Little-known tax boosts schools but bugs taxpayers

IN THE OTHERWISE bleak picture of school-district finances, here's a bright spot: the little-known School Income Tax.

A stepped-up effort by the city to collect the tax, also known as the Net Income Tax, appears to be working. It collected just over $37 million the past fiscal year, ended June 30 - about $7 million from delinquent accounts. That's up about $10 million over the prior year and about 20 percent above Revenue Commissioner Clarena Tolson's goal of $30.9 million.

The problem is, many people subject to the tax don't know it. The city has made next to no effort to publicize it. And some taxpayers don't find out until they get a call from a collection agency.

The tax applies to "unearned income" such as dividends, interest, estate and trust income, short-term capital gains, rental income and distributions from S corporations (corporations that give all their profits directly to shareholders). All the tax money goes to the schools.

The tax has been in effect since 1969. But the city doesn't send you a bill, depending instead on taxpayers to self-report.

The city Revenue Department's recent collection tactics have some taxpayers, such as Christine Knysh of the Northeast, crying foul.

Knysh, sole owner and shareholder of Total Care Network, an S-corp, received a letter in March from Revenue Collection Bureau Inc. telling her that she owed six years of back taxes, penalties and interest on her S-corp income. Knysh and her accountant, Abe Cades, didn't know that the tax applied to S-corp income.

"First I was angry, because I was never aware that I owed tax," Knysh said. "I was also angry that they sent the letter to my home because I thought that there was a corporate veil that protected me. "

The collection agency calculated penalties and interest of up to 103 percent, but offered to waive the penalty if she paid in 30 days and waived her right to appeal to the Tax Review Board.

Knysh, worried the city would go after her house, signed the waiver and paid the interest and principal of nearly $3,000.

Cades learned the city was going after S-corp distributions when his clients began to receive letters from what he called a "collection outfit."

"We've been filing for individuals where they have dividends but the city never sent anything to people with S-corp distributions prior to this year."

The city insists that it does extensive outreach to tax preparers and Pennsylvania CPA groups to educate them about the tax.

City Councilwoman Blondell Reynolds Brown convened a hearing in October to find out if the tax could be more efficiently collected. Tolson testified that the main challenge was identifying taxpayers who were not reporting at all. She said her department would work with the state to identify nonreporting taxpayers and then begin "an educational effort."

When Councilman Bill Greenlee expressed concern about what form the first notices might take, Tolson reassured him they would let people know they may be subject to the tax, ask for information and request they file. Brown characterized them as "a friendly FYI."

Brown was shocked to learn, in a recent call from the Daily News, that the first "friendly FYI" some taxpayers got came from a collection agency. She called the terms offered to Knysh "inappropriate and wrong."

"I have a different philosophy where it's important to educate first," Brown said. "There should be some kind of grace period. "

The city's first "FYI" letters went out near the beginning of the year. According to Tolson, some were sent by the city and some through a pilot program using collection agencies to collect the tax and do "discovery, assessment and audit work." The agencies are paid 13 percent to 15 percent of the money they collect.

Tolson is opposed to an amnesty for delinquent taxpayers.

"Amnesty programs undermine collection efforts," she said. "We offered amnesty in 2010. By offering it again five years later, people will just wait for the next amnesty rather than paying on time."

The numbers back up Tolson's position. About $7 million has been collected from delinquencies this year. The 2010 amnesty brought in only $1.4 million.

On June 3, nearly two months after Knysh paid the collection agency, she received a bill from the city dated May 13. It had no record of her payment and now wanted the full principal, interest and penalty of more than $4,600.

Also at issue is how the city taxes S-corp distributions. S-corps report what is called the "distributable" amount to the IRS. But their shareholders many not receive that full amount. The portion they do take is called the "distributed" amount.

Since 2007, the city has been taxing the distributable amount.

That means that Knysh, who rolls all of her distributable amount back into her business, is paying tax on money she's never received.

"It's oppressive to a small business," she said.

Frank Paiva, acting chief counsel to the Revenue Department, believes the 2007 decision was legal but "not as equitable as we'd like it to be." For that reason, starting with distributions made in 2013, taxpayers who file to the city will only be taxed on the distributed amount.

"If someone's not filing, we'll tax on the distributable share. It's not equitable or good for business, but we need the money for the schools," Paiva said.

That's good news for lawyer Stewart Weintraub of Chamberlain Hrdlicka in West Conshohocken. Weintraub will be representing a case before the Tax Review Board that involves a bill of more than half a million dollars in tax, interest and penalty.

Weintraub says his case does not challenge the legality of taxing the distribution but is "challenging the regulation that says all the income is subject to taxation."

"The phone hasn't stopped ringing from accountants with clients involved in the same issue," he said.

His client's case is scheduled for trial on Sept. 9.