Ruling Could Cost City Tens of Millions
By Albert B. Crenshaw
Washington Post Staff Writer
Wednesday, March 15, 2006
The District could lose tens of millions of dollars in business taxes after a recent D.C. Superior Court judge's ruling that the city is illegally taxing many businesses whose owners live in the suburbs.
The ruling, by Judge Jose M. Lopez, would especially affect real estate developers and owners, many of whom operate in the city through partnerships but live elsewhere. Lopez ruled that the District was breaking federal law when it applied the city's unincorporated-business-franchise tax to those partnerships that passed on profits and losses to investors and others who live outside Washington.
Such partnerships typically include some of the District's biggest developers, which regularly form new entities to build or manage individual projects.
"The court is mindful of the gravity of this holding," Lopez wrote in his March 8 decision.
The District has for years been fighting unsuccessfully in the courts and Congress for the right to tax commuters and other nonresidents. D.C. officials, who said they would appeal the decision, did not offer an estimate of how much the ruling might cost the District.
"If upheld on appeal, this decision would cause significant damage to the revenues of the District," the D.C. Office of Tax and Revenue said in a statement yesterday.
Several observers suggested the loss in revenue would be sizable.
Ed Lazere, executive director of the D.C. Fiscal Policy Institute, which analyzes D.C. tax and budget issues, said the tax generates about $100 million a year for the city. If the ratio of suburbanites to D.C. residents is the same among real estate investors and other owners of unincorporated businesses as among workers generally -- roughly two-thirds suburban to one-third District -- then the loss could round to $70 million, "which is huge," he said.
The effect would be so large, said attorney Paul G. Marcotte Jr. of Paley, Rothman, Goldstein, Rosenberg, Eig & Cooper in Bethesda, that "I suspect this is not the final word."
"The District strongly believes that this decision is incorrect," the tax office said.
Lopez's ruling was in response to a suit by Kenneth Bender and other members of a prominent area real estate family who sought a refund of about $240,000 for taxes they paid over three years on income from their interests in companies such as Jack I. Bender & Sons, Rhode Island and M Associates, and Twelfth and L Streets LP.
Yesterday, some developers said the ruling might make the District more attractive for investors.
"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.
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