NV LEGISLATURE 2013 Geoffrey Lawrence Nevada Policy Research Institute.

NV LEGISLATURE 2013Geoffrey 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”Costs directly attributable to production or acquisition of goods

Additional costs

Labor Deterioration

Raw materials Obsolescence

Handling, processing, transportation

Spoilage

Storage Preproduction and postproduction costs for facilities

Depreciation Insurance

Rents for facilities and equipment Utilities

R&D Quality control; including replacement of defective components

Electricity

Taxes paid for acquiring materials Licensing and franchising

Margin tax: How does it work? Deductions not allowed under “costs of

goods sold”• Rents for equipment or

facilities not directly used in production

• Corporate income taxes

• Selling costs • Labor dispute expenses

• Distribution • Compensation of directors, officers and consultants

• Advertising • Litigation costs

• Expenses for idle facilities • Fines and legal settlements

• Rehandling costs • Amounts paid to affiliated groups

• Bidding costs; solicitation of contracts

• Interest on debt

Margin tax: How does it work? Apportionment to state:

Total income derived in NV/Total firm income

Income sources to be apportioned:• Sales of tangible personal

property• Use of patent, copyright,

trademark, franchise or license

• Revenue from services • Sales or real property

• Rental of property • Royalties from mineral interests

• Any other business done in NV

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: Major pitfalls

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?

State

Per-pupil spending (2009)

Reading Score Rank

Math Score Rank

Arizona $9,641 41 39California $11,458 48 46Idaho $8,525 29 16Montana $10,941 8 7Nevada $10,377 47 43New Mexico $10,798 46 48Oregon $11,156 27 24Texas $10,596 36 18Utah $7,756 24 28Washington $11,200 16 9

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