DC Eliminates Liquidation Exemption from Unincorporated Business Franchise Tax
In the waning days of the COVID summer, the District of Columbia (DC or District) eliminated a valuable tax exemption that real estate investors have routinely used to avoid paying DC taxes on the sale of a property in the District. Unless Congress overrules the District government, which is unlikely, this change in law will take effect on January 1, 2021.
Most states and localities do not impose income taxes on partnerships or LLCs that are taxed as partnerships (collectively "unincorporated businesses"). However, the District of Columbia levies a franchise tax at the current rate of 8.25% on unincorporated businesses, who are required to calculate and pay the tax directly as if they were corporations.
The District has historically had a regulatory exemption that substantially reduces the franchise tax payable on a sale of assets in connection with the termination and liquidation of an unincorporated business, which is colloquially known as the "liquidation exemption." The DC Tax Regulations provide that "gain or loss from the sale or other disposition of property that results in the termination of an unincorporated business subject to the tax imposed under title 8 of the Act shall be recognized and reported by the owners of the business rather than by the business entity." D.C. Mun. Regs. tit. 9, § 117.13. Conversely, in general, "gain or loss from the sale or other disposition of property that does not result in the termination of an unincorporated business subject to the tax … shall be recognized and reported by the unincorporated business entity." D.C. Mun. Regs. tit. 9, § 117.14 (emphasis in original).
For many years, real property owners in DC have structured ownership in a manner that maximizes the availability of the liquidation exemption. The prototypical structure is to have a separate partnership or LLC that is taxed as a partnership own each investment, with the owners of that partnership not being subject to DC tax.
August 2020 Legislation
In August 2020, the DC Council passed, and the Mayor signed the Unincorporated Business Franchise Tax Amendment Act of 2020, which was part of a larger budget bill. That bill states simply that "[t]axable income shall include gain from the sale or other disposition of any assets, including tangible assets and intangible assets, including real property and interests in real property, in the District, even when such a sale or other disposition results in the termination of an unincorporated business." This provision is slated to be effective as of January 1, 2021.
Because of the District's unique relationship with the federal government, the Council passed two separate but substantially identical versions of this bill—an emergency version and a permanent version. The emergency bill became effective immediately upon the Mayor's signature but will expire on November 16, 2020. The permanent bill is subject to Congressional review before it can become law. The Mayor has signed the permanent bill and it was transmitted to Congress on September 3, 2020 for a 60-day review period. Upon going through the various stages of review, the DC Council projects that the permanent bill will become law in the District on December 1, 2020.
Congress rarely overrides District legislation during its review period. Assuming no override here, the liquidation exemption will disappear on January 1, 2021. For some taxpayers considering a taxable sale of property in the District in the coming months, this may provide an incentive to close the sale in 2020.
© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.