Business License TaxesMay 16, 2006Taxation Committee Local Governmental Relations Committee Legislative CommitteeThis Issues Briefing Paper is for discussion purposes only and has not been approved bythe Taxation Committee, Legislative or Executive Committees or the Board of Directors.Issue Should C.A.R. sponsor legislation relating to the collection of business license taxes (BLTs) by local jurisdictions?Action OptionalOptions 1.Do Nothing. Existing C.A.R. policy is that BLTs should be addressed at the local level and not via state legislation which raises the employee/independent contractor issue.2. Sponsor Legislation. Change the characterization of real estate salespersons and broker associates from “independent contractors” to "employees" for purposes of the BLT, while at the same time preserving their status as "independent contractors" for other purposes.3. Sponsor Legislation. Prohibit the application of a BLT to a regulated business entity except at the office address shown in the regulatory records of the business.4. Sponsor Legislation. Provide that any individual that is required by statute to be supervised and receive their compensation through a designated entity is an employee.5. Other.Status/ Summary Cities have become increasingly aggressive and creative in applying BLTs to real estate license activities, and every indication is that the pressure on municipal revenues willonly increase. The law is clear that municipalities can tax business activities within their jurisdiction, but the taxation power is limited to a tax apportioned to the amount of activity actually performed within their jurisdiction. Cities are applyingtax ordinances to real estate sales more broadly than before, are treating each independent contractor salesperson as a separate business (who, thus, owes a tax separate from that paid by the supervising broker) and are using aggressive contract collection companies to pursue real estate licensees. C.A.R. has twice appointed special task forces to study the situation (the first in 1998 and most recently in 2004) and twice the task forces have concluded that the best strategy with which to address the situation would be strong advocacy efforts by Realtors® at the local level. In particular, the task forces have rejected state legislation strategies that include any concession that real estate salespersons are anything other than independent contractors for any purpose, including for payment of BLTs.Discussion
Cities have as part of their inherent "police" powers the authority to raise revenues by taxing the privilege of doing business within their jurisdiction. Over the years, the courts have affirmed that power, so long as the tax levied is properly apportioned to the amount of business activity actually carried out within the jurisdiction. For this reason, a flat fee BLT is inconsistent with the law – but is 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 with which to comply.In order to comply with the law, more progressive cities have sought to assess a tax based upon a business' gross receipts generated within their jurisdiction. Note that simply assessing a multi-jurisdictional business based on its total gross receipts is just as legally flawed as imposing a flat fee, unless the gross receiptsare those earned only within the jurisdiction. Unfortunately for cities, any apportionment of activity in a service oriented business like real estate is often arbitrary and hard to validate.Problems Associated with Business License Tax Collections Multiple Jurisdictions. In some urbanized areas a single agent may have a 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 of those cities may attempt to charge a BLT for granting the agent the privilege of doing business within its boundaries. While one might argue (and, certainly, city representatives 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." In addition, if a real estate licensee does practice across multiple city boundaries, inappropriately apportioned taxes may tax the same incomein multiple cities and ultimately force the licensee to pay a much higher amount in taxes."Double" Taxation of Sales Commissions. If a city concludes that an independent contractor is a business separate from an employing or supervising broker, it taxes 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 and, thus, those commission dollars will be taxed twice.
