributions Expense from Line 19) x Limitation Percentage.
3) Determine if there any excess contributions that may be carried forward.

Capital Losses

Pennsylvania conforms to federal law provisions allowing corporations to deduct capital losses only to the extent
of their capital gains. Capital gains or losses are reported on Schedule D of the Federal Income Tax Return. The
total amount from Schedule D is entered on Form 1120, Page 1, Line 8.
Consistent with IRC § 1212, excess contributions can be carried back three years then carried forward five years.
Carry backs cannot increase or produce a net operating loss in the tax year to which it is carried. Losses are
applied to the extent of capital gains without causing gains to go into the negative. For Federal purposes, if a
taxpayer is offsetting a current capital gain with a carried back/forward capital loss, the taxpayer typically files an
FF 1139 – Corporation Application for Tentative Refund or a Form 1120X - Federal Amended Return, with the IRS.
For Pennsylvania purposes, capital losses are treated as having been carried back or forward (as applicable) even
if the taxpayer has not filed either an FF 1139 or FF 1120X for those periods.

State Reference - 72 P.S. § 7401.(3)1.(a) & 61 Pa. Code § 153.11
Federal Reference – IRC § 165(f) & IRC §1211-1212
Audit Procedures

1) Review applicable periods to determine whether a Report of Change (RCT-128C) was filed with the
Department. Reports of Change should be filed for any changes resulting from carry back/forwards of capital
losses.
2) A capital loss is treated as applied to an available capital gain, even if a Report of Change was not filed with
the Department.
3) A capital loss schedule should be created to calculate the applicable carryback and/or carryforward for each
tax year under audit.

Adjustments for IRC 163(j) - “Limitation on Business Interest”

IRC Section 163(j), as amended by the Tax Cuts and Jobs Act of 2017, limits the deduction for business interest
expense for tax years beginning after December 31, 2017, to the sum of:
1. The taxpayer’s “business interest income,”
2. 30% of the taxpayer’s “adjusted taxable income,” plus
3. The taxpayer’s “floor plan interest.”

10

The taxpayer will be entitled to claim carryforward amounts in future periods, if eligible. These adjustments
should be presented as an adjustment to federal taxable income reported on the proforma FF 1120 and resulting
RCT-101, Line 1 when the taxpayer is subject to the limitation; however, there are instances where the taxpayer
may report the adjustments as an Other Addition/Deduction on the RCT-101. The Department issued Corporation
Tax Bulletin 2019-03 to address the Pennsylvania Corporate Net Income Tax treatment of IRC § 163(j). Note that
for years 2019 and 2020 the 30% limit was increased to 50%.

State Reference - 72 P.S. § 7401.(3)1.(a) & Corporation Tax Bulletin 2019-03
Federal Reference – IRC § 163(j)
Audit Procedures

1) For tax years beginning after January 1, 2018, auditors must review the Pennsylvania Corporate Tax Report
along with Form 8990 “Limitation on Business Interest Expense Under Section 163(j)” included with the
Consolidated Form 1120.
2) If the Federal Consolidated Group reports an interest limitation under Code Section 163(j), then each member
with a Pennsylvania corporate net income tax filing obligation will need to perform its own set of calculations
on a separate company basis to determine if the interest expense limitation applies to it.
•

Request the separate company calculation, such as a proforma Form 8990, and determine if limitation
applies.

•

Verify that any disallowed business interest expense is accurately reflected on the RCT-101, Line 1.

•

On the Consolidated Form 8916-A, IRC 163(j) adjustments will be reflected as temporary (timing)
differences on Part II. The separate company Form 8916-A may also reflect temporary differences on
Part II, but these may represent pro-rated amounts from the consolidated totals.

3) Interest expense excluded pursuant to IRC 163(j) may be carried forward to subsequent years for future
interest expense deduction without any statutory limit.
•

Request taxpayer schedules to support any IRC 163(j) carryforward and review the application of any
carryforward amounts for each tax year;

•

Verify the Federal Consolidated Group is not subject to any limitation on the deduction of its current year
interest expenses under Code Section 163(j) (No disallowed business interest expense on Form 8990);
AND

•

Confirm taxpayer previously had an interest limitation carryforward under Code Section 163(j) that was
previously reported in a prior period.

