The Taxation and Business Environment of Washington D.C.

When deciding where to move or open a business, taxes may not always be the deciding factor but certainly help inform your decision. With the rise of “Zoom towns” in other parts of the US as freelancers and entrepreneurs embrace remote work that their W-2 counterparts are now discovering, many Washington D.C. residents decide to leave the District due to housing costs or other factors and choose Virginia or Maryland to remain close by.

As of 2019 figures from the Census Bureau, it’s estimated there were almost 24,000 employer establishments within the district and a significantly larger amount of solopreneurs, with almost 63,000 non-employer establishments at the time. These numbers are likely to have dramatically shifted in the wake of the COVID-19 pandemic.

If you’re considering opening a business within the District, it’s paramount to understand the nuances of doing business and what type of taxation environment it entails.

Corporate Franchise Taxes

The District levies a corporate franchise tax on businesses formed as corporations. This includes S corporations. Similarly to New York City, Washington D.C. does not recognize S status. While you may realize the same benefits and risks that come with S status at the federal level, your business will need to pay entity-level taxes at the local level similarly to a larger C corporation.

As the District also imposes a personal income tax, income that is passed through to you with an S corporation structure will also be taxed at the local level.

Corporate franchise tax rates were last updated in 2019, and have slightly fallen over the years. As of 2021, the corporate franchise tax rate is 8.25% with a $250 minimum tax if District-based gross receipts are $1 million or less, and the minimum tax goes up to $1,000 if those receipts exceed $1 million.

Franchise Taxes on Unincorporated Businesses, and Exemptions

For businesses that are unincorporated, or are structured as any other type of entity other than a corporation, the unincorporated business tax applies.

This includes multiple and single member LLCs. If you elect to have your LLC classified as a corporation, then you would need to pay the corporate franchise tax instead.

However, there is some relief for small business owners using a non-corporate structure but has additional complexity. The unincorporated business tax applies to businesses that have gross receipts exceeding $12,000. There is a 30% salary allowance for paying the owners, plus a $5,000 exemption to help determine taxable income.

Unincorporated businesses are also exempt from paying this tax is more than 80% of the gross income is from personal services rendered by the owners. In order to qualify for this exemption, capital assets (such as vehicles, equipment, and real estate) cannot be a major factor in generating that income. While this law would exempt most self-employed people relying on providing services, it would not exempt equipment rental businesses or landlords that rely on their capital assets.

Businesses subject to the unincorporated business tax pay the same minimum taxes as corporations subject to the corporate franchise tax, at the same 8.25% rate as of 2021.

Commercial Property Tax

Like most municipalities, Washington D.C. bases property tax rates on classification. The tax rate is based on each $100 of the total assessed value of the company’s property. 

Most commercial property falls into Class 2, which is is separated into three categories based on the total assessed value of commercial and industrial real estate holdings that include hotels and motels:

  • Class 2 Tier 1: $1.65 per $100, assessed value less than $5 million
  • Class 2 Tier 2: $1.77 per $100, assessed value between $5-10 million
  • Class 2 Tier 3: $1.89 per $100, assessed value exceeds $10 million

For example, if a Class 2 storefront is assessed at $900,000 under the first tier, the property tax is $14,850 ($900,000 divided by 100, multiplied by $1.65).

To encourage active property use, Class 3 property is taxed at $5 per $100 if the property is vacant, $10 per 100 at Class 4 if the property is considered blighted by the District.

Sales Tax

Washington D.C. has the highest sales tax burden in the metropolitan area compared to northern Virginia and Maryland. The general sales tax rate is 6%, which is similar to those two regions, but deploys a multiple rate system for other items. Generally, all tangible personal property is subject to this sales tax. Most groceries and medicines (including over the counter medicines) are not subject to sales tax. There is one annual sales tax holiday in the winter when no sales tax gets collected from any purchases.

Restaurant meals, liquor, and soft drinks consumed on the premises plus vehicle rental have a 10% sales tax, while soft drinks meant to be consumed off the premises have an 8% sales tax. Alcoholic beverages with the same purpose have a 10.25% sales tax. Sporting tickets and other types of vehicle rental also carry a 10.25% sales tax, and commercial lot parking has an 18% tax.

