Nevada Approves Commerce Tax, A New Tax on Business Gross Receipts

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Key Findings

• On May 31, the Nevada Legislature approved the Nevada Revenue Plan, a package of tax changes championed by Governor Brian Sandoval (R) which includes $1.4 billion in new and extended taxes over the biennium.
• The Nevada Revenue Plan increases the corporation annual business fee, expands the payroll tax, raises the cigarette tax, and creates a new Commerce Tax on the gross receipts of businesses with at least $4 million in revenue in Nevada.
• The plan also makes temporary payroll tax and sales tax increases permanent.
• The package won substantial backing despite reservations regarding the package’s structure, particularly the gross receipts-based Commerce Tax component.
• The new Commerce Tax imposes differential-rate gross receipts taxes based on 26 business categories, with a partial credit against the payroll tax (known as the Modified Business Tax) for tax payments under the Commerce Tax.
• Public finance scholars tend to look upon gross receipts taxes unfavorably because they are non-neutral, lead to tax pyramiding, and distort business decision-making.
• Through separate legislation, Nevada lawmakers also broadened the base and lowered the rate of the Live Entertainment Tax, greatly reducing the tax’s complexity.

Executive Summary

On May 31, the Nevada Legislature approved S.B. 483, a package of tax changes championed by Governor Brian Sandoval (R) collectively termed the Nevada Revenue Plan. The tax package includes an increase in the corporation annual business fee, an expanded payroll tax, a higher cigarette tax, and a new Commerce Tax on the gross receipts of businesses with at least $4 million in revenues in Nevada, along with making temporary payroll tax and sales tax increases permanent.

The package, totaling $1.4 billion in new and extended taxes over the biennium, won substantial backing despite reservations regarding the package’s structure, particularly the gross receipts-based Commerce Tax component. Public finance scholars tend to look upon gross receipts taxes unfavorably because they are non-neutral, lead to tax pyramiding, and distort business decision-making. Both the Nevada Legislature and Nevada voters had rejected prior attempts to impose other types of gross receipts taxes, and some of those who supported the new tax package did so while expressing a desire to revisit the decision in the future.

The provisions of S.B. 483 go into effect on July 1, 2015. This includes the new Commerce Tax, which will be paid quarterly.

Business License Fee Increased

Under existing law, all Nevada businesses pay a business license fee (BLF) of $200 annually, a fee that had been scheduled to drop to $100 per year in Fiscal Year 2016. Instead, the fee will increase to a flat $500 for corporations while remaining a flat $200 for pass-through businesses. Corporations with authorized stock are also required to file initial and annual lists, with a graduated fee structure based on the value of the company’s authorized stock. At present, list fees range from $125 to $11,100 depending on authorized stock value.[1] The new tax package increases all fees in the schedule by $25.

Payroll Tax Broadened and Increased

The Modified Business Tax (MBT) is currently imposed on businesses other than financial institutions in the amount of 1.17 percent of wages paid above an exemption level of $85,000 per quarter. Financial institutions pay a higher rate of 2 percent. The MBT rate had been scheduled to decline to 0.63 percent for nonfinancial institutions beginning July 1, 2015. The MBT base has been narrowed significantly since the tax’s introduction in 2003, with exemption level increases in 2011 and 2013.

After significant debate over whether to expand the MBT or adopt a new gross receipts tax, the final plan includes elements of both options. The MBT will increase from 1.17 percent to 1.475 percent for most businesses, effective July 1, 2015. Mining companies will join financial institutions in paying the higher 2 percent tax rate. The MBT base is broadened by reducing the exemption to $50,000 per quarter, increasing the estimated number of MBT taxpayers to 18,607, up from the 13,492 paying the tax at present.[2] An earlier proposal to remove the MBT exemption for employer-provided health care costs was dropped.

After the first year, taxpayers may deduct up to 50 percent of their Commerce Tax payments over the previous four quarters from their MBT liability. Moreover, should total revenue from all business taxes exceed projections by more than four percent, the MBT rate will be adjusted downward, though to a rate no lower than 1.17 percent.

Temporary Taxes (“Sunsets”) Extended

The state’s 6.85 percent sales tax is actually composed of four taxes: the 2 percent state rate, a 2.6 percent Local School Support Tax, a 0.5 percent Basic City-County Relief Tax, and a 1.75 percent Supplemental City-County Relief Tax. The Local School Support Tax’s current rate is a temporary increase adopted in 2009, scheduled to sunset to 2.25 percent at the end of the current fiscal year.[3] The newly adopted tax plan makes the current rate permanent.

