D.C. Firms Taxed Illegally, Court Says

"Paying less tax is always a good thing," said Jeff Neal, a partner at Monument Realty LLC -- a major developer in the District, including the area near the new baseball park.

"Because of the unincorporated business tax -- in part -- D.C. is a more expensive place to do business, so any reduction of that premium would be welcome," Neal said. "I would be pleased if there were things that reduced the tax."

On the other hand, investors who still live in the District would have to pay taxes that others do not. "It's an invitation to step out" of the District, said attorney Gerald Sherman of the Washington office of Buchanan Ingersoll PC.

The UB tax, as it is often called for short, was authorized by Congress as far back as 1947, the court noted, but with restrictions that have been extended and clarified by subsequent legislation and court decisions. Earlier rulings have held that income earned by professionals in partnerships, such as doctors, lawyers and architects, cannot be taxed. Any profits or losses are supposed to be included on their personal tax returns.

Under current D.C. law, any unincorporated business with more than $12,000 of gross income must file a UB return. The tax rate is 9.975 percent of taxable income above $1,007. Businesses with more than $12,000 of gross income and less than $1,007 in taxable income, or with a loss, must pay $100.

In 1997, the Virginia Supreme Court reached essentially the same conclusion as Lopez. In a case in which a Fairfax couple sued after being denied a credit against their Virginia taxes for UB tax paid to the District on income on a real estate partnership, the court concluded that the UB tax was an income tax and illegal under the D.C. Home Rule Act as a tax on the income of nonresidents. The effect of that decision was to deny the couple a Virginia credit.

Marcotte said that in his view, if an appellate court does not find a way to reverse the decision, Congress might have to step in.

For now, the city's tax and revenue office advises that "unincorporated businesses should continue to file D.C unincorporated franchise tax returns (including returns due for the 2005 taxable year) and pay this tax on the business's entire net income from District sources. Failure to file these returns and pay this tax will result in the assessment of penalties and interest."

Marcotte suggested that investors might also want to file a refund claim to preserve their right to the money on the chance that the ruling will stand.

Staff writer Dana Hedgpeth contributed to this report.