District of Columbia Business Income Tax

What kind of tax will you owe on District of Columbia business income?

Most states tax at least some types of business income derived from the state. As a rule, the details of how income from a specific business is taxed depend in part on the business’s legal form. In most states corporations are subject to a corporate income tax, while income from pass-through entities such as S corporations, limited liability companies (LLCs), partnerships, and sole proprietorships is subject to a state’s tax on personal income. Tax rates for both corporate income and personal income vary widely among states. Corporate rates, which most often are flat regardless of the amount of income, generally range from roughly 4% to 10%. Personal rates, which generally vary depending on the amount of income, can range from 0% (for small amounts of taxable income) to around 9% or more in some states.

Currently, six states – Nevada, Ohio, South Dakota, Texas, Washington, and Wyoming – do not have a corporate income tax. However, four of those states – Nevada, Ohio, Texas, and Washington – do have some form of gross receipts tax on corporations. Moreover, five of those states – Nevada, South Dakota, Texas, Washington, and Wyoming – as well as Alaska and Florida currently have no personal income tax. Individuals in New Hampshire and Tennessee are only taxed on interest and dividend income.

Apart from taxing business income through a corporate income tax or a personal income tax, many states impose a separate tax on at least some businesses, sometimes called a franchise tax or privilege tax. This is frequently justified as a tax simply for the privilege of doing business in the state. As with state taxes on business income, the specifics of a state’s franchise tax often depend in part on the legal form of the business. Franchise taxes are generally either a flat fee or an amount based on a business’s net worth.

The District of Columbia (DC) has a corporate franchise tax and an unincorporated franchise tax. Both are effectively business income taxes. The corporate franchise tax applies to corporations. The unincorporated franchise tax applies to all other business entities. In addition, if income from your business passes through to you personally, that income will be subject to taxation on your personal state tax return.

The District of Columbia’s corporate franchise tax applies to corporations. Unlike most other states, the District of Columbia does not recognize the federal S corporation election and taxes S corporations like traditional (C-type) corporations. For 2018, the corporate franchise tax is assessed at a flat rate of 8.25%. (Rates have varied over the years.) The tax is based on net income derived from business in DC. There is a minimum tax of $250 if DC gross receipts are $1 million or less. If DC receipts are greater than $1 million, there is a $1,000 minimum tax.

The District of Columbia’s unincorporated franchise tax applies to all businesses operating in DC other than corporations. The rates and minimum taxes are the same in most cases. However:

  • an unincorporated business with gross income of $12,000 or less is not required to file a return or pay the $250 minimum franchise tax;
  • an unincorporated business is exempt from the tax if more than 80% of gross income is derived from personal services rendered by the members of the entity and capital is not a material income-producing factor; and
  • a trade, business, or professional organization that by law, customs, or ethics cannot be incorporated is exempt from the tax.

For purposes of comparison, note that DC taxes personal income at marginal rates ranging from 4.0% to 8.95%.

Here’s a brief look at additional details for five of the most common forms of District of Columbia business: corporations (C corporations), S corporations, LLCs, partnerships, and sole proprietorships.

Corporations. District of Columbia corporations are subject to DC’s corporate franchise tax.

Example: For the 2018 tax year, your District of Columbia corporation had taxable income of $500,000. Other things being equal, your corporation will owe District of Columbia corporate franchise tax in the amount of $41,250 (8.25% of $500,000).

S Corporations. An S corporation is created by first forming a traditional corporation, and then filing a special form with the IRS to elect “S” status. Unlike a traditional corporation, an S corporation is not subject to separate federal income tax. Rather, taxable income from an S corporation is passed through to the individual shareholders, and each individual shareholder is subject to federal tax on his or her share of the corporation’s income. In other words, S corporations are pass-through entities. (Note that a shareholder’s share of the S corporation’s income need not actually be distributed to the shareholder in order for the shareholder to owe tax on that amount.)