4) Special Considerations:
•

On a separate company basis, the IRC 163(j) limitation may be prorated for “sham transactions” and
permanently excluded as a carry forward. Related interest expense or costs for the intangible expense
addback may be prorated as well. Refer to Corporate Tax Bulletin 2019-03 Originally Issued
April 29, 2019, “Pennsylvania Corporate Net Income Tax Treatment of IRC § 163(j).”

•

IRC 382 can also alter the annual amount of the IRC 163(j) carryforward deduction in situations where a
loss corporation already subject to IRC 163(j) is merged into a taxpayer. This may require proration of
interest expense previously excluded from the Pennsylvania Net Loss of the corporations that were
merged for carryforwards. Refer to Corporation Tax Bulletin 2008-03 (restated), Issued October 11, 2023,
“Net Loss Deduction Limitations Under Internal Revenue Code Section 381 and Section 382.”

•

Corporation Tax Bulletin 2019-03 addresses most issues with respect to IRC 163(j) adjustments. If an
issue is discovered not specifically covered by the bulletin, the auditor and supervisor should consult
with an audit program specialist.
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Sham Transaction Adjustments

Sham transactions reflect deductions that have no business purpose other than the avoidance of taxes and also
for lacking economic substance. The Department has the authority to employ the sham transaction doctrine
which gives the Secretary the authority ‘to disregard, for taxing purposes, transactions that have no economic
substance or business purpose other than tax avoidance.’ Intercompany transactions are sometimes identifiable
by eliminations on the federal consolidating schedules. Those that are excessive and incongruent with ordinary
and usual expenses relative to all other expenses should be reviewed. For tax years beginning after
January 1, 2015, intercompany intangible expense and interest expense related to intercompany intangible
expense must be treated as intangible expense addback rather than sham transaction.

State Reference - 72 P.S. § 7401(3)(1)(a) & 72 P.S. § 7401(3)(1)(t)(1))
Audit Procedures

1) Identify possible sham transactions from the following:
a. Separate Company Pro-Forma FF1120
•

Royalty or Interest Income

•

Interest Expense – Line 18 and Form 8916-A, Part III. For tax years beginning after January 1, 2015,
interest expense related to intercompany royalty expense must be treated as intangible expense
addback rather than sham transaction.

•

Other Income – Line 10 – Service Fees, Royalty, Interest, Management Fee, Miscellaneous,
Intercompany.

•

Other Deductions – Line 26 – Royalty, Miscellaneous, Intercompany, Factoring, Administrative,
exceptionally large amortization expense. For tax years beginning after January 1, 2015,
intercompany royalty expense must be treated as intangible expense rather than sham transaction.

•

Cost of Goods Sold (Other Costs) FF1125A Line 5 – Royalty, Interest, Miscellaneous, Intercompany,
Factoring, Administrative.

•

Balance Sheet (Intercompany Accounts) – Notes Receivable, Loans Payable, Other Current Assets.

•

Schedule M-3 – Review for intercompany items.

•

Schedule 8916-A - Review for intercompany items.

b. Consolidated FF1120
•

Verify the taxpayer’s separate company column matches the pro-forma

•

Verify taxpayer’s affiliated entities from FF851, organizational chart, etc.

•

Verify what transactions are being reported as eliminations. For instance, royalty and interest income
and expense, or intercompany assets and liabilities

c. Review Form 10-K for Consolidated Group that Taxpayer is a member.
•

Compare gross profit ratio (gross profit/total revenue) and net profit ratio (net income before
taxes/total revenue) on Form 10-K to gross profit/net sales and Line 28 (less dividends)/net sales on
both Consolidated FF1120 and separate company FF1120 of Taxpayer under audit. Note: Dividends
from Line 28 are excluded in the analysis as most dividend income on the FF1120 may be
intercompany and would be eliminated on the Form 10-K.

•

Identify any disparities between the Form 10-K, Consolidated FF1120, and separate company FF1120
margins for additional questioning. The purpose of this analysis is to identify potential profit
shifting due to foreign intercompany transactions or domestic intercompany transactions.

12

•

o

If the margins are higher on the Form 10-K than on the consolidated return, and the margins
on the consolidated return and proforma return are comparable, it may indicate foreign
intercompany transactions.

o

If the margins on the Form 10-K and consolidated FF1120 are comparable with the separate
company margins of the Taxpayer significantly lower, it may indicate intercompany
transactions with domestic affiliates in the consolidated group.

o

If the gross margin is higher on the Form 10-K than on consolidated / separate company
FF1120, it may indicate that the intercompany transactions are related to intercompany
expenses in COGS, perhaps even purchases.

o

If the net margin is higher on the Form 10-K relative to the FF1120s and the gross margins are
comparable between Form 10-K, consolidated FF1120 and separate company Taxpayer
FF1120, there may be intercompany transactions among the operating expenses.

