Business License Tax AdministrationSeptember 20, 2006Taxation Committee Local Government Relations Committee Legislative CommitteeThis Issue Briefing Paper is for discussion purposes only and has notbeen approved by the 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. Prohibit the application of aBLT to a regulated business entity except at the office address shown in the regulatory records of the business.3. 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 will only 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. As a result, brokers and agents are often taxed by each of the cities in which some part of the real estate transaction that they perform is located. Consequently, Realtors® may end up paying BLTs in several cities. 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. This position was reiterated by the members of the Taxation Committee who attended the June business meetings. Several legislative options were discussed at that time but, ultimately, the committee members directed staff to prepare a paper which focuses solely on the legislative option that does not implicate the employee/independent contractor issue.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 tocomply.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 receipts are those earned only within the jurisdiction. Unfortunately for cities, any apportionment of activity in a service oriented business like real estate is often arbitrary andhard to validate. Each city in which a Realtor® operates is attempting to determine what each portion of the real estate transaction represents in terms of an agent’s ultimate income – a virtually impossible task.Problems Associated with Business License Tax Collections
Taxation of Sales Commissions by 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 propertiesin 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 abusiness 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 multiplecity boundaries, inappropriately apportioned taxes may tax the same income in multiple cities and ultimately force the licensee to pay a much higher amount in taxes. This occurs because the administration of the BLT by any individual city is not coordinated with those of neighboring cities and, as a result, the same income may be taxed more than once."Double" Taxation of Sales Commissions by Individual Cities. 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.Potential State Solution. 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 state law with regard to how the tax itself is applied, or change the status of real estate practitioners so that they become members of a non-taxable category (in other words, “employees” which implicates the employee/independent contractor issue and that, as already noted, will not be discussed here.)The state legislative 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 changethe 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. (Which may prompt cities to move from a nominal flat rate BLT to a gross receipts tax based on the broker of record’s entire income.)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. And, from the perspective of real estate agents and brokers, thisapproach would solve their multi-jurisdiction problem and by implication – because only the regulated business, as opposed to individual agents, could be taxed – the “double” taxation problem faced by agents without endangering theindependent contractor status of agents.Attributing all of a real estate business’ income to its legal location runs counter to the court rulings that require that a city can tax only that portion of a business’ income that is generated within the city. However, the courts ruled in that manner because they were concerned about multi-jurisdictional taxation. In other words, the courts sought to avoid several jurisdictions taxing the same income by requiring that a jurisdiction maytax only that income that is generated within the jurisdiction. However, as noted above, in a service industry such as real estate such an apportionment is virtually impossible. Consequently, while it is difficult to predict how the courts would rule on a challenge to this proposed change in the administration of the BLT, it appears that such a statutory change would be on fairly firm legal ground.Some Final Considerations
California cities are already disenchanted (to put it mildly) with C.A.R.'s legislation restricting local control over 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 for any lost revenues. Such a proposed change would require a city to hold a Proposition 218 vote on the tax increase and win voter approval of the increase prior to implementation. However, winning voter approval may not be difficult given that the body politic will likely be inclined to impose a tax on real estate licensees!