The District of Columbia is unusual in that it does not recognize the federal S election. Instead, DC taxes S corporations as if they were traditional corporations: S corporations with DC income are subject to DC’s corporate franchise tax. In addition, each individual S corporation shareholder will owe state tax on his or her share of the company’s income.

Example: For the 2018 tax year, your District of Columbia S corporation had taxable income of $500,000. Other things being equal, your corporation will owe District of Columbia corporate franchise tax in the amount of $41,250 (8.25% of $500,000). In addition, the corporation’s net income will be allocated to you and your fellow shareholders, and you will each pay tax on your own portions on your individual state tax returns. Each shareholder’s rate will vary depending on his or her overall taxable income for the year.

Limited Liability Companies (LLCs). Standard LLCs are pass-through entities. In most states, LLCs are not required to pay income tax to either the federal or state government. In DC, however, LLCs are subject to the District’s unincorporated franchise tax. In addition, income from the LLC is distributed to individual members, who then pay federal and state taxes on the amounts allocated to them.

Also note that while, by default, LLCs are classified for tax purposes as partnerships (or, for single-member LLCs, disregarded entities), it is possible to elect to have your LLC classified as a corporation. In that case, the LLC would also be subject to District of Columbia’s corporate franchise tax.

Example: For the 2018 tax year, your multi-member LLC, which has the default tax classification of partnership, had taxable income of $400,000. More than 80% of that income is derived from personal services rendered by the members of the LLC. In addition, capital is not a material income-producing factor. Therefore, the LLC is exempt from DC’s unincorporated franchise tax. However, the LLC’s net income will be allocated to you and your fellow members, and you each will each pay tax on your own portions on your individual state tax returns. Each member’s rate will vary depending on his or her overall taxable income for the year.

Partnerships. Partnerships are pass-through entities. In most states, partnerships are not required to pay income tax to either the federal or state government. In DC, however, partnerships are subject to the District’s unincorporated franchise tax. In addition, income from the partnership is distributed to individual partners, who then pay federal and state taxes on the amounts allocated to them.

Example: For the latest tax year, your partnership had net income of $400,000. More than 80% of that income is derived from personal services rendered by the partners. In addition, capital is not a material income-producing factor. Therefore, the partnership is exempt from DC’s unincorporated franchise tax. However, the partnership’s net income will be allocated to you and your fellow partners. You each will each pay tax on your own portions on your individual state tax returns. Each partner’s rate will vary depending on his or her overall taxable income for the year.

Sole Proprietorships. In most states, sole proprietorships are not separately required to pay income tax to either the federal or state government. In DC, however, sole proprietorships are subject to the District’s unincorporated franchise tax. That tax aside, income from your business will be distributed to you as the sole proprietor, and you will pay tax to the state on that income.

Example: For the latest tax year, your sole proprietorship had net income of $100,000. More than 80% of that income is derived from personal services rendered by you. In addition, capital is not a material income-producing factor. Therefore, your business is exempt from DC’s unincorporated franchise tax. The $100,000 in net income is distributed to you personally, and you pay tax on that income on your individual federal and state tax returns.

Note on Multistate Businesses and Nexus

Our primary focus here is on businesses operating solely in District of Columbia. However, if you’re doing business in several states, you should be aware that your business may be considered to have nexus with those states, and therefore may be obligated to pay taxes in those states. Also, if your business was formed or is located in another state, but generates income in District of Columbia, it may be subject to District of Columbia taxes. The rules for taxation of multistate businesses, including what constitutes nexus with a state for the purpose of various taxes, are complicated. If you run such a business, you should consult with a tax professional.

Additional Information

For further guidance on District of Columbia’s corporate franchise tax and business franchise tax, check the Office of Tax and Revenue website. For information on business-related taxes in other states, check Nolo’s 50-State Guide to Business Income Tax. And, if you’re looking for detailed guidance on federal income tax issues, check Tax Savvy for Small Business, by Federick Daily (Nolo).

June 2018

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