In order to balance a previous budget in 2009, the Nevada legislature required the prepayment of the Net Proceeds of Minerals Tax, essentially obligating the mining industry to pay two years’ worth of taxes in a single year. As a consequence of this decision, each year mining companies must estimate their tax liabilities for the subsequent year and remit the tax in advance. In unexpectedly lean years for mining, this requires the state to make substantial refunds long after money has been committed, but reverting to a standard system of taxation would necessitate foregoing collections for a year to restore the traditional cycle. Set to expire on June 30, 2015, advance payment has been extended another two years, to 2017.

Revenues from the Governmental Services Tax (GST), levied on car ownership, will continue to be diverted to the General Fund for another year. Subsequently, the state will phase in the dedication of GST revenue to the State Highway Fund over two years. A $100 court fee assessed on DUI convictions has been extended two years as well.

Cigarette Tax Increased by 125 Percent

Cigarette taxes, currently set at 80 cents per pack, will rise markedly to $1.80 per pack under the new tax package, which would put Nevada in the highest third of states for cigarette excise tax rates; the state currently ranks 34th.[4] The new rate will give the state the second-highest cigarette tax in the region, trailing Arizona’s $2 a pack but ahead of Utah’s $1.70, Oregon’s $1.31, California’s 87 cents, and Idaho’s 57 cents.[5]

Live Entertainment Tax Reformed

Nevada’s Live Entertainment Tax (LET) is imposed on admission, food and beverage, and merchandise at venues where live entertainment is provided and admission is charged. Smaller venues, with maximum capacity between 200 and 7,499 people, are currently taxed at a rate of 10 percent. Venues with capacity over 7,500 are taxed at a rate of 5 percent, and venues with capacity under 200 are exempt. The tax is riddled with exemptions, including ones for large events like Burning Man and Electric Daisy Carnival.

In legislation separate from the broader tax bill, S.B. 266, the LET is significantly simplified and reformed on a revenue-neutral basis. With limited exceptions, venues will now be subject to a 9 percent tax on admissions, with food and beverage exempt from the LET. Boxing matches will continue to be subject to the tax but at a reduced 8 percent rate. NASCAR’s continued exemption from the LET is contingent upon holding two races per year in Nevada. Non-profit events distributing more than 7,500 tickets are no longer exempt, a policy adopted in response to Burning Man’s effort to avoid admissions tax by reclassifying itself as a charity.

Commerce Tax Imposed on Business Gross Receipts

The new Commerce Tax is a modified gross receipts tax, which revises and refines the proposal previously embodied in Governor Sandoval’s Business License Fee plan. That plan would have established a fee-based gross receipts structure within the BLF framework, with each firm’s tax liability determined using a matrix of over 1,800 possible fees, based on industry classification and their Nevada gross receipts.

The new Commerce Tax divides Nevada’s economy into 26 business categories, each consisting of one or more industry classifications as delineated under the North American Industry Classification System (NAICS). Each business category is assigned its own gross receipts tax rate as indicated in the following table, with rates ranging from 0.051 percent to 0.331 percent. Businesses which do not fit into any other category are taxed at the 0.128 percent rate for Unclassified businesses.

The Commerce Tax is levied on businesses’ Nevada gross revenue in excess of $4 million per year, less certain subtractions including distributions from pass-through entities, stock proceeds, bad debts expensed on federal taxes, and net income from a passive entity to the extent that income was generated by another business entity.[6] Sectors already paying gross receipts taxes (gaming, mining, and insurance) can exclude from the Commerce Tax any revenue subject to those taxes.

Modeled after gross receipts taxes in Ohio, Texas, and Washington state, the Nevada Commerce Tax is computed by multiplying a company’s adjusted Nevada gross revenue above the $4 million threshold by the corresponding rate for the business category encompassing the company’s primary NAICS code. Should the business span multiple categories, it is to be taxed under the category to which the plurality of its economic activity can be attributed.

Tax rates were derived from a 2011 study of the Texas Margin Tax which attempted to calculate the effective tax rates experienced by firms across a range of industry classifications.[7] The rates