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 have never before attempted to collect. This problem has also been exacerbated by contract (i.e., commission based) collection companies that aggressively interpret existing ordinances and apply them as broadly aspossible. (See the issue briefing papers on “Municipal Auditing Companies” prepared for the January 2006 and September 2005 Taxation Committee meetings for a more detailed discussion of this problem.)Possible Solutions The only options to change the result with regard to BLTs 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 change state law with regardto how the tax itself is applied.Local Solutions. As noted above, the issue of double taxation relates to sales agents’ independent contractor status. When a listing broker receives payment of a commission out of escrow, it triggers a tax assessment based upon that business activity. If the tax is measured by the gross receipts of the business, the broker is being taxed upon both the broker’s share and his or her agent’s share of the commission. However, when thebroker pays the agent's share of the commission to an independent contractor, some cities assert that the compensation is to an independent business and, thus, subject to a BLT. 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.Option A: Pass Local Ordinances. 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. 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 employers and employees and, thus, 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 given that such special treatment will reduce the revenue to the city. Moreover,it is less likely to be successful in situations where the city has already put a business license tax in place.Option B: Make Agents Employees. Typically, a BLT is applied to a business and not to its employees. So, if an agent were to be anemployee, rather than an independent contractor, the issue would be moot. Some real estate companies use an employee model; however, as noted below, this approach has so many negative consequences that most companies find it unacceptable.State Solutions Option A: Sponsor Legislation to Make Agents “Employees” for Purposes of BLTs. A variation of the employee approach is attempting to characterize 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. Such an approach would solve the “double” taxation problem but not the multi-jurisdiction problem faced by brokers. Moreover,C.A.R. task forces have twice (in 1998 and 2004) rejected this approach and have been unequivocal in their recommendations to the Board of Directors. They reasoned that C.A.R. has always maintained that agents are independent contractors and has notconceded that they are employees for any purpose. They were concerned that opening the door to treatment as employees for one purpose would make it politically difficult to resist the efforts of others to classify them as employees for other purposes. Indeed, the concern has been that yielding on employment status for BLTs might actually encourage efforts to re-classify agents.Independent contractor status carries significant advantages for agents in the form of tax deductions (automobile, home office, and no income tax withholding) and for employing brokers (administrative savings, reduced liability, and avoiding the 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 to cover sales agents), C.A.R. has continued to maintain that agents can be employed as independent contractors if they choose that status. Consequently, taking this approach would represent a departure from existing C.A.R. policy.(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 significantliability protections on employers, Realtors® have not resisted the mandate as much as they might have otherwise done.)
Option B: Sponsor Legislation to Tax the Business, Not the Workers. Another solution and one that would represent the adoption of new policy would be to attempt to change the administration of the BLT itself. One approach would be to change the law so that a city could only tax a state regulated business activity (for example, real estate) only at the location where the state regulator's records show the business 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 sell properties within the city. Taxing only real estate offices that are located within a city would deprive the city of jurisdiction over brokers and agents from outside the city boundaries that sell properties within the city. However, such a system would also give the city the ability to tax all of a local office’s business activity even if generated outside the city’s boundaries.This does approach does not lenditself to local adoption because state law only allows a city to tax the business on an apportioned basis – that is, on the amount of business activity generated within the jurisdiction. Since it cannot tax out of area activity, businesses could "game" the system and avoid owing any tax at all and, as a result, 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 ofbusinesses will create a rough equity of distribution of tax proceeds among the jurisdictions. And, from the perspective of real estate brokers, this approach would solve their multi-jurisdiction problem and by implication – because only theregulated business could be taxed – the “double” taxation problem faced by agents without endangering the independent contractor status of agents.Option C: Sponsor Legislation that takes a “Hybrid” Approach. An approachthat may avoid the problems associated with specifically defining agents as “employees” – instead of as “independent contractors” – would be to sponsor legislation providing that any individual that is required by statute to be supervised and receive their compensation through a designated entity is an employee. This approach would not specifically define real estate agents as “employees.” Instead, the term “employee” wouldbe clarified to include those individuals that are required by state law to be supervised by and receive their compensation from another individual. This would clearly include real estate agents since state law requires agents to be supervised by, and receive their compensation from, a broker. As a result, this approach would address the “double” taxation problem faced by agents.However, the approach could also be combined with a provision that limits cities to applying their BLT only to businesses that are physically located within their jurisdiction which would serve to address the multi-jurisdiction problem that confronts brokers. The advantage of legislation that contains separate provisions addressing the “double” taxation and multi-jurisdiction problems (as opposed to the “all or nothing” approach described immediately above) is that if one of the two provisions is not well received by the legislature, that provision could be deleted from the measure so that at least one of the BLT problems is addressed.Some Final Considerations 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 and one the prior year. If cities believe that their ability to raise revenues and their ability to control local business activity is under attack, they can be expected to strongly oppose the legislation. More importantly, if state legislation is adopted to change the manner in which BLTs can be administered, cities will almost undoubtedly attempt to amend their local ordinances to increase their BLT rates to compensate forany lost revenues.