Running a business is no small feat in today’s economic environment. The negative impact of declining tax revenues from America’s businesses and citizens has been felt in local communities. These falling revenues are resulting in unprecedented steps being taken by municipality after municipality across the country. Closer to home, the example of North Las Vegas’ efforts to deal with its fiscal crisis shows that Nevadans share the pain as well.
Another recent example is the proposed Margin Tax under the Education Initiative which taxes the modified gross revenue of a business. Under this proposal, a 2 percent tax would be levied on a business with revenues in excess of $1,000,000. It is inevitable that Texas will be referenced in the ensuing debate as the state, like Nevada, does not tax income and has implemented a similar program. The Education Initiative in Nevada went even further and upped the tax ante suggesting a rate between two and four times the Texas tax rate.
The controversial and heavily challenged Texas Franchise Tax has had a disproportionate effect on various industries in Texas. The same will be true of the proposed Nevada Margin Tax, which allows businesses to reduce defined revenue by either: a) 30 percent of revenue; b) labor (excluding wages in excess of $300,000 and 1099 contract labor); or c) cost of goods sold.
From a financial perspective, as CFOs of businesses look at an additional cost, they will have to fight to keep alive companies that are minimally profitable. Some employers out of necessity may lay off employees and hold back wage increases. The cumulative impact will be to reduce business activity. Texas recognized the potentially devastating impact of the tax on the retail sector, for example, and cut the rate to the sector by 50 percent. There is a significant potential negative impact on many types of businesses in our state.
Take, for example, a company with $10 million gross revenue that has a $4 million labor cost and a $3 million cost of goods sold with a five percent net pre-tax profit margin of $500,000. The business faces a Margin Tax of $120,000 under the Education Initiative. What business owner would want to effectively pay nearly 25 percent of his or her profit in a state business tax? This is in addition to $170,000 of federal tax liability if the business is a C Corporation. The business would be required to pay nearly 60 percent of its income in combined state and federal tax, with a large share going to our supposed low tax environment state of Nevada. What is left for the business is about $200,000 in profit. This example does not take into consideration additional taxes to an S Corporation business owner due to the expiration of the Bush tax cuts and rising federal tax rates on “wealthy” tax payers. The above result is significantly more negative if the firm has a loss before the imposition of the Margin Tax.
While the Nevada Margin Tax is supposedly modeled on the Texas Franchise Tax, it does not contain many of the provisions that Texas law contains to define filing requirements for commonly owned businesses, for example. Texas law also contains many provisions that relate to specific industries, such as medical services and real estate to apply the tax in a manner that deals with industry specific issues. The Texas Franchise Tax has been modified many times since its inception in 2008. It is of vital importance to understand, then, that a proposed Nevada Margin Tax cannot be modified at all for three years after passage. A badly conceived and badly written law will be unchangeable for three years. This is Kafka-esque at best.
Every business owner with over $1 million of revenue will experience a significant impact from the Nevada Margin Tax. In addition to the tax itself, the costs to compile the separate data necessary to compute the tax and to prepare the tax returns will be onerous. The public battle on the Margins Tax will be a sound bite for the residents of Nevada, who may not understand the negative short and long term impacts on Nevada.
While there will be various specific experiences with the proposed Margin Tax, this much is certain; many successful businesses simply will not locate in or stay in Nevada. Business-owners and community leaders must discuss, in a non-partisan fashion, the impact that a significant increase in taxation will have on Nevada.
Co-written by: Curt Anderson, Jason Thomas and Leonard Wright of Fair, Anderson & Langerman.