The same Form 10-K can be used for PA audit cycles of up to three years, as Form 10-Ks will have
comparative income statements for the current year, prior year, and year before the prior. For example,
Form 10-K for 2023 will have income statements for 2023, 2022, and 2021 that can be used for margin
analysis.

2) Additional Information to be Requested
•

Question any of the above transactions if they seem out of the ordinary or are not easily identifiable.
Request a book to tax trial balance. If the trial balance is insufficient, request a detailed breakdown by
account for each questionable item. Note that the Schedule M-3 along with Form 8916-A and other
supporting statements for the Schedule M-3 that detail book-to-tax differences are a summary of the
book-to-tax general ledger. The difference is Schedule M-3 will group related accounts together, whereas
the detailed general ledger shows amounts strictly by account.

•

Transfer Pricing Study and a detailed list of all intellectual property, if applicable. The Transfer Pricing
Study must be current and inclusive of the covered transactions being questioned. Note that per the
federal regulations a Transfer Pricing Study cannot be applied retroactively. This includes a prohibition
on taxpayers adjusting or correcting their Transfer Pricing on timely filed amended FF1120X’s.

•

If any explanations indicate the presence of intercompany transactions not disclosed on the FF1120,
provide an applicable request for financial records to the taxpayer as to their exact nature, the parties
involved, and who is the purchaser and who is the provider.

•

Once the taxpayer responds to the record request, determine if further detail is required. On all
intercompany transactions that are questioned, request names/EINs of all the parties involved and the
roles that they play in these transactions, as well as supporting agreements, transfer pricing studies, etc.
Auditors should completely understand how the intercompany transactions are arranged and reflect this
knowledge in the audit narrative.

3) The five areas of analysis are:
•

Review – Is the intercompany expense proportional to the payroll and other costs of the affiliate that
provides the services, as reflected on consolidating FF1120?

•

Intercompany Agreements – Determine if the transaction is supported by both intercompany agreements
and Transfer Pricing Study.

•

Money Flow – Determine if there is actual cash flow vs. bookkeeping entry or if there is a circular flow of
funds between the parties involved.

•

Day-to-Day Operations – Verify the provider of services is truly run as a going concern, that is, with
business locations, own payroll, checking accounts, etc.

•

Board Directors’ action – Review the current audit period board minutes for language on the treatment of
intercompany transactions and distribution of earnings.
13

4) How to adjust (Determine if addback provision applies or if it is a sham)
•

If the transaction involves intangible expenses or costs, the adjustment must be reported as an intangible
expense addback in the Statutory Addition section of the CNI tax calculation. The taxpayer may claim an
exception for the addback, such as the foreign treaty exception or conduit exception, by filing the REV-802
with the auditor.

•

If the transaction involves interest expense or costs directly related to an intangible expense or cost, the
adjustment must be reported as an IE addback in the Statutory Addition section of the CNI tax calculation.
The taxpayer may claim an exception for the addback, such as the foreign treaty exception or conduit
exception, by filing the REV-802 with the auditor.

•

If documentation is not provided by the taxpayer or the expense involved does not meet the statutory
definition of intangible expense or interest expense from 72 P.S. § 7401(8)-(9) and you cannot determine
business purpose other than tax avoidance, the transaction may be considered a sham and is reported
as an adjustment to the federal taxable income. The adjustment is shown on the 1120 Income Analysis
as a miscellaneous adjustment to Line 28.
o

When describing the treatment of sham transactions, the adjustment should be described as the
transaction being eliminated from federal income, and not described as added to federal income.

Gain/Loss Sale Subsidiary Stock

Gains or losses included in Federal taxable income from the sale of subsidiary's stock attributed to excess losses
or accumulated earnings and profits used for consolidated purposes per Treas. Reg. § 1.1502 (1996) are not
recognized on a separate company basis.

Audit Procedures

1) If not included in tax return filed, request a breakdown of how gain was calculated, showing the reduction in
basis of stock for losses used by parent.
2) Recalculate the gain or loss on sale of stock for Pennsylvania purposes without the reduction for losses used
by the parent.
3) Note that the result of this review is typically that the gain will be smaller and the loss larger for Pennsylvania
purposes than the amounts reported for federal income tax purposes.

