Local Business License TaxesDecember 20, 2005Legislative Committee Local Government Relations Committee Taxation CommitteeThis Issues Briefing Paper is for discussion purposes only and has not been approved by the Legislative, Local Governmental Relations, Taxation or Executive Committees or the Board of Directors.Issue: Should C.A.R. sponsor legislation regarding the collection of business license taxes by local jurisdictions?Action: OptionalOptions: 1. Do Nothing. Existing policy; requires Realtors to fight inappropriate taxes at the local level, does not change cities' authority to tax or the licensees' independent contractor status.2. "Have our cake and eat it too" - Change the characterization of real estate salespersons and broker associates to that of "employee" for BLT (Business License Tax) purposes, while at the same time preserving the status of "independent contractor" for all other purposes.3. Business Entity taxation - Prohibit the application of a BLT to a regulated business entity except at the office address(es) shown in the regulatory records of the business.4. OtherStatus/ Summary: Cities have become increasingly aggressive and creative in applying business license taxes to real estate license activities, and every indication is that the pressure on municipal revenues will increase. The law is clear that municipalities can tax business activities within their jurisdiction, but the power is limited toa tax apportioned to the level of activity actually performed in the jurisdiction. Cities have begun to apply tax ordinances to real estate sales more broadly than before, have begun to treat each independent contractor salesperson as a separate business(thus owing a separate tax) and have begun to utilize aggressive contract collection companies to pursue real estate licensees. C.A.R. has twice appointed special task forces to study the situation (most recently in 2004) and twice concluded that the best strategy to address the situation is strong advocacy efforts by Realtors at the local level. In particular, the Task Forces have rejected strategies that include any concession that real estate salespersons might be "employees" for any purpose, including for BLT calculations.Discussion: All cities have as part of their inherent "police" powers the authority to raise revenue by taxing the privilege of doing business within the jurisdiction. Over the years the courts have affirmed that power, solong as the tax levied is properly apportioned to the amount of business activity actually carried out in the jurisdiction. For this reason, a flat fee BLT is inconsistent with the law -- but often not challenged by Realtors® and other businesses because the flat fee is so nominal that any apportioned fee is bound to end up being more expensive and more difficult to comply with.In order to comply with the law, more progressive cities have sought to assess a tax based upon a business' gross receipts generated within the jurisdiction. Note that simply assessing a multi- jurisdictional business based on its gross receipts is just as legally flawed as imposing a flat fee, unless the gross receipts are those earned within the jurisdiction.Unfortunately for cities, any apportionment of activity in a service oriented business like real estate is necessarily arbitrary and hard to validate.The Problems - Multiple Jurisdictions. If a real estate licensee practices across multiple city boundaries, an inappropriately apportioned tax will tax the same income in multiple places and effectively force the licensee to pay a much higher tax rate. In some urbanized areas a single licensee may practice in (or just pass through) asmany as a dozen different jurisdictions, all of which would like to collect a tax.- "Double" Taxation of Salesperson Commissions. If a city concludes that an independent contractor is a business separate from an employing or supervising broker, it is encouraged to tax the commission proceeds flowing to the salesperson from the employing broker. If the city does so, these proceeds will have already been included in the gross receipts attributed to the employing broker prior to the pass-through of the commission split.
- Heavy-Handed Enforcement. Some cities have attempted to creatively apply existing BLT ordinances to previously untaxed sales activities, and have even sought back taxes and penalties from licensees from whom they never before attempted to collect. The problem has also been worsened by contract (commission based) collection companies that aggressively interpret existing ordinances and apply them as broadly as possible. See “Municipal Auditing Companies,” prepared for January 2006, and September 2005 Taxation Committee for additional information.The only options to change the result in business license rules are to use political power to defeat the tax ordinances at the local level; change the status of real estate practitioners so that they become members of a non-taxable category; or go to state law and change the way the tax itself is applied.Possible Solutions Both of the recent task forces on BLT have been unequivocal on their recommendationto the Board of Directors. They have recommended against any response that might put at risk the continued ability to characterize sales agents as independent contractors. That status carries significant advantages for agents in the form of tax deductions(auto, home office, no withholding) and for employing brokers (administrative savings, reduced liability, avoiding FICA/Social Security match). While some administrative decisions have gone against C.A.R. (most notably the assertion by the state that workers compensation must be purchased covering sales agents) C.A.R. has continued to maintain that agents can be employed as independent contractors if they choose that status. A Political Reality Check. California cities are already disenchanted(to put it mildly) with C.A.R.'s legislation restricting local control over the construction of affordable housing. They were even successful in requesting a veto of one of C.A.R.'s bills last year. If cities believe that their ability to raise revenuesand their ability to control local business activity is under attack, they can be expected to strongly oppose the legislation.Potential Solutions for the Problem of Taxation in Multiple Jurisdictions. In some urbanized areas a single agent may havea home office in one city, an employing broker in another city, and list and sell properties in as many as ten or more surrounding cities. Each