On September 19, 2023, the D.C. Tax Revision Commission met for the second time to discuss proposals for changes to the D.C. tax scheme. Among the multiple topics reviewed, the Commission’s members discussed whether to create a business activity tax, which would primarily target entities that do not pay the District’s net income taxes on business entities – Corporation Franchise Tax or Unincorporated Business Franchise Tax. However, reception among the members on this proposal was mixed. The Commission also discussed a broad range of proposals, covering a range of tax types.

Business Activity Tax

For background, the District’s status as a federal enclave and not a state (while “functioning” as a state, county, and municipality for tax purposes) is unique among U.S. jurisdictions.  Pursuant to the Home Rule Act[1] and ultimate oversight by Congress, the District cannot impose tax on the personal income of non-residents. Because the District cannot tax the income of non-residents, it imposes the Unincorporated Business Franchise Tax to tax the entities of which they are owners, such as partnerships. However, the Unincorporated Business Franchise Tax does not apply to the income of professional partnerships.

To address what it views as those inequities, the Commission now proposes creating a Business Activity Tax. The tax would apply at a 0.5% or 1.0% rate on the formula of Gross Receipts – [Cost of Goods Sold + Capital Purchases]. The Commission also considered the Business Activity Tax liability being a nonrefundable credit against the Corporation Franchise Tax or the Unincorporated Business Franchise Tax. In its proposal paper, the Commission specifically identifies law partnerships as being subject to new tax liabilities, along with, potentially, nonprofit entities. 

The Commission’s members were not convinced by the business activity tax proposal. There were concerns about the tax applying to businesses that failed to make a profit and, also, providing a disincentive to start-ups considering locating in the District. The Commission’s members did not entirely rule out the tax, though, because of its potential as a revenue-raiser.

Other Proposals

The Commission brainstormed a number of other policy ideas affecting income taxes, taxation of partnerships, property taxes, and administrative issues, including:

• Joyce to Finnigan. The District currently uses the Joyce method of combined reporting.  In other words, District combined reports may include only entities that separately have nexus with the District. The Commission’s members broadly supported switching to the Finnigan method of combined reporting, which would treat the entire combined group as includible in the combined return, unless otherwise excluded.

• Pass-Through Entity Tax. Unlike many other states, the District does not currently have a SALT cap workaround option for individuals to bypass the federal cap on deductions for state taxes paid. The federal cap does not apply for taxes paid by businesses because they qualify instead as deductible business expenses. By allowing unincorporated pass-through entities that are not subject to the unincorporated business franchise tax (such as law and accounting partnerships) to pay entity-level tax and giving their owners an equivalent tax break at the individual level, the owners can reduce their federal income tax liabilities. This change would be optional for District taxpayers. The members of the Commission also supported this proposal.

• Finally, the Commission’s members also discussed: (1) switching from I.R.C. rolling conformity to static conformity; (2) whether to increase the franchise tax filing thresholds and minimum tax amounts; (3) repealing, or increasing the threshold for, personal property tax; and (4) eliminating or limiting the District’s bar on issuing clean hands certificates for taxpayers with outstanding tax liabilities.

Future meetings and next steps

The Commission currently has scheduled four more proposal review sessions – September 26^th, October 10^th, October 20^th, and October 24^th. At the next meeting, the Commission expects to discuss whether to levy a per-employee service fee on employers and create an “extreme” wealth tax.

[1] D.C. Code Ann. § 1-206.02(a)(5).