Calculation for Federal S Corporations Filing as Pennsylvania C-Corp

The taxpayer may opt out from being treated as a Pennsylvania S-Corp by filing Pennsylvania form REV-976 Election not to be Taxed as a Pennsylvania S Corporation.

Audit Procedures
1) Calculate Federal Taxable Income from FF1120S as starting point
a. Additions from Schedule K of FF 1120S, unless otherwise noted:
i.
Net real estate rental income.
ii.
Other net rental income.
iii.
Interest.
iv.
Ordinary dividends.
v.
Royalties.
vi.
Other portfolio income.
vii.
Gain (net of capital gains + Sect. 1231 gain against capital losses). Should not be less than zero.
viii.
Sect. 1231 (a loss is considered an ordinary loss included in the calculation of taxable income; a gain
is included in the capital gains and netted against capital losses).
ix.
Other income.
14

b. Deductions from Schedule K of FF 1120S unless otherwise noted:
i.

Deductions related to portfolio income.

ii.

Other deductions.

iii.

Interest expense on investment debts.

iv.

Total foreign taxes paid.

v.

Total expenditures to which section 59(e) election may apply.

vi.

Domestic production activities deduction IRC section 199.

c. Total = Total net income before section 179 & charitable contributions.

Extraterritorial Income Deduction

Extraterritorial income is the gross income of the taxpayer attributable to foreign trading gross receipts, which
may be reported as either other deduction or other expense on the federal income tax return. The extraterritorial
income is typically included in the calculation of federal taxable income. There is no statutory provision to add
back this item when calculating Pennsylvania taxable income. Additional details on extraterritorial income can
be found on the instructions for federal form 8873.

15

Section IV: Statutory Deductions
Dividends

Pennsylvania law allows a deduction for corporations that receive dividends from domestic and foreign
corporations. Domestic dividends are deductible to the same extent as allowed to arrive at the federal dividend
deduction in IRC Section 243. Taxpayer’s must provide form REV-798, Schedule C-2 when reporting the
Pennsylvania dividends received deduction.
For tax periods beginning prior to January 1, 2018 - The amount of dividend deduction allowed is based on the
percentage of ownership:
•

100% dividend deduction for sum of total deductions on Federal Schedule C.

•

100% dividend deduction for foreign dividend gross-up.

•

70% dividend deduction for less than 20 percent owned foreign corporation, including Subpart F income.

•

80% dividend deduction for greater than or equal to 20 percent owned foreign corporation, including
Subpart F income.

•

100% dividend deduction for foreign corporations that meets the 80 percent voting and value test,
including Subpart F income.

For tax years beginning on or after January 1, 2018, IRC Section 951A subjects certain U.S. taxpayers to tax on
their global intangible low-taxed income (“GILTI”) and IRC Section 250 of the Code authorizes a Federal deduction
for taxpayers reporting GILTI and taxpayers with foreign-derived intangible income (“FDII”). Pennsylvania issued
Corporate Tax Bulletin 2019-02 to provide guidance on how GILTI and FDII are treated for Pennsylvania Corporate
Net Income Tax purposes. In general, since GILTI is treated in a manner similar to Subpart F income for Federal
income tax purposes, Pennsylvania will treat GILTI income as dividend income for Corporate Net Income Tax
purposes. However, since both the GILTI deduction and the FDII deduction are reported on line 29 of Federal Form
1120, neither deduction amount is permitted to be taken for Pennsylvania purposes. As a consequence, the
dividend received deduction is applied against the gross GILTI income amount rather the net GILTI amount which
includes the GILTI deduction taken pursuant to IRC 250.
For tax periods beginning on or after January 1, 2018 - The amount of dividend deduction allowed is based on the
percentage of ownership:
•

100% dividend deduction for sum of total deductions on Federal Schedule C

•

100% dividend deduction for foreign dividend gross-up

•

50% dividend deduction for less than 20 percent owned foreign corporation, also applicable to Subpart F
Income and Global Intangible Low-Taxed Income (GILTI).

•

65% dividend deduction for greater than or equal to 20 percent owned foreign corporation, also
applicable to Subpart F Income and Global Intangible Low-Taxed Income (GILTI).

•

100% dividend deduction for foreign corporations that meets the 80 percent voting and value test, also
applicable to Subpart F Income and Global Intangible Low-Taxed Income (GILTI).

The Repatriation Transition Tax (RTT) was a one-time deduction on untaxed earnings of foreign corporations
accumulated prior to 2018. For additional guidance refer to Information Notice 2018- 01.

