While most people are aware of the state part of state and local tax (SALT), many are less familiar with local taxes and often overlook them. Local taxes take many different forms, and many are so-called business license taxes, which are based on gross receipts or payroll earned in the locality that imposes the tax.

Unlike federal or most statewide taxes, the imposition of local taxes can vary based on the type of business being conducted, with lower rates sometimes applied to activities such as wholesaling and higher rates on profession-based activities such as law or accounting. In addition, some local taxes are imposed directly on pass-through entities such as partnerships and S corporations.

An employee working just a few days in a city may be enough to trigger these taxes. With the work-from-home trend extending beyond the COVID-19 pandemic, it is especially important for businesses to understand how to avoid or mitigate the impact of the various types of local taxes. The following are examples of taxes to watch out for in cities in California as well as in other states.

California Cities

Many cities in California impose local business license taxes. The most prominent of these are Los Angeles and San Francisco, which impose the Los Angeles Business Tax (LABT) and San Francisco Gross Receipts Tax (SFGRT), respectively, on gross receipts sourced to the city. Additional California cities, like Beverly Hills, Oakland, San Mateo, and Santa Monica, also require businesses to file gross receipts tax returns. Other major California cities, like Santa Cruz and San Diego, subject businesses to a business license tax based on the number of employees working in the city.

Los Angeles

The LABT is generally due at the end of February each year. The city allows a 45-day extension if at least 90% of the liability is paid by the original due date. The tax is imposed on every person who physically performs work within Los Angeles for seven or more days per year. This means that individuals, pass-through entities, and disregarded entities may be subject to tax in addition to corporations. City enforcement efforts use a variety of information to identify those who may be subject to the levy, including other tax filings. Many individuals working as sole proprietors who reported income on a federal tax return Schedule C have been shocked by notices from Los Angeles requesting an LABT return.

However, businesses that only earn passive income, like interest and dividends, are not subject to the LABT and may be able to avoid filing a return even if they receive a notice from the city.

The LABT is based on business gross receipts and the rate ranges from 0.101% to 0.425%, depending on the category into which the business is placed. The Wholesale Sales and Multimedia categories have the lowest rates, whereas the Professions & Occupations category has the highest rate. The city provides limited guidance on the various categories and routinely places businesses in higher-rate categories. The rates are applied to the gross receipts attributable to work done in Los Angeles determined based upon apportionment rules that also vary based upon the business category. For service businesses and businesses that license intangible property, the apportionment rule is typically a form of cost-of-performance sourcing, focusing on the percentage of activity or cost in the city. This approach departs from California state sourcing for income tax purposes, which instead focuses on the location where the customer benefits from the service or license.

Ensuring the business is placed into the correct category is crucial as the rate and apportionment rule applied can significantly impact the amount of tax due. In addition, with work from home becoming more prevalent, there may be opportunities to source receipts outside of Los Angeles if employees are no longer working in the city. However, businesses should also be aware that employees working from home within the city can trigger tax even if the main offices of the business are outside of the city.

San Francisco

The SFGRT, which is also generally due at the end of February each year, with a 60-day extension available if 100% of the liability is paid by the original due date, is imposed on those engaged in business in San Francisco that had more than $2 million in combined taxable San Francisco gross receipts. Businesses subject to the tax include those maintaining a fixed place of business within the city; performing any work, including solicitation, within the city for all or part of any seven days during the calendar year; or generating more than $500,000 in San Francisco-sourced gross receipts from customers within the city during the calendar year. As with the LABT, pass-through and disregarded entities may be subject to tax. However, unlike the LABT, which does not allow combined returns, combined returns are required in San Francisco if the business files a California state combined return for income tax purposes.

The SFGRT rates range from 0.053% to 0.943% and vary by business classification determined by the NAICS code of the business. The apportionment or allocation methodology also differs by classification and may be based on payroll for services performed within the city, sales to customers within the city, or a combination of both. For businesses with over $50 million in taxable gross receipts, an additional Homelessness Gross Receipts Tax of 0.175% to 0.69% is imposed on combined taxable gross receipts over $50 million.

Similar to the LABT, it is important to correctly determine the NAICS code that applies to the business because a misstep in the classification can result in a substantial difference in the tax. In addition, if employees are no longer working from San Francisco as a result of the pandemic, there may be opportunities to reduce the apportionment of receipts to San Francisco and reduce liability.

Cities in Other States

Outside of California, other localities impose taxes for the privilege of doing business within the locality. New York City is well known for imposing various taxes depending upon the type of entity doing business within its borders. In addition, while Ohio and Kentucky have numerous localities that impose income taxes, other states only have a few localities that subject businesses to local tax. The following are some of these lesser-known taxes.

Philadelphia

Philadelphia imposes a Business Income & Receipts Tax (BIRT) on every individual, partnership, association, limited liability company (LLC), and corporation engaged in a business, profession, or other activity for profit within Philadelphia. The tax is generally due April 15, with a 60-day extension available or a full six-month extension if a federal tax extension was granted. The rate is 1.415 mills ($1.415 per $1,000) on gross receipts and was recently reduced to 5.99% on taxable net income.

St. Louis

Saint Louis requires all businesses located in the city and all nonresident businesses that perform work, services, or business activity in the city to pay the earnings tax of 1% of the business's earnings. Businesses subject to the tax may include individuals, pass-through entities, and corporations. The tax is generally due April 15 for all calendar-year taxpayers and 105 days after the close of the year for fiscal-year taxpayers, with a six-month extension available.

Portland and Multnomah County

Portland, Oregon and Multnomah County require every individual, partnership, or corporation to file a business income tax return if they are doing business within Portland or Multnomah County. Unlike many other local taxes, the Portland/Multnomah County tax is based on net business income, which may be apportioned if the income is earned both within and outside the localities. The Portland tax rate is 2.6% of the net business income, while the Multnomah County rate is 1.45% of the net business income. For the 2022 tax year, apportionment of services moved from cost-of-performance sourcing to market-based sourcing to bring the tax in line with Oregon state's sourcing regime. Both taxes are due three-and-a-half months after the end of the year, with a six-month extension available.

Portland also imposes the Pay Ratio Surtax (PRS) on publicly traded companies if the CEO-to-median worker compensation ratio is equal to or above 100:1. If the ratio is equal to or above 100:1 but less than 250:1, the surtax is 10%. If the ratio is equal to or above 250:1, the surtax is 25%.

The Takeaway

Businesses, including self-employed individuals, may be subject to these local taxes if they have activity in any of these localities. It is important to understand how each of the taxes apply, from differences in rates based on the type of business to the apportionment methodologies available. Andersen's SALT team can assist in helping businesses to avoid local taxes, mitigate their impact, calculate amounts owed, and comply with filing requirements.