- Philadelphia has decoupled from key OBBBA provisions, requiring taxpayers using Method II to file their business income and receipts tax (BIRT) to follow Pennsylvania rules for research expenditures, business interest expense, and qualified production property.
- Affected taxpayers must calculate separate Philadelphia tax adjustments, including five-year recovery of research expenditures, pre-2025 Section 163(j) treatment, and addbacks for Section 168(n) deductions.
- Taxpayers should review 2025 BIRT filings and payments, amend affected BIRT returns, and consider requesting penalty and interest waivers.
These Key Takeaways were generated by AI and reviewed by a BDO professional.
The Philadelphia Department of Revenue recently released guidance addressing the impact of Pennsylvania Act 21 of 2026 on the computation of net income for Philadelphia business income and receipts tax (BIRT) purposes. Act 21 requires Philadelphia to conform to Pennsylvania’s treatment of some federal tax provisions enacted under the One Big Beautiful Bill Act (OBBBA), as noted in Pennsylvania Act 45 of 2025. As a result, Philadelphia decouples from the affected federal provisions beginning with tax year 2025. Taxpayers subject to the rules must maintain separate Philadelphia calculations and sufficient documentation to support each adjustment.
The guidance applies only to taxpayers that compute BIRT net income under Method II, not under Method I. For BIRT purposes, taxpayers must make an irrevocable election to calculate net income using either Method I or II, and the elected method must be used in all subsequent tax years. Under Method I, net income is determined based on the taxpayer’s books and records in accordance with reasonable accounting principles. Under Method II, taxpayers begin with federal taxable income before the dividends-received deduction and net operating loss deduction and then apply the adjustments required under Philadelphia law. The resulting income is subsequently apportioned and allocated for BIRT purposes.
Changes at a Glance
| Area | Federal item affected | Philadelphia treatment |
|---|---|---|
| Research and experimentation (R&E) expenditures | Deductions for domestic or foreign R&E under IRC Sections 59(e), 174, 174A, or 481.` | Add back to taxable income any federal deductions claimed for domestic or foreign R&E expenditures. Taxpayers can subsequently deduct those expenditures for City tax purposes at a rate of 20% of the original expenditure per tax year until the full amount has been recovered. That recovery method applies to all affected taxpayers, including federally defined small businesses, and covers both domestic and foreign R&E expenditures. |
| Business interest expense | Federal limitation under IRC Section 163(j). | Calculate the allowable deduction as though IRC Section 163(j) remained in effect on December 31, 2024. |
| Qualified production property | Federal deduction under IRC Section 168(n). | Add back the Section 168(n) deduction for qualified property. Recover cost using general depreciation under IRC Section 167 and 168, excluding depreciation rules under Section 168(n). |
What Taxpayers Should Do Now
Given that Philadelphia’s guidance was issued after the original filing deadline but before the extension deadline, taxpayers should evaluate whether their 2025 filings and taxes paid remain accurate. Philadelphia taxpayers that filed and paid 2025 BIRT based on the OBBBA treatment of the specified provisions should amend their returns. Any corresponding impact on net profits tax (NPT) credits might also require an amended NPT return. Taxpayers whose amended returns result in additional 2025 tax due can request a waiver of penalties and interest for tax year 2025.
BDO Insights
- Philadelphia BIRT Method II filers cannot automatically use the new federal treatment for some research expenditures, business interest expense, or qualified production property. For tax years beginning after December 31, 2024, affected taxpayers must compute specific Philadelphia adjustments that follow Pennsylvania decoupling rules.
- Taxpayers that have remitted payment but have not yet filed returns should file in accordance with Philadelphia's decoupling guidance and pay any additional tax due. They also can request waivers of penalties and interest for tax year 2025.
- Taxpayers should contact their advisers to assess whether the guidance applies, identify affected federal deductions, calculate and document Philadelphia adjustments, evaluate amended return and payment considerations, and prepare any appropriate penalty and interest waiver requests.
Please visit BDO’s State & Local Tax Services and Income, Franchise, and Gross Receipts Tax pages for more information on how BDO can help.