State Reference - 72 P.S. § 7401(3)1.(b) & Corporate Tax Bulletin 2019-02
Federal Reference – IRC §243, §951A, & §250
16

Audit Procedures

1) Review pro-forma FF1120, Schedule C and compare to amounts reported on REV-798, Schedule C-2.
2) Obtain a detailed schedule of all dividends listing the name and percentage ownership to verify the proper
amount of dividend deduction was reported.
3) If records are not provided, the Federal Form 851, the FF1120 Consolidating Spreadsheets, and Form 5471s
may be utilized for tracing the flow of domestic and foreign dividends to the Taxpayer.

Interest on US Securities

Interest income is reported on FF1120, Line 5. As a general rule, interest earned on municipal and state
obligations are already excluded from interest income reported on FF1120 Line 5. Interest income from securities
issued by the United States government or any of its agencies is deductible from Pennsylvania taxable income to
the extent it is included in Federal taxable income and exempt income under Federal Law.
Interest income must be reduced by the following:
•

Interest expense on indebtedness incurred to carry security.

•

Expenses incurred in the production of such interest income.

•

Other expenses deducted on the Federal Income Tax return that would not have been allowed under
26 USC section 265 if the interest were exempt for Federal Income Tax.

Corporation Tax Bulletin 2024-02 lists securities determined to be obligations of the U.S. Government. Interest
from repurchase agreements is not considered interest from US securities; therefore, it is not deductible. A
repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. A dealer sells
government securities to an investor, usually overnight, and buys them back the following day at a slightly higher
price. The small price difference represents an implicit overnight interest rate. It is an exchange of a security
(acting as collateral) for cash. The implied interest rate is the difference between the sale and repurchase prices.

State Reference - 72 P.S. § 7401(3)1.(b.1)) & Corporation Tax Bulletin 2024-02
Audit Procedures

1) Verify that the taxpayer owns the securities and/or the securities are managed on behalf of the taxpayer.
Documentation may consist of Form 1099 Interest or annual brokerage statements.
2) Obtain a detailed schedule showing the calculation of net interest deduction, which should include a listing
of investments that generated the exempt interest income.
3) Confirm amount claimed is included on FF1120, Line 5.
4) Verify that the securities for which the interest income exemption is being claimed are listed as US
Obligations on Corporation Bulletin 2024-02.
5) Verify that none of the interest income is derived from repurchase agreements.

Current Year Additional Pennsylvania Depreciation

Pennsylvania corporate tax law does not conform with the Internal Revenue Code (IRC) Section 168(k).
Pennsylvania corporate taxpayers are required to add back all bonus depreciation claimed under Section168(k)
when computing taxable income. See Section V. Statutory Additions – Current Year Bonus Depreciation for
additional information regarding the addback adjustment for 168(k) bonus depreciation.
Pennsylvania law allows the corporate taxpayer to recover, or deduct, the amount of depreciation previously
added back until the total amount included as taxable income in prior years has been claimed. The bonus

17

depreciation carryforward balance should not be less than zero (negative). If the taxpayer reported an addition
for 168(k) bonus depreciation, they are entitled to take the appropriate deduction as follows:
•

Property placed in service prior to 9/28/2017 – The 3/7ths fraction is used to recapture bonus depreciation
disallowed over the life of an asset. An additional deduction is also allowed to recapture the amount of
depreciation claimed under section 168(k) that has not been recovered through the 3/7ths deductions.
The additional deduction must take place in the earlier of the taxable year in which qualified property is
fully depreciated for Federal income tax purposes or is sold or otherwise disposed of by a taxpayer.

•

Property placed in service on or after 9/28/2017 – The Modified Accelerated Depreciation System
(MACRS) calculation is typically used to recapture bonus depreciation disallowed over the life of the
asset. An additional deduction is also allowed to recapture the amount of depreciation claimed
under section 168(k) that has not been recovered on qualified property which is sold or otherwise
disposed of during a taxable year by a taxpayer and for which depreciation was included as taxable
income.

Schedules C-3 and C-4 are used as an ongoing historical reference for all bonus depreciation calculations for
property placed in service prior to 9/28/2017.
For tax periods with property placed in service on or after 9/28/2017, REV-1834, Schedule C-8 “Adjustment for
Bonus Depreciation” is used to report bonus depreciation adjustments for both depreciation calculations for tax
periods 2017 and forward. (Prior to 9/28/2017 and on or after 9/28/2017). REV-1834, Schedule C-9 “Adjustment
for Deduction for Property which is fully Depreciated, Sold or Otherwise Disposed” is used to report additional
bonus depreciation additional deductions for a fully depreciated, sold, or otherwise disposed assets.