city may attempt to charge a business license tax for the privilege of doing business within its boundaries. While one might argue (and city representatives certainly do) that a business license fee is a small price to pay for being able to sell half-million dollar properties, the agent may soon feel that he or she is being "nickeled and dimed to death." Employee vs. Independent Contractor. Because BLTs typically apply to businesses, and not to each employee of a business, one solution might be to restructure the relationship between salespersons and employing brokers so that salespeople are clearly employees. Some real estate companies use an employee model. As noted above, this approach has so many negative consequences that most companies find it unacceptable. Cake Saving Rules. A variation of the employee approach is attempting to "have our cake and eat it too" - that is, characterizing real estate salespersons and broker associates as "employees" for BLT purposes, while at the same time preserving the status of "independent contractor" for all other purposes. Some Associations of Realtors® have had some success at the local level by arguing that the unique relationship between brokers and agents is more like that of employees and ought to be treated as such. Unfortunately, such a conclusion is not legally required and is unlikely to be successful without a strong public relations and governmental relations effort. Even worse, it is less likely to be successful in situations where the city has already put a business license tax in place.If a contractual change to employee is unacceptable, and persuading the city to treat agents that way is unsuccessful, a final option might be statewide legislation attempting to define agents as employees ONLY for the purposes of BLT. C.A.R. task forces have twice (in 1998 and 2004)rejected this approach. They reasoned that C.A.R. has always maintained that agents are independent contractors, and not conceded that they are employees for any purpose. They were also concerned that opening the door to treatment as employees for one purpose would make it politically difficult to resist the efforts of others to make them employees for all purposes. Indeed, yielding on employment status for the business license might actually encourage efforts to re-classify agents.
NOTE: agents have been characterized as employees for the purposes of workers compensation, but it is a status that was forced upon them and not chosen. However, since workers compensation confers significant liability protections on employers, Realtorshave not resisted the mandate as much as they might have.
Business Location - Taxing the Business and Not the Workers. If we are unable to resolve problems by changes in the broker-agent relationship, anotherapproach might be to change the business license tax itself. One approach might be to change the law so that a city could only tax a state regulated business activity (e.g. real estate) only at the location(s) where the state regulator's records show thebusiness to be located. In this approach each city would be able to assess all the real estate companies that “hang” a license within the city, but not those whose regulatory address is outside the jurisdiction – even if they sellproperties within the city. Taxing only offices within a city would deprive the city of jurisdiction over agents from outside the city boundaries when they sell there, but would also give the city the ability to tax all of a local office’s business activity even if generated outside the city boundaries.Potential Solutions for “Double” Taxation of Commissions. The issue of double taxation is also related to sales agents’ independent contractor status. When a listing broker receives payment of a commission out of escrow the broker triggers a tax assessment based upon that business activity. If the tax is measured by the gross receipts of business, the broker is being taxed upon both the broker’s share and the listing agent’s shares of the commission. However, when the broker pays the agent's share of the commission (either directly or through escrow) to an independent contractor, some cities assert that the compensation is to an independent business and subject to a business license tax. They take this position even though the same dollars were taxed as part of the broker’s gross receipts as they were passed through to the sales agent.Employees Only. Typically, a business licensetax is applied to a business and not its employees, so if an agent were to be an employee, rather than an independent contractor, the issue would be moot. It does not appear that any real estate companies have been willing to trade independent contractorstatus for employee status as a way to reduce a local business license tax.Saving our Cake City by City. It is possible for a local ordinance to be structured in such a way as to treat salespeople as employees regardless of their employment relationship with their broker. Los Angeles reportedly has such an approach. In theory, since local taxation ordinances are the product of local political action, an appropriate political campaign can achieve a Realtor-friendly result. Such would be a "cakeand eat it too" approach on a jurisdiction by jurisdiction basis. In practice, such special treatment in the tax ordinance will reduce the revenue to the city, and only an extraordinary effort by local Realtors is likely succeed. Unfortunately, there has been mixed success at the local level.Business Location - Taxes at the Home Address. A business location limitation does not lend itself to a local approach, because state law only allows a city to tax the business on an apportioned basis --that is, on the amount of business activity generated in the jurisdiction. Since it can not tax out of area activity, businesses could "game" the system and avoid owing any tax at all -- cities would never enact such a rule. However, if state law is changed to allow cities to attribute all of a business's activity to its "legal" location, the wide distribution of businesses will create a rough equity of distribution of tax proceeds among the jurisdictions. What cities lose in being unableto tax out of area businesses, they can make up in applying their tax to all of local business's revenue, even if the business takes place out of the area.SHOULD C.A.R. SPONSOR LEGISLATION TO CHANGE THE BUSINESS LICENSE TAX LAW?If C.A.R. attempts to change the Business License Tax law, which of the available options should it pursue?