A version of this article appeared in GlobeSt.com on November 30, 2015.
The city of San Francisco is in the midst of transitioning from a payroll tax, previously its main source of tax revenue, to one favored by many other large cities—a tax on gross sales. The phase in includes a looming February filing deadline and significant penalties for noncompliance.
The multiyear phase in of changes also has proved confusing, particularly to developers and investors who are susceptible to mistakes because of the inherent complexity of real estate ownership structures. With full transition to a tax based on gross receipts set for 2018, real estate companies are carefully analyzing how the increasing levels of taxation affects them and their revenue planning. For example, the tax on gross revenue derived from residential real estate differs from tax on gross revenue from commercial real estate.
Historically, companies paid a San Francisco business tax based only on employee wages earned on work performed in San Francisco. Now in its second year of a four-year phase in, the gross receipts tax (GRT) is increasing while the payroll expense tax (PET) is going down. The new GRT is scheduled to increase by a quarter each year until reaching the full tax rate for each category of tax-paying entities.
Additionally, the tax rate is graduated based on a taxpayer’s gross receipts. For example, the tax base rate for real estate, rental, and leasing services starts at 0.285 percent and gradually increases to 0.3 percent; and gross receipts are allocated based on real properties located in San Francisco. In contrast, if the business determines that another business classification applies, such as professional, scientific, and technical services (which is activity described in the North American Industrial Classification System, or NAICS, code 54), the tax base rate starts at 0.4 percent and increases to a maximum rate of 0.56 percent; and gross receipts is apportioned based on payroll expense and not allocation by where the real estate is located.
Compliance can be confusing. To start, there are two separate deadlines:
- The annual PET and GRT return is due on the last business day of February following the close of the prior calendar year.
- The annual registration, based on the coming fiscal year covering July 1 to June 30, is due midyear on May 31.
Significant penalties are levied if the filings aren’t made on time or filed by the requisite entity. Some owners may unknowingly overpay and may be subsequently prevented from recovering the overpayment due to the short one-year statute of limitation on refund claims. Among the questions that need to be addressed:
- Which entity is required to register and file?
- How are gross receipts determined if there’s rental income from residential and commercial tenants?
- How should management fees be reported?
The issues for investors and lessors of real estate are particularly complex. Large real estate companies often have complex legal structures with varying ownership and multiple business activities in multiple locations. The GRT sourcing rules and rate schedules are based on the industry in which the gross receipts are derived by referencing the NAICS. Depending on how the gross receipts are recorded for accounting and reported for federal income tax purposes, the tax outcome can be significantly different.
Businesses with rental income from residential and commercial real estate have additional compliance requirements. A lessor of residential real estate is treated as a separate person with respect to each individual building in which it leases residential real estate units; accordingly, the lessor must obtain a business account number as well as file a return for each individual building. Furthermore, a lessor earning rent from both residential and commercial units in the same building in San Francisco is required to obtain a business account number for the residential units in addition to a business account number for the commercial rental units.
Relief is available for some. Similar to the payroll expense tax, the gross receipts tax provides an exemption to small businesses, which are defined as businesses with no more than $1 million in gross receipts. In order to properly report and remit the GRT, owners and advisors should spend time reviewing their business activities and the nature of gross receipts generated to better understand how this change affects their business.
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For more information about the San Francisco gross receipts tax or for assistance complying with and navigating its registration, filing, and payment requirements, contact your Moss Adams tax professional.