481(a) Adjustments

Section 481(a) of the Internal Revenue Code requires taxpayers to compute adjustments to federal taxable
income for any changes in either an overall accounting method or the accounting treatment of any item. Changes
in accounting method are reported on Federal Form 3115 and any resulting changes to taxable income may
appear as a 481(a) Adjustment within the taxpayer books and records. Some examples of changes that may affect
depreciation include changes in:
•

Depreciation method or recovery period

•

Treatment of salvage proceeds or costs of removal

•

Method of accounting for dispositions of depreciable property

•

Treatment of depreciable property from a single asset account to a multiple asset account (pooling), or
vice versa.

•

Opting into or out of bonus depreciation

For Pennsylvania purposes, the recognition of any 481(a) adjustments relating to Pennsylvania bonus
depreciation depends on the facts and circumstances of the information obtained during the audit.

State Reference – 72 P.S. § 7401(3)1.(r)(1) and (2)
Federal Reference – IRC 168(k)

18

Audit Procedures

1) Auditor must request a detailed list of all 168(k) property to determine the proper addback and deduction.
The detail should also include disposition information.
2) Reconcile the federal deprecation amounts on bonus assets to the Additional PA Bonus Depreciation
Deduction to determine if the reported amount is accurate. The PA Bonus Depreciation cannot exceed the
Federal Bonus Depreciation previously reported as an addition to Pennsylvania Taxable Income.
3) When determining the carryforward balance for bonus depreciation, the auditor must use the additions and
deductions based on the last adjusted action per department records.
4) For property placed in service on or after 9/28/2017, auditors may estimate the current year MACRS
depreciation to determine a reasonable estimate of audited amounts.
5) Taxpayers are entitled to a bonus depreciation deduction from partnerships based on their ownership
percentage, if bonus depreciation from partnership interests was added back in prior years. A separate
schedule showing the partnership amounts and their reconciliation to the taxpayer’s reported/audited figures
should be included with the audit package.
6) Taxpayers are entitled to bonus depreciation carry-in balances from merged or acquired entities. Prior to
allowing the PA Bonus Depreciation Deduction, verify with the taxpayer the merged/acquired entity’s EIN and
review historical balances for that entity in the Department’s records.

Intangible Income or Related Interest Income

Effective for tax years beginning after December 31, 2022, certain taxpayers may make an election on their
originally filed Form RCT-101 Corporate Tax Reports to exclude an intangible expense or cost or an interest
expense or cost, which were added back to a related entity’s corporate net income tax base for the same tax year.
The following are required by corporate taxpayers to deduct the intangible expense or cost or an interest expense
or cost:
•

The election must be made by the taxpayer on an originally filed report.

•

The taxpayer shall identify the name and Federal EIN of the taxpayer to which the election applies.

•

The exclusion may not exceed the intangible expense or cost, or the interest expense or cost, paid,
accrued or incurred by the taxpayer related entity’s corporate net income tax base for the same tax year.

•

If such an election is made, the taxpayer that made the adjustment required by 72 P.S. § 7401(3)1.(t)(1)
shall not be entitled to receive any credit against tax due in this Commonwealth as calculated under
phrase (t)(1)(A) or (B).

State Reference - 72 P.S. § 7401(3)1.(u)
Audit Procedures

1) Review REV-798, Schedule X to identify the name and FEIN of the Affiliated Entity(s) paying Intangible Income
and/or Interest to the taxpayer under audit.
2) Verify that the Affiliated Entity(s) paying Intangible Income and/or Interest to the taxpayer are adding back the
Intangible expense or cost as required by 72 P.S. § 7401(3)1.(t)(1) and the amounts do not exceed the
intangible expense or cost incurred by the taxpayer related entity’s corporate net income tax base for the
same tax year.
3) Confirm the election was made by the taxpayer on an its originally filed Pennsylvania Corporate Tax Report.
If such an election was not made, the taxpayer is not entitled to the intangible income deduction upon audit.

