While most states employ some type of a net income tax to raise revenue from businesses, some states impose a gross receipts tax instead of, or as a supplement to, a business income tax. Under a net income tax approach, tax regimes follow a methodology in which federal taxable income is modified by certain state adjustments. Though complex, taxpayers by and large are familiar with this framework. However, gross receipts taxes, a less widely understood tax form, is important for tax payers to gauge in order to comprehend the implications and the potential impact on their business.
What is a Gross Receipts Tax?
A gross receipts tax is levied on the total in-state sales of a business. Unlike with state income taxes, federal taxable income is irrelevant. Rather, gross receipts taxes are levied on all transactions at a relatively low rate. Often, no deductions are available to be applied against a taxpayer’s gross receipts to reduce the tax base.
What Sets Gross Receipts Taxes Apart?
When compared to income tax, gross receipts taxes contain some unique attributes:
- Gross receipts taxes are entity-level taxes, meaning they apply to pass-through entities, such as limited liability companies and S corporations, which are usually not subject to state income tax.
- Since gross receipts taxes are not based on net income, retailers of tangible personal property are not afforded the solicitation protections of P.L. 86-272.
- The nexus standards that permit a state to legally impose its gross receipts tax on an out-of-state business generally do not require physical presence. Many “gross receipts states” have adopted “economic nexus” standards whereby a taxpayer is deemed to have nexus if specific thresholds are exceeded with respect to in-state property, payroll or sales.
- Businesses with net operating losses resulting in zero net income tax are nevertheless liable for gross receipts taxes. This can result in a significant financial burden on unprofitable companies, low margin enterprises and start-up businesses.
How Does Gross Receipts tax Compare to Sales Tax?
On the surface, gross receipts taxes look like sales tax since both are levied on sales, but sales tax only applies to the final consumer of a product or service. Those selling the product or service are usually exempt from sales tax liability. Gross receipts taxes, on the other hand, apply to multiple levels of sales, from manufacturer to wholesaler, wholesaler to retailer, and retailer to consumer, a phenomenon known as “pyramiding.”
What are Some Examples of State Gross Receipts Taxes?
Ohio’s Commercial Activities Tax (“CAT”) is the classic model of a gross receipts tax. Most Ohio-sourced receipts generated in the ordinary course of business are subject to the CAT. The CAT applies to entities conducting business in Ohio, including retailers, wholesalers, service businesses and manufacturing companies. Since the CAT is a gross receipts tax, those businesses with large revenues and low gross profit margins are impacted the most.
The CAT is imposed as follows:
- gross receipts less than $150,000 = no tax
- gross receipts from $150,000 to $1 million = $150 tax; and
- gross receipts over $1 million = $150 base tax + 0.26% of gross receipts over $1 million.
Texas’s franchise tax is a gross receipts tax which is levied on a taxpayer’s margin. The taxable margin is the lowest of the following:
- Total revenue multiplied by 70%;
- Total revenue minus cost of goods sold (calculated differently than for federal tax purposes);
- Total revenue minus compensation (includes many employee benefits but limits W-2 wages to $360,000 per person); or
- Total revenue minus $1 million.
The general tax rate is 0.75%, but a reduced rate of 0.375% is available for taxpayers engaging in retail or wholesale trade. Taxpayers with less than $20,000,000 of total revenue are eligible to elect a reduced tax rate of 0.331%.
Washington’s business and occupation tax (“B&O tax”) is a gross receipts tax with variable rates depending on a business’s activity classification. The four primary activity classes are retailing, wholesaling, manufacturing, and services and other activities. Other tax classifications include printing and publishing, radio and broadcasting, and timber or wood products. Depending on the business activity classification, B&O tax rates range from 0.471% to 1.5%. There are no deductions for cost of goods sold, payroll or taxes, but a small business credit may be available should annual revenues not reach certain thresholds.
What Other States are Considering Implementing a Gross Receipts Tax?
In 2015, Nevada introduced a commerce tax imposed on in-state gross revenues. Oregon voters recently defeated a proposed a 2.5% gross receipts tax, reasoning that the rate was exceptionally high for such a tax; however, it is expected that a new bill with lower rates will soon be introduced in the state legislature. Moreover, in West Virginia, the governor has gone on record as favoring a 0.045% gross receipts tax, which has been endorsed by the state Chamber of Commerce.
If you require assistance with your business’s gross receipts tax obligations, please contact Alan Goldenberg, Principal of State and Local Taxation and Tax Controversy, at firstname.lastname@example.org or 212-897-6421, or your Friedman LLP tax professional.