NV Legislature 2013 Geoffrey Lawrence Nevada Policy Research Institute
Outline • Margin tax • How does it work? • Major pitfalls • How does it apply real estate? • Where does it go from here? • Mining tax alternative • Property tax bills • State of education
Margin tax: How does it work? • Margin defined as: • 1) 70 percent of revenues • 2) Revenues minus labor compensation • (No more than $300,000 per employee) • 3) Revenues minus “cost of goods sold” • Tax liability = 2% of “margin” • Can be thought of as a modified gross receipts tax
Margin tax: How does it work? • Does not apply to: • 1) Firms with <$1 million in annual revenue • 2) “Passive entities” • 3) Tax-exempt 501(c)s • Ex.: Joe the farmer • Margin = R – D = $1 million - $300,000 • $700,000 * 0.02 = $14,000 • If pre-tax profit = $2,000; after-tax profit = ($12,000)
Margin tax: How does it work? • Revenue defined: • For corps and partnerships, revenue base is net of: bad debts, distributive income, and foreign royalties or dividends declared on federal income tax filings • For other entities: Will be described in regulations • “Pass-through” revenue is exempt • Dividends from federal, state and local bonds are exempt • Credit for any MBT or gaming tax amounts paid
Margin tax: How does it work? • Possible deductions under “costs of goods sold”
Margin tax: How does it work? • Deductions not allowed under “costs of goods sold”
Margin tax: How does it work? • Apportionment to state: • Total income derived in NV/Total firm income
Margin tax: How does it work? • Affiliated groups: • Defined as businesses with at least one common owner • TX definition: 80% of controlling interest held by common owner • Must file combined return if engaged in unitary business • Must declare single exemption for all firms in group • Group members cannot exempt “costs of goods sold” if procured from another member of group • Each member is jointly and severally liable for the tax of the combined group
Margin tax: Major pitfalls • $1 million threshold captures most small businesses • High marginal tax rates distort behavior • Compliance costs higher for small firms • Applies to firms operating at financial loss • Tax “pyramids” up the supply chain • Industries with disproportionately high capital or labor costs can avoid most of the tax
Margin tax: Impact on real estate • Unique impact on different groups: • Builders, owners, tenants, brokers, agents
Margin tax: Impact on real estate • Builders: • Likely to apply “costs of goods sold” deduction • Ex.: Company A Construction: • $80,000,000(R) - $50,000,000(D) = $30,000,000(M) • (Assuming “costs of goods” accounts for 62.5% of R) • $30 million * 0.02 = $600,000 tax liability • If builder already pays $300,000 in MBT, then net new liability = $300,000
Margin tax: Impact on real estate • Owners: • TX law prohibits owners from deducting depreciation and interest—the largest potential deductions for property. • As a result, most commercial landlords pay on 70% of gross rents. • Owners also must pay on capital gains from sale of real property.
Margin tax: Impact on real estate • However, if property is owned by a partnership, the partnership may be able to avoid the margin tax altogether by qualifying as a “passive entity.” • Rents must account for less than 10% of total revenue; at least 90% must accrue from dividends, interest or royalties from minerals • Ex.: Building A has a fair-market value of $10 million and generates $1.2 million in annual rents. If the owner sells in mid-January, after receiving only $50k in rental income, it will be <10% of gross receipts and owner can avoid tax on capital gains.
Margin tax: Impact on real estate • Tenants: • Will the margin tax be passed through to tenants? • Question #1: Would the owner even want it to? • In this case, the owner’s books must be made available to the client so the client can confirm the liability owed. The liability must also be apportioned for the individual property. • If margin tax is not expressly included within the definition of operating expenses or taxes for which the tenant is responsible within the lease, it’s unlikely it could be passed through.
Margin tax: Impact on real estate • Existing leases would likely require renegotiation before margin tax could be passed through. • New leases should specifically address the issue of margin tax. • Potential language: • "From and after the date hereof and notwithstanding anything to the contrary in the lease, “operating expenses” shall specifically include the margin tax and/or any other business tax and/or any successor statutory provision for reports due under any such provision; provided that such margin tax and/or any other business tax shall not be based upon any revenue from sales of real property or other extraordinary transactions consummated by landlord. For the purposes hereof, any margin tax and/or any other business tax payable by tenant shall be calculated as if the building were the only income-producing asset belonging to landlord."
Margin tax: Impact on real estate • Brokers: • Can exclude “pass-through” revenue • Can exclude from revenue any commissions paid to non-employees (agents) when calculating gross receipts • Can then deduct compensation for any employees or 30 percent of revenues
Margin tax: Impact on real estate • Agents: • TX margin tax does not apply to proprietorships nor independent contractors; the NV proposal does apply to these entities • Thus, unlike in TX, it appears that agents would have a personal margin tax liability • Can they deduct for labor compensation? • If so, deduction still capped at $300k • Does this conflict with personal income tax ban?
Margin tax: Where does it go? • Legislature failed to act within 40 days • Automatically goes to ballot • Becomes law with simple majority vote • Cannot be changed for 3 years
Mining tax alternative • Nothing introduced yet, but would presumably impose a severance tax • First, requires passage of SJR 15 to remove “net proceeds of mines” tax from constitution • Competing ballot measure • Most votes wins; provided there’s a majority
Mining tax alternative • Initiative petitions governed by different constitutional rules than standard legislation: • Competing measures must be “approved” by governor • No provision for legislative override • Sandoval has said he will not support • SJR 15 also requires a majority popular vote to become effective. It’s not clear that a mining tax question can be included on the same ballot with SJR 15—it has to become law first.
Property tax bills • AB 201: Would raise “assessed value” from 35 to 45 percent of “taxable value” over 10 year period. • “Taxable value”= Market value of land + Depreciated value of improvements • Ex.: $1 million property in NLV (rate = $3.35) • Current AV = $1,000,000 * 0.35 = $350,000 • Tax bill = $350,000 * ($3.35/$100) = $11,725 • Future AV = $1,000,000 * 0.45 = $450,000 • Tax bill = $450,000 * ($3.35/$100) = $15,075
Property tax bills • AB 26: Would slow the allowable rate of depreciation for improvements from 1.5% annually to 1.0% • Depreciation period would extend from 50 years to 75 years • Would not immediately increase liabilities; but would lead to higher liabilities in future years
Education • Do we spend enough?
Education • No correlation nationwide between spending & performance • Highest spender (DC at $20,066) has worst results • Highest spender in West (CA) has worst results • Significant correlation between performance and specific policy directives: • Degree of school choice • Meaningful evaluations • Alt. Teacher Certification • Nothing more important than quality of teacher