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Pennsylvania’s 2025-2026 Budget Bill: Decoupling from Federal Tax Changes

Pennsylvania’s 2025-2026 Budget Bill: Decoupling from Federal Tax Changes

Summary:

  • Pennsylvania’s new budget bill makes a major change by decoupling state taxes from several federal tax rules on research expenses, business interest deductions and qualified production property.
  • The budget did not include three proposals that many were watching: a faster Corporate Net Income Tax phase-down, the adoption of combined reporting and the elimination of property taxes by 2029.
  • New benefits include the Working Pennsylvanians Tax Credit and funding for the Childcare Recruitment and Retention Program.
  • Businesses will now see bigger differences between their federal and Pennsylvania tax filings.
  • Several community, health and housing programs were expanded or updated as part of the state’s overall Fiscal Code bill.

After months of delay, Pennsylvania has finalized its 2025-2026 state budget, passing a wide-ranging Fiscal Code (HB 416) that implements the full spending plan for the coming year. The bill includes provisions or discussion around almost every part of state government, from business taxes to childcare funding.

While the budget includes many smaller updates, the biggest change for the business community is the decision to decouple the state’s Corporate Net Income Tax (CNIT) from several parts of the federal tax code. This means Pennsylvania will not follow some of the federal changes that took effect under the One Big Beautiful Bill Act (H.R.1). As a result, C Corporations will see differences between what they can deduct on their federal return and their Pennsylvania state return.

The budget also does not accelerate planned reductions to Pennsylvania’s corporate tax rate and does not adopt combined reporting. For business owners, this means some tax relief that had been discussed earlier this year will not occur. However, for families and nonprofits, the budget includes new benefits, such as a refundable state tax credit for working families and more support for childcare providers.

Pennsylvania Decouples from Key Federal Tax Changes

The most important tax change in this year’s budget is the state’s decision to decouple from several federal updates included in H.R.1. Pennsylvania has decoupled from the federal treatment of:

  • Research and Experimentation (R&E) expenses
  • Expensing of qualified production property
  • Business interest expense limits

How Domestic R&E Expenses Will Be Handled

Federal law prior to H.R.1 requires businesses to deduct research and experimentation costs over five years instead of all at once. Under H.R.1 businesses now have a choice to expense immediately or amortize over five years. H.R.1. requires C corporations to add back to Pennsylvania taxable income any amounts related to domestic R&E costs, including:

  • Federal amortization deductions, and
  • Federal deductions from accounting method changes for R&E.

The amount added back must then be amortized over five years for Pennsylvania purposes, with 20% deductible annually starting in the year of the add-back.

C corporations will need to capitalize and amortize domestic R&E costs over five years for Pennsylvania tax purposes even though they may deduct them immediately for federal purposes. For prior-year R&E costs, corporations must also capitalize federal deductions and amortize them over five years.

This will specifically impact C corporations in high-research industries such as biotech, pharmaceuticals, manufacturing, technology and engineering. Since Pennsylvania’s personal income tax law is purposefully not tied to federal tax principles in most instances, individuals, fiduciaries and pass-through entities (partnerships and Pennsylvania S corporations) are not affected by these law changes.

Accordingly, if corporations choose to calculate their Pennsylvania taxable income using federal income tax law, they don’t need to make any modifications to their Pennsylvania taxable income for R&E costs, interest or deductions for qualified production property. This creates an extra layer of record-keeping because companies must now track two versions of their R&E deductions, one for federal taxes and one for PA’s taxes.

No Immediate Expensing for Certain Property

A major federal change allows companies to deduct the full cost of certain commercial property upfront. Pennsylvania chose not to adopt this rule. Instead, businesses must continue depreciating property gradually over time using traditional depreciation schedules rather than immediate expensing.

For industries such as manufacturing, construction, logistics or commercial real estate, this means that state-level tax savings will come in smaller annual amounts, not a large deduction in the year the property was placed into service.

Interest Expense Limits Will Use Older Rules

Businesses are allowed to deduct interest paid on business loans but federal law updated how much interest can be deducted. Pennsylvania rejected these updates and will continue using the older rules that were in place at the end of 2024. This means Pennsylvania may allow less interest to be deducted compared to federal returns, further creating a separation between federal and state filings. The federal law will be based upon earnings before interest, taxes, depreciation and amortization (EBITDA) basis for the limitation while Pennsylvania will be based upon an earnings before interest and taxes (EBIT) calculation.

Reporting Requirements on Decoupling

As these new changes are significant, the Department of Revenue must create a detailed report explaining how decoupling impacts taxpayers and state revenues. This report must include the number of affected taxpayers, estimated revenue impacts and comparisons to what would have happened if the state had followed federal rules. This means that lawmakers expect to revisit these issues in the future as they evaluate how these decisions to decouple impact Pennsylvania’s competitiveness and revenue stability.

What Lawmakers Chose Not to Include in the Budget

Not everything under consideration this year made it into the final budget. Three major items were not included in the proposal that had been up for discussion:

Corporate Net Income Tax Phase-Down Remains the Same: Pennsylvania’s CNIT has dropped gradually since 2023. Under existing law, the rate will fall from 7.99% to 7.49% by 2026, with the ultimate rate of 4.99% by 2031. Lawmakers considered speeding up these reductions, but the budget does not change the current schedule.

No Combined Reporting: Pennsylvania also decided not to adopt combined reporting, a system used by many states to tax multistate corporations as a single combined group. For now, Pennsylvania will continue to separate entity reporting, avoiding significant shifts in how the state calculates income for multistate companies.

No Property Tax Elimination: There was a proposal to eliminate property taxes to school districts by July 1, 2029, which would have required alternative sources of funding for public education. However, that bill currently remains with the Pennsylvania Senate and was not included.

New and Expanded Consumer and Workforce Benefits

While the budget does not drastically change corporate tax policy, it does introduce new benefits for families, childcare providers, nonprofits and community organizations.

Working Pennsylvanians Tax Credit: One of the biggest additions to the budget is the Working Pennsylvanians Tax Credit, a refundable Pennsylvania tax credit for residents who qualify for the federal Earned Income Credit (EITC). Under this program, eligible taxpayers can receive a Pennsylvania credit equal to 10% of their federal EITC amount.

Childcare Recruitment and Retention Funding: The budget also allocates $25 million to help childcare centers retain employees and reduce turnover. Providers participating in the Childcare Works program will receive roughly $450 per employee to use toward recruitment and retention bonuses.

What Happens Next for the Pennsylvania Budget?

Pennsylvania’s new budget brings important changes that will affect businesses, families and community organizations throughout the Commonwealth. For businesses, the biggest impact is the state’s decision to decouple from several federal tax rules. These changes will make state tax planning more complex and may affect how companies invest in research, property and financing.

If you have any questions, please contact your Brown Plus advisor.

Posted In: Tax | Insights

About the Author - Randy Fackler, CPA, CEPA, MST

Randy is a Principal and the Tax Director at Brown Plus and is one of the key members of the Firm’s Tax Department. As Tax Director and Principal, Randy is responsible for managing tax consulting and compliance services for his clients, as well as overseeing the Brown Plus Tax Department.

Randy has over 30 years of experience in public accounting and working with clients in numerous industries including manufacturing and distribution, retail, healthcare, professional services and high-net-worth individuals. He assists clients with general business advisory services such as tax accounting methods, tax planning and consulting, cash flow needs analysis, merger and acquisition analysis, product profitability analysis, forecasting and more.

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