Amid efforts to close a budget deficit, Maryland lawmakers are considering a series of bills that could significantly change the state’s tax environment.
Commercial real estate professionals warn those measures could significantly reduce transaction volumes, profit margins and competitiveness of the CRE industry in Maryland.
HB 1014, the Fair Share for Maryland Act, would impose new or heightened taxes on pass-through entities, corporations, REITS and partnerships that commonly hold commercial real estate. Those include:
• A new surcharge of 8.25 percent on the pro rata share of income distributed to a member of a pass-through entity from the entity’s taxable income that exceeds $1 million;
• A new transportation fee of 2.25 percent on earnings in excess of $10 million for corporations and pass-through entities;
• A change in Maryland income tax brackets that would raise the rate on taxable income above $1 million to 7 percent (from the current 5.75 percent); and
• A new 1 percent tax on capital gains income for individuals with adjusted gross income of at least $350,000.
Combined, those measures would nearly double the state taxes paid by some CRE professionals, said Richard Levine, Counsel for St. John Properties Inc.
In Baltimore County, for example, the typical principal with a CRE pass-through entity currently pays a combined state and county income tax rate of 10 percent “which is one of the highest rates in the United States,” Levine said. The addition of the 8.25 percent surcharge on share income and the 1 percent tax on capital gains would push that individual’s rate above 19 percent.
And that increase would be widely felt throughout the CRE industry, said Scott Dorsey, Chairman and CEO of Merritt Properties.
“Many people assume that these pass-through entities – LLCs, partnerships and proprietorships – are small businesses,” Dorsey said. “This is not the case. Sixty-five percent of all business income is attributable to these types of businesses. For example, both Merritt Properties and St. John Properties are pass-through entities.”
“In commercial real estate, every single project, without a doubt, is a pass-through entity,” Levine said.
The bill would have less impact on some CRE entities.
HB 1014 would require businesses to file “combined reporting,” said Jack Lopez, Director – Tax with COPT Defense Properties.
Although the bill doesn’t specify how that would be executed, some states and the District of Columbia require combined reporting and assess taxes based on the combined activities of all the legal entities within a corporate structure. This is in contrast with assessing taxes on each separate entity, Lopez said.
“COPT Defense Properties is structured as an UPREIT and, aside from the administrative burden of preparing the combined report, we expect the provision to be net neutral for our tax liability,” Lopez said. “Other states that require combined reporting generally allow REITs to apply their dividends paid deduction toward the entire combined group.”
The new and heightened taxes along with the transportation fee, however, could make some CRE projects unattractive to developers, financiers and buyers, and effectively create a “transaction logjam,” said Michael Trail, Chief Investment Officer for MCB Real Estate.
“It could most hurt emerging developers who are managing projects with razor thin margins and bootstrapping some developments,” Trail said. “It could be especially challenging for high-transaction businesses who are doing developments then selling the assets so they can invest the proceeds in doing the next deal, building the next building and creating more jobs. This could have a cascading impact throughout the economy.”
In addition to HB 1014, the General Assembly is debating other tax bills.
SB 1045/HB 1554 would establish a 2.5 percent sales tax on many business-to-business services, including environmental consulting services, HVAC servicing, pest control, landscaping, and repairs to elevators and electrical equipment in commercial and industrial buildings.
Several bills – including HB 23, HB 641 and HB 330 – would enable local governments to create special tax rates for different commercial, residential and industrial property classes and subclasses.
The prospect of new rounds of varying tax rates injects “a whole lot of uncertainty into the industry” that could depress CRE activity, Trail said. “I’ll give you an example. Chicago went through a huge tax reassessment over the past year or two. Every time we found a deal in Chicago, we would call our investors and it would be a complete blackout. They didn’t want to deal with the taxing uncertainty.”
More and higher taxes would also weaken Maryland’s ability to compete with other states in attracting business investment, Dorsey said.
The combined state and local tax burden for new and growing businesses already tops out around 9 percent in most Maryland jurisdictions “as opposed to 5.75 percent in Virginia and 4.5 percent in North Carolina,” Dorsey said. And North Carolina is planning further tax cuts.
Consequently, in the “Rich States Poor States” report (an economic competitiveness index published annually by the American Legislative Exchange Council for Economic Reform) Maryland currently ranks as 45th in the country in terms of the attractiveness of its tax environment, he said.