Unless you have been sheltering in a cave, you know that 2020 has been one of the most challenging years that taxpayers have faced in long while. A heat map of adjectives used to describe 2020 would likely surface the words “unprecedented,” “hellacious,” maybe even “apocalyptic.” The torpefying effect of so many major events in one single year made it easy to miss the myriad of important developments in San Francisco tax law. This article intends to highlight those changes and to help businesses navigate their possibly new and increased compliance obligations.
In the November election, San Francisco voters approved two significant tax measures: raising gross receipts taxes and establishing a new controversial tax on businesses with highly compensated CEOs. It has been reported that the city projects a $116M budget shortfall for the current fiscal year. Will these tax increases help speed the recovery or will they amplify the growing budget gap caused by the pandemic?
Proposition F: Business Tax Overhaul
Appropriately titled the Business Tax Overhaul, Proposition F makes several changes to San Francisco business taxes. Proposition F eliminates the payroll expense tax and replaces it by increasing the gross receipts tax rate across all industries, effective Jan. 1, 2021. Depending on the business activity, some rates for lower brackets of receipts will be temporarily reduced, including for retail trade, food services, the arts, manufacturing, accommodations, and “certain services” (including maintenance and laundry businesses). However, most higher brackets among all industries will experience rate increases. Additionally, the gross receipts tax rate increases will continue annually through 2024 for various industries, including professional, scientific, and technical services, unless certain gross receipts thresholds are met.
Other changes include expanding the small business exemption threshold, increasing the administrative office tax rate in phases, eliminating the credit for businesses that pay a similar tax elsewhere, and changes to the annual registration fees for businesses (lowered for businesses with less than $1 million in gross receipts and raised for businesses over $1 million in gross receipts).
Proposition L: Overpaid Executive Gross Receipts Tax
Proposition L enacts the new Overpaid Executive Gross Receipts Tax. This tax is otherwise known as the “CEO Tax” because it places an additional tax on San Francisco businesses when their highest-paid managerial employee (who is typically the CEO) earns more than 100 times the median compensation paid to its San Francisco employees. The highest-paid managerial employee does not have to be located in San Francisco and that person’s compensation will include wages, salaries, bonuses, commissions, and property given in exchange for services, such as stock options. The additional tax would either increase the Gross Receipts Tax or the Administrative Office Tax, whichever applies to that business and is effective January 2022. The progressive tax rate ranges between 0.1% to 0.6% and is assessed on gross receipts sourced to San Francisco as determined for Gross Receipts Tax purposes.
San Francisco v. All Persons Interested in the Matter of Proposition C
In September, legal challenges to San Francisco’s 2019 Proposition C were largely terminated when the California Supreme Court declined review of the lower court’s decision to uphold its enactment. The California Court of Appeal held that Proposition C, Additional Business Taxes to Fund Homeless Services, was constitutionally enacted when it received approval by a majority of voters (61%). Defendants in the case challenged the Proposition because it lacked two-thirds vote, or a supermajority, which they argued was required under two separate articles of the California Constitution. However, the Superior Court determined that the Constitutional provisions requiring super-majority votes only apply to measures placed on the ballot by local government, and not by the people. The Court of Appeals affirmed the voter’s ability to enact initiatives by majority vote largely by citing public policy.
Taxpayers should be aware that there are other challenges to the two-thirds voter approval ongoing in state courts. Businesses with more than $50 million in revenue should continue to pay the tax, which became effective on Jan. 1, 2020.
Takeaways
In the last few years, a number of systemic tax changes have increased the complexity of San Francisco business taxes. It is imperative that both in-city and remote businesses with San Francisco customers understand and plan for city taxes. Just as there is risk in ignoring these changes, there is opportunity to plan and structure to minimize exposure and potential liability.
In the world of tax, it is often said that the one thing that is constant is change. With a myriad of well-publicized and challenging social issues, San Francisco is continually looking for creative solutions to address issues such as rising homelessness and drug addiction. These solutions almost always require a source of funding with tax increases a popular target for policy makers.
However, with the discovery that much of the business done in San Francisco can be done remotely, well-known and long-established businesses have begun to see the benefit to de-centralize or to relocate. Several Bay Area titans have announced plans to leave California for states with lighter tax burdens. In San Francisco, nearly 90,000 households have reportedly left the city during the pandemic, likely due to rising taxes and increased mobility and remote working options. As a post-pandemic world approaches, only time will tell whether the tax increases achieve the necessary balance between policy goals and the new remote work dynamic.
