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.
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.