For businesses located outside of the District, Washington D.C. follows the South Dakota model after the results of Wayfair v. South Dakota in 2018. If a business makes $100,000 in sales or 200 transactions to customers within the District in a given year, they must collect and remit 6% sales tax on goods and services subject to sales tax. This threshold only applies to sales within Washington D.C., not the entire gross.

While Washington D.C. has an overall higher tax burden compared to many states, many choose to own and operate a business within the District on account of the large and economically diverse population, and proximity to government jobs and services, in addition to the demand for a wide array of services, amenities, and skilled trades.

While the District does not recognize S status, the corporate income taxes paid at the local level are deductible on the federal business tax return. In turn, Washington D.C. allows business owners to take a percentage of the taxed business income as a deduction on your District-level personal tax return.

However, if you are a Virginia resident, the state of Virginia does not recognize Washington D.C. corporate franchise taxes at the personal level. If your business is located in the District but you live in Virginia, you will essentially face double taxation at the state level.

Jeff Lipsey and Associates can assist small business owners with navigating the taxation and overall business environments when scoping out where and when they would like to start a business. Contact us today to speak to one of our friendly and professional business tax experts.

How Did the Wayfair Supreme Court Case Impact Sales Tax Collection for Small Businesses?

In 2018, the Supreme Court ruled 5-4 in Wayfair v. South Dakota that state governments can mandate that retailers outside of their state to collect and remit sales tax from in-state customers, even if they don’t have some kind of physical presence there like a store, warehouse, server, or registered agent. In the wake of this decision that overturned over 50 years of precedent, state tax authorities swiftly enacted thresholds and timelines for sales tax compliance concerning out-of-state sellers.

It’s estimated that there are over 9,000 different sales tax jurisdictions throughout the United States and the landmark Wayfair ruling only further complicated their administration. Washington D.C. has the highest sales tax burden in the entire metropolitan area, despite being a quarter of a point lower than Maryland and northern Virginia’s 6% general rates, due to the multiple rate system used in the District. For instance, food eaten in restaurants has a higher sales tax rate than the general rate of 5.75%.

Decades ago, mail-order catalogs, home shopping TV channels, and early forms of Internet stores did not yet gain enough ground to get lawmakers’ attention until Quill v. North Dakota that was decided in 1992. Now that ecommerce is part of daily life for most people, businesses are looking to lawmakers for a more uniform, nationalized solution after the Wayfair case.

Precedent for Sales Tax Nexus in Quill Corp. v. North Dakota

Quill Corporation, an office supply company that was incorporated in Delaware with operations chiefly headquartered in Illinois, was sued by the North Dakota state tax commissioner for failure to collect and pay use tax on sales to customers within the state. Quill did a large volume of mail-order business and only collected sales tax from customers in states where they had some type of physical presence: employees, property, or a physical store or warehouse. Quill had no such presence in North Dakota.

The North Dakota tax commissioner argued that Quill established a presence in North Dakota simply because of floppy disks bearing the company’s name that were now physically located in the state. The North Dakota State Supreme Court upheld the tax commissioner’s position, but the Supreme Court disagreed and based the ruling on the Dormant Commerce Clause. This clause prevents state governments from interfering with business activity across state lines, unless they are authorized to do so by Congress.

The decision essentially barred state governments from imposing sales and use tax collection requirements on out-of-state businesses unless they had valid physical nexus. Selling products that bear the company’s name and branding and delivering them to customers in the state did not constitute nexus, per the 1992 ruling. Quill did not have offices or other physical locations in North Dakota and remote employees were rare at the time, but none of their staff was in the state.

However, Wayfair v. South Dakota has now overturned this case and states can now impose sales and use tax requirements on businesses that sell to their constituents. With the exponential rise in Internet-driven sales in the decades following the Quill decision, revenue-starved states had been pushing for “Kill Quill” actions that would authorize them to collect more sales taxes as they could not trust individual taxpayers to report use tax on their personal tax returns. Furniture giant Wayfair was brought before the South Dakota State Supreme Court, and after arguments in the Supreme Court, this authority has now been granted to state tax departments.

How is Nexus Redefined Under Wayfair?

