The District of Columbia (the District) imposes franchise taxes, in lieu of income tax, on “unincorporated businesses” such as partnerships or limited liability companies that are taxed as partnerships. The current franchise tax rate for unincorporated businesses, whether foreign or domestic, is 8.25% of the taxable income of the entity. For entities subject to the tax, the minimum tax payable is $250. However, if the entity’s gross receipts within the District of Columbia are greater than $1,000,000, the minimum tax is $1,000.
For many years, pursuant to D.C. Mun. Regs. tit. 9, §117.13, the District has provided a regulatory exemption, referred to generally as the “liquidation exemption,” whereby unincorporated businesses that sell their property and subsequently dissolve could reduce their franchise tax liability. The regulation provides that the gain received or loss suffered in connection with “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.” If, however, the sale of the property does not result in the termination of the unincorporated business, then under D.C. Mun. Regs. tit. 9, §117.14 the gains or losses are recognized and reported by the entity and not the owners of that entity. For example, in the case of a limited liability company (taxed as a partnership) that sells real property located in the District and elects to dissolve, any gains from the sale of that property are taxable to the entity’s members and are not included in the entity’s taxable income for the purposes of calculating the 8.25% franchise tax payable.
In August, however, the District of Columbia Council (the Council) passed, and Mayor Bowser signed, the “Unincorporated Business Franchise Tax Amendment Act of 2020” as part of a larger budget bill. The new bill provides that taxable income of an unincorporated business includes the gain from the sale or other disposition of any assets, including real property and interests in real property, “even when such a sale or other disposition results in the termination of an unincorporated business,”
thereby eliminating the liquidation exemption that real property owners in the District have historically relied upon for significant tax savings. There are two versions of the bill, an emergency version and a permanent version. The emergency version became effective immediately on enactment of the bill, but is set to expire on November 16, 2020, while the permanent version was submitted to Congress on September 3, 2020, for its required 60-day review period of proposed District legislation. Unless Congress takes the highly unusual step of overriding the bill during the review period, the permanent version will become law and the exemption will end on January 1, 2021. Thereafter, the 8.25% franchise tax will apply to any gains from the sale of real property, even if the unincorporated entity terminates its business in the District following the sale.
Unincorporated businesses contemplating sales of their District real property and wishing to take advantage of the regulatory exemption should consider completing the sales before the end of 2020, when the amendment takes effect and the regulatory exemption is terminated.
Some have taken the position that actual liquidation/dissolution is not required if the unincorporated business ceases to carry on business in the District, even if it continues to carry on business outside the District. As provided by the regulation, if a sale results in “termination of the unincorporated business” in the District, no tax is imposed on the entity.