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Five Fixes for the District’s Business Taxes

Presentation to the District of Columbia Tax Review Commission January 31, 2023

Michael Mazerov, Senior Fellow

State Fiscal Policy Division

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  • All states face major constraints on their taxing authority from US Constitution (as expansively interpreted by US Supreme Ct) and congressional statutory preemption
  • DC faces even more severe constraints from congressional preemption of its ability to tax non-residents – as extended by Bishop decision
  • DC really can’t afford unnecessary leakage from or loopholes in its tax structure!

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Recommendation #1: Enact a Business Activity Tax and Repeal the UBT

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  • Was most significant recommendation of 1998 TRC; all arguments in favor then still true today
  • Only legally viable way to circumvent Bishop decision and enable DC to tax profits of law, consulting, accounting, etc. firms owned by non-residents
  • Substitute for unincorporated business tax
  • Structure as “subtraction method” – gross receipts minus purchases from independent firms – so that “compensation” does not appear in base definition
  • C corps pay higher of BAT or CIT (via credit)
  • Very analogous to New Hampshire biz tax structure

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Recommendation #2: Maximize DC’s Ability to Impose CIT on Out-of-DC Corps

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  • DC’s authority to tax out-of-state corporations constrained by federal PL86-272 (1959); can’t tax sellers of tangible personal property that only “solicit sales” in DC (e.g., manufacturers selling to retailers)
  • DC code has minimal language stating when corp is subject to CIT (franchise tax) and no reg on subject
  • DC should issue guidance based on latest Multistate Tax Cmn guideline on PL86-272, which puts corps on notice as to which activities conducted in DC by out-of-state corp DC considers to be in excess of those protected by PL-86-272

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Recommendation #3: Switch to “Finnigan” Method of Combined Reporting (CR)

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  • DC uses “Joyce” method of CR, which forces DC to establish taxing jurisdiction separately over every member of combined group selling into DC
  • DC sales of members of combined group without separate nexus aren’t included in DC apportionment – reducing revenue yield from CR and opening tax planning opportunities
  • DC should switch to “Finnigan” CR method which obviates both these problems by treating entire corporate group as single taxpayer; simple change in law
  • Majority of CR states now Finnigan, and trend has been in that direction

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Recommendation #4: Enact a Higher Corporate Minimum Tax

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  • DC’s corporate minimum tax is $250 and $1,000 for corporations with more than $1 million in DC receipts
  • Several states now have much more robust CMTs
  • E.g., Oregon’s CMT is $100,000 for corps with more than $100m in OR sales
  • DC should enact higher CMTs based on higher tiers of DC gross receipts
  • CMTs prevent corporations from zeroing out their liability based on taking advantage of multiple credits
  • Even unprofitable corps benefit from DC services

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Recommendation #5: Tax REITs as Regular Corporations

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  • Real Estate Investment Trusts are essentially mutual funds for real estate investments; no corporate tax due if REIT pays out at least 90% of profits as dividends.
  • Federal govt taxes recipients of REIT dividends instead
  • Likely that significant share of DC commercial property owned by REITs.
  • Such REITs likely owned overwhelmingly by out-of-state investors whose REIT dividends DC can’t tax
  • It is self-inflicted wound that DC recognizes REIT status
  • DC should subject REITs to CIT, as New Hampshire does

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Michael Mazerov

mazerov@cbpp.org

www.cbpp.org

202.408.1080