In 2016, South Dakota passed a law requiring out-of-state Internet sellers that deliver more than $100,000 of goods or services into the state every year, or have 200 or more transactions regardless of amount, to collect and remit sales tax. Wayfair sued the state, citing Quill and declaring this action unconstitutional. However, the Court sided with the state by holding that Quill and related rulings were outdated because ecommerce and modern logistics now gave out-of-state sellers potentially unfair advantages over sellers located within the state.

45 states impose sales tax and most have used the authority granted by the Wayfair decision to model their economic nexus closely to South Dakota: $100,000 in sales or 200 transactions. At the time of writing, only Missouri and Florida have yet to enact an economic nexus threshold.

Rules for D.C. Businesses Under Internet Amendment of 2018

Washington D.C. businesses are now subject to the Wayfair nexus rules after Mayor Bowser signed the Internet Sales Tax Emergency Amendment Act of 2018 (Emergency Act) on December 31, 2018. In addition to a 6% sales tax on digital goods, businesses in the District that collect sales tax must comply with this mandate for all sales made after April 1, 2019. This law affects businesses that are not based in Washington D.C. but sell to customers who live there. Other states and jurisdictions have not taken such immediate steps, and phasing in compliance for businesses that sell to their constituents.

Washington D.C. copied South Dakota and has imposed the $100,000 in sales or 200 transaction threshold for requiring sales tax remission. This only applies to transactions within the District, not gross for the year.

As many Washington D.C. residents consider relocating to Maryland or Virginia for personal or business reasons, if they do not already live there but own a business in the District, each state has their own rules for sales tax administration. As a Washington D.C. business owner is likely to ship merchandise or perform services within the two states, you may be responsible for sales tax remittance to one or both of these states if your customer base is spread across the entire metropolitan area.

Maryland Sales Tax Nexus

Maryland has a general sales tax of 6%, 9% on alcoholic beverages, and 11.5% on passenger car and recreational vehicle rentals (8% for truck rental). Maryland expects its residents to pay use tax on purchases from merchants outside of Maryland if the purchase is subject to sales tax, even if it was made in person out of state but the product is used in Maryland.

Services are generally not taxed in Maryland, but most tangible products are.

Businesses outside of Maryland are responsible for collecting sales tax if they meet the same guidelines laid out in Wayfair: the mandate applies if there are 200 transactions within the state or $100,000 in sales within the calendar year.

Virginia Sales Tax Nexus

Most of Virginia has a 5.3% general sales tax rate, while the northern Virginia counties closer to Washington D.C. have a 6% rate as does Central Virginia. James City, Williamsburg, and York County have a 7% rate and as of July 1, 2021, Charlotte, Gloucester, Northampton, and Patrick Counties will have a 6.3% general sales tax rate. Food and personal hygiene items are subject to a statewide 2.5% reduced sales tax rate.

Similarly to Maryland, services in Virginia are generally exempt from sales tax, unless they are in connection with the sale of tangible property (such as selling handmade furniture and adding an assembly fee).

As of July 1, 2019, Virginia utilizes the Wayfair model and mandates that sellers from out of state are responsible for sales tax administration if they have 200 transactions or $100,000 or more in sales from Virginia customers. However, Virginia specifically differentiates online sellers from online marketplaces and facilitators, as direct and facilitated sales made within the state are subject to the mandate, while payment processors that do not sell merchandise are exempt.

The key takeaway from the Wayfair case is that our laws are finally beginning to catch up with technology, and it isn’t always for the better. While state governments are pleased with the Wayfair decision and this will help state budget shortfalls, many commerce groups feel this decision hurts the smallest businesses that are now faced with undue compliance burdens, which gives large corporate sellers like Wayfair and Amazon an unfair advantage. With thousands of jurisdictions that would potentially require sales tax returns, retailer advocates are seeking a federal solution to this problem.

Jeff Lipsey and Associates can assist small business taxpayers with their Washington DC and metro area sales tax compliance questions if they are out of state. Contact us today to speak to one of our friendly and professional business tax experts.

When Should You Start to Outsource Your Accounting?

With so many different apps and online accounting and recordkeeping solutions for small businesses and freelancers today, many are putting their accounting matters into their own hands. For freelancers in particular, keeping track of earnings and expenses on a spreadsheet may be sufficient recordkeeping to stay organized for tax season. It’s estimated that 62% of small business owners have some type of in-house accounting solution, whether it’s through software or a dedicated staff member opposed to fully outsourcing.

