Modernized business tax aimed at attracting start-ups

San Francisco proposes more business-friendly taxes

San Francisco voters may redefine “business as usual” as the city overhauls its second-most lucrative tax.

After months of economic studies and discussions with small business owners, San Francisco city officials have proposed to replace the city’s payroll-based business tax with a gross receipts-based tax. The idea has resonated with local technology-minded entrepreneurs, who may see their tax liability substantially reduced if voters approve the shift in November.

San Francisco’s current Business Expense Tax generates about 12% of the city’s general fund revenue. Under the tax, most businesses are required to pay 1.5% if local payroll exceeds $250,000. Businesses under the $250,000 threshold qualify for a small business exemption from the tax.

Entrepreneurs have long derided the tax as harmful to local business growth (because it can be avoided by maintaining low employee levels in – or entirely leaving – San Francisco), a nightmare for start-ups (which may be taxed despite generating no revenue), and out of step with other major California cities (over 30 of whom use a gross receipts tax and none of whom use a payroll tax).

Under the gross receipts tax proposed by Mayor Ed Lee and Board of Supervisors President David Chiu, San Francisco businesses would instead be required to pay an annual license registration fee and a tax between 0.075% and 0.650% of gross receipts attributable to San Francisco. Unlike the current payroll tax, the license fee and gross receipts tax would be marginal (crossing the exemption threshold would result in tax only on the excess) and progressive (rates would increase as a company’s gross receipts rise).

Although the proposal is nearly financially neutral overall, start-ups would fare much better under the new system.  Aside from the tax-without-revenue issue, small start-ups currently wary of crossing the $250,000 exemption threshold would enjoy a roomier $1 million gross receipts exemption. However, sole-proprietorships and partnerships, previously able to escape the Payroll Expense Tax by making non-payroll distributions to owners, would lose the benefit of this technique.

The proposal represents a radical shift for San Francisco, whose 42-year old payroll tax makes it the last great hold-out in a statewide shift away from the payroll tax paradigm. Overall, the shift would spur innovation in San Francisco, reaffirming the city’s status as a Silicon Valley start-up machine.

(Image source: alberione)