19

Other Deductions

Taxpayers may claim any other allowable deductions on RCT-101, Line 2E and Schedule OD. Examples include
Federal wages disallowed as a result of tax credits under IRC Section 45B (FICA tax obligations on employee tips)
or IRC Sec 51(Work Opportunity Credit). There are instances where the taxpayer may report an IRC 163(j) interest
limitation adjustment as an Other Deduction on the RCT-101; however, these adjustments should be presented
as an adjustment to federal taxable income. For tax periods commencing after December 31, 2023, an other
deduction may also be claimed for ordinary and necessary business expenses of certain medical cannabis
businesses, as defined in 72 P.S. § 7401(3)1.(b.2), which were not taken by the corporation on its federal
Form 1120.

State Reference - 72 P.S. § 7401(3)1.(b.2) & 72 P.S. § 7401(3)1.(c))
Federal Reference – IRC 45B & IRC 51
Audit Procedures

1) For tax credits claimed under IRC 45B and 51, verify the amounts to the FF8846 and the FF5884,
respectively.
•

Examples of credits not allowed is the empowerment zone employment credit, welfare to work credit,
renewal community employment credit, Indian employment credit and employee retention credits.

2) Review any other deductions claimed for compliance with Pennsylvania Law. If there is no statutory or
regulatory provision for the reported amounts, the deduction should be disallowed.

20

Section V: Statutory Additions
Taxes Imposed on or Measured by Net Income

In arriving at Pennsylvania taxable income, no deduction shall be allowed for taxes imposed on or measured by
net income. To the extent that such taxes have been deducted for Federal income tax purposes, they must be
added back to Federal taxable income before apportionment for Pennsylvania Corporate Net Income Tax
purposes. For Federal income tax purposes, deductions for taxes paid (not including federal taxes) are reported
on FF1120, Line 17. All taxpayers reporting expenses for taxes on federal income tax returns must complete
REV-860, Schedule of Taxes, even if no taxes are imposed on or measured by net income.
Important Considerations:
If a corporation pays a tax to a state which is a combination of taxes imposed on net income and some other
element (i.e., gross receipts or net worth), the portion based on net income must be added back in calculating
Pennsylvania taxable income.
If a corporation is required to pay a tax which could be based on either net income or some other item (i.e., gross
receipts or net worth), and the tax paid for the period is based on net income, the total tax is added back in the
calculation of Pennsylvania taxable income.
If a corporation overpays or over accrues income taxes in a prior year and adjusts the income tax expense for this
overpayment or over accrual in a subsequent year, then the taxpayer may decrease the tax addback for the
amount of this adjustment. However, the amount of the decrease is limited to the amount of these taxes added
back in the year of the overpayment or over accrual.

State Reference - 72 P.S. § 7401(3)1.(o) & Corporation Tax Bulletin 2008-05
Federal Reference – IRC §164
Audit Procedures

1) Obtain a schedule listing the income tax expense by-state.
2) Verify completeness of the by-state schedule, by reconciling to:
• FF1120, Line 17, Income Taxes (Or Taxes based on income)
• REV-860, PA Schedule C-5
3) Verify the reported amounts only include states that impose an income tax.
4) Negative tax addbacks should be reviewed and supported with records that substantiate any overpayments
or over accruals:
5) Prior year tax addback detail should be reviewed (if available) to determine whether current year negative can
be offset by prior year addbacks on a by-state basis
6) An audited negative tax is permitted to the extent that a prior year positive addback can be verified for that
specific state
7) For negative tax addbacks that do not offset against known prior year positive amounts:
• Taxpayer’s representative should be requested to provide proof of:
• Proof of refund for prior period, such as a copy of a refund check and/or
• Documentation of prior period tax accrual reported on the Pennsylvania return
• A written explanation for the negative amounts
8) Negative tax amounts that cannot be validated through proof of refund, documentation of prior period tax
accrual and reporting, offset by previously reported positive amounts as documented by available records,
or other adequate explanation should be disallowed
21

Current Year Bonus Depreciation

Pennsylvania corporate tax law decoupled from the Internal Revenue Code (IRC) Section 168(k). Accordingly,
Pennsylvania corporate taxpayers are required to add back all bonus depreciation claimed under Section168(k)
when computing taxable income. Taxpayers must file the appropriate Pennsylvania Schedule to show the full
depreciation calculation. For assets placed in service prior to 9/28/2017, all amounts are contained in the
REV-799 (Schedule C-3 and Schedule C-4). For assets placed in service on or after 9/28/2017, summary amounts
are reported on the REV-1834 (Schedule C-8 and Schedule C-9).
Federal 168(k) qualifying property generally includes new property with a recovery period of 20 years or less and
qualified leasehold improvement property. Property amortized under Section 197 does not qualify. Bonus
Depreciation applies after any reduction for a Section 179 allowance.
Since Pennsylvania has elected not to adhere to the timing of Federal bonus depreciation, corporate taxpayers
must adjust their depreciation expense when filing their corporate income tax returns. This involves a two-step
process.
1. The amount of Federal bonus depreciation must be added back to income. Federal bonus depreciation
amounts are reported on the FF4562, Line 14 and Line 25
•