But when is it time to outsource your accounting needs to a professional? It can be difficult to afford a CPA’s fees when you’re just starting out and looking to stabilize your cash flow first. Every business is totally unique with their own goals and administrative burdens, and entrepreneurial and market trajectory can’t always be accurately predicted. However, here is a good idea of when it’s time to outsource your accounting.

You Are Unsure How to Properly Maintain Books and Records

Every entrepreneur excels at different aspects of running a business, and has weaknesses in others. Having dedicated professionals like accountants and attorneys to help you is crucial for your success. Even if math is your strong suit, it doesn’t necessarily translate to accounting knowhow as it is a complex information system that requires specialized knowledge to handle correctly.

While utilizing a bookkeeping app can help give you an idea of your overall numbers, outsourcing to a professional becomes integral if this aspect of owning a business is stressing you out and causes you to put off properly maintaining your books. If receipts and invoices are piling up, and you don’t know what to do when the bank asks for a P&L and balance sheet, it’s time to start working with an accountant who can get you on the right track.

Transaction Volume Becomes Unwieldy

When your business is just starting out, there may not be many transactions to record yet. As your business gains momentum over time, picking up more customers, clients, revenue streams, or deals means that the number of transactions has also grown. What used to take 15 minutes upon going through your bank and digital processor statements now takes hours.

Although some online accounting solutions have “smart” AI implemented to tackle changes in transaction volume, as well as copy and paste functions for recurring transactions like rent and insurance expenses, managing larger transaction volume becomes more costly simply in how much more time it takes. The more time that you spend on entering transactions and other administrative aspects of your evolving business, the less time that you have to spend on more revenue-producing activity plus your personal life.

When your business presents an ongoing need for accounting help because of transaction volume, this is when it becomes critical to outsource it.

Transactions Become More Complex

Some transactions are very simple, such as recording the receipt of payment for services or disbursing cash to pay for supplies. Other transactions can become far more complex, whether they are seldom or routine. For instance, there are business deals that entail the purchase or licensing of intellectual property with possible payment of royalties. These deals require a degree of legal knowledge to determine how to treat them for tax and bookkeeping purposes. While common in the software and games industries, most accountants have training in commercial paper that helps decipher these agreements and how they must be accounted for.

Buying and selling a businesses or components, mergers, selling property, and business deals introduce more complexities in both tax laws and accounting standards that basic bookkeeping software can’t automatically compute with its AI.

When your business transactions grow more complex than basic recording of revenue and expenses, it’s time to start working with a professional.

Your Business is Going Through Significant Changes or Growth

Both transaction volume and complexity go hand in hand with business growth. As your business matures and your goals may change, along with the business entity you originally chose, you are more likely to need to outsource accounting. Significant changes to operations are also apt to necessitate outsourcing your accounting, as you may be unfamiliar with how to properly record transactions of this nature. As regulations constantly update, accounting professionals are dedicated to staying on top of those changes so that you and your team can direct your attention to maintaining and improving business operations.

Achieving business growth is an exciting stage, but it can also be an awkward one: your administrative burden has increased, but you may not have the resources to hire a dedicated internal accountant or expensive back office stacks. In-house accounting professionals are costly to attract, retain, and train. Back office and business intelligence software meant for more robust transaction volume and complexity is equally expensive with a time-consuming learning curve. An outsourced accounting firm grants access to experienced and knowledgeable professionals, and the subsequent technologies they use, without the need to manage internal staff and costly platform subscriptions.

You’re Unsure What Financial Data is the Most Important

There’s a reason why accountants are often instrumental to helping a small business grow: they don’t just do your books so you don’t have to, they also help you determine which numbers you should be paying the closest attention to.

Different types of businesses have differing needs for parsing financial data and making more informed business decisions. Some business processes may rarely request financial statements, while others will require them to be submitted frequently. If you’re not sure which data you should pay attention to, outsourcing to an accountant can help you produce the financial reports you need on a timely basis. As it doesn’t make sense to hire in-house accounting staff at a small scale, an outsourced accountant is your best “human” solution.

Jeff Lipsey and Associates can assist small business owners with figuring out the right accounting solutions for their needs and creating a smooth transition from in-house recordkeeping to outsourced accounting. Contact us today to speak to one of our friendly and professional business tax experts.

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