Much like the universe, tax complexity is ever-expanding. One local example of this principle is San Francisco’s new gross receipts tax on businesses, replacing the old payroll tax. Beginning this year (and extending over the next five years during a phase-in), the gross receipts tax will create an entirely new universe of tax winners and tax losers.
Over this time span, those businesses with less than $1 million of gross receipts will see their tax burden slashed to almost nothing, while innumerable other businesses will operate under a much heavier burden, not just in tax cost but in externalized (and therefore publicly invisible) compliance costs. Big deal, you might be saying: my business has under $1 million in revenue. Why should I keep reading?
If this is your situation, you are indeed one of the winners of the new system, particularly if your business maintained a payroll that was taxable under the old system. But you’re still not a winner, unless you’re content to keep your business growth at or below the rate of inflation. That’s because the GRT’s “small business exception” for businesses with less than $1 million of gross receipts impacts—in an almost unbelievable way—businesses that exceed the annual limitation by even a single dollar.
In contravention of one of the most basic principles of tax equity, a typical San Francisco business—say, a professional services firm with $999,999 of gross receipts—pays no tax under the GRT. But if that same business received $1,000,001 of gross receipts, it would pay the gross receipts tax not merely on the $1 of receipts that exceed the exemption, but on the entire $1,000,001 amount.
In our example, that extra dollar of gross receipts leaves the business with a $4,000 tax bill compared to $0 tax for gross receipts with sub-$1 million gross receipts. If that same business runs on tight profit margins (perhaps 5 percent), this inexplicable provision of the GRT would consume $4,000 of what would otherwise be a slim $50,000 in profits.
Unfortunately, the GRT is perverse in many ways, including the perverse complexity of calculating a business’s GRT:
As a first step, the business must be placed into one of seven broad industrial categories. Second, any multi-location business must review and allocate its gross receipts between San Francisco and non-San Francisco sources under one of three methods—the “sales method” (allocating receipts based on sourcing rules), the “payroll method” (apportioning receipts using a payroll factor), or a “combined method” applying each of the previous methods to half the total receipts. The sourcing rules for a “sales method” apportionment requires time—and fact-intensive customer data collection, including “the extent the purchaser of the services received the benefit of the services in the city,” and “the extent the property is used in the city.” Know your customer, indeed!
By comparison, the payroll tax was basic arithmetic: San Francisco payroll over $250,000 was taxable at 1.5 percent. The primary complexity there was how to allocate a worker’s salary if she split time in company workplaces inside and outside the city.
Before we leave the topic of GRT complexity, also know that it provides for:
Different (and therefore progressive) tax rates depending on the business’s industrial categorization, with the result that a dollar of gross receipts by a dentist is taxed more heavily than a dollar of gross receipts by a grocery store.
Within each of those categories, progressive rates increase as gross receipts increase
Tax credit offsets! Special tax zones! Quarterly installments! (All this and no regulatory guidance, other than the City Code itself, has yet to be issued.)
Along with being a fiendishly complex tax for San Francisco businesses, the GRT is also an indisputably inequitable tax. While it provides for progressivity by taxing traditionally higher-margin businesses more heavily than other lower-profit industries, this attempt at leveling only matters if the business has exceeded the $1 million exemption limit. This means that the GRT—by definition—impacts high-revenue businesses without regard to their profitability, or indeed, even their unprofitability.
Also stung by the cost of tax compliance are those businesses (or business groups) with locations or operations inside and outside the city that together gross over $1 million. Even if your business will not be subject to the GRT, it must still make an annual declaration (on the city’s business registration statement) that its San Francisco-based gross receipts were less than the $1 million limit—which, of course, means the business must still conduct all the record-keeping and data analysis to support its determination that it had less than $1 million in San Francisco gross receipts.
In other words, when it comes to San Francisco’s new gross receipts tax, even being exempt from the tax itself doesn’t exempt local businesses from the hidden tax of exhaustive record-keeping and expensive professional analysis.
Attorney Andrew L. Jones practices tax law, business law, and estate planning in San Francisco. (This article is intended to provide general information and should not be considered legal, tax, or financial advice.)