For assets acquired after 9/8/2010 and before 1/1/2012, the Department permitted full recovery of
disallowed 100% bonus depreciation in the year that such depreciation was claimed and allowable
for federal tax purposes. The net result was that no adjustment was necessary.

2. Taxpayer is entitled to a Pennsylvania deduction (See Section IV. Statutory Deductions – Current Year
Additional PA Depreciation)
•

For assets placed in service prior to 9/28/2017 – The deduction is equal to a fraction of 3/7 times the
amount of depreciation calculated under normal rules with the remaining basis.

•

For assets placed in service on or after 9/28/2017 – The deduction is equal to the regular MACRS
depreciation calculation on the property without regard to the bonus depreciation amounts.

•

If the taxpayer disposes of an asset, or the asset is fully depreciated, prior to the taxpayer recovering
all of the disallowed bonus depreciation, the taxpayer is allowed to deduct the remaining disallowed
depreciation in the last year the asset is depreciated on the federal income tax return.
o

The Adjustment for Disposition must be reported on the proper schedule.

o

Other Adjustments are only applicable to assets placed in service prior to 9/28/2017, as the
MACRS calculation would not create a balance.

Mergers and Conversions

In the case of mergers, where the acquired corporation had unrecovered bonus depreciation, the balance is
transferred to the survivor. In the case of conversions, where a corporate subsidiary becomes a single member
LLC (disregarded entity), the balance is transferred to the owning member corporation. In either case for the
balance to be transferred the merger target or the entity converted to a disregarded LLC must have been filing in
Pennsylvania and added back bonus depreciation on a previously filed corporate tax report in order to have a
balance to transfer to the surviving taxpayer.

State Reference – 72 P.S. § 7401(3)1.(q)
Federal Reference – IRC 168(k)
22

Audit Procedures

1) Verify the addback of Federal bonus deprecation from the FF4562, Lines 14 and 25.
2) Review Department records for bonus depreciation history to verify the balance carry-in for the taxpayer and
any merged or converted entities, if applicable.
3) Review partnership returns for bonus depreciation reported by partnership on Form 4562 and include an
amount proportional to the profit / loss ownership percentage as an addback. If, as filed, the bonus
depreciation added back is greater than what is reflected on the Corporate Form 4562, the difference could
be due to the inclusion of partnerships.

Intangible Expense or Related Interest Expense

Act 52 of 2013 requires, for tax years beginning after 12/31/2014, an addback of intangible expenses to income
for intercompany expense deductions for royalties, licensing, or leasing fees on intangible property, including
those embedded with other expenses or misclassified as other expenses, or as amortization expense on
intangible property purchased from an affiliate. In addition to disallowing intangible expenses or costs, the
addback also disallows interest expenses that are directly related to an intangible expense or cost. Taxpayers
must complete REV-802, Schedule C-6 to report all intangible expense and related interest expense or claim any
applicable exceptions to the addback.
There are three exceptions that a taxpayer may claim to override the disallowance of the intercompany intangible
expenses. See Information Notice Corporation Taxes 2016-1.
1. Principle Purpose & Arms-Length - The principal purpose must be a valid business purpose, other than
the avoidance of CNI tax. The terms are considered arm’s length where the terms of the transaction under
consideration are such as would have been arrived at in independent transactions with or between
unrelated parties under similar circumstances.
2. Foreign Treaty - An affiliated entity domiciled in a foreign nation which has in force a comprehensive
income tax treaty with the United States providing for the allocation of all categories of income subject to
taxation.
3. Conduit - The affiliated entity pays expenses to an unaffiliated entity for the same intangible asset.

State Reference - 72 P.S. § 7401(3)1.(t) & Information Notice Corporation Taxes 2016-1
Audit Procedures
How to review when the taxpayer has filed the REV-802

1) Verify the total intercompany intangible expense and related interest expense from various sections of the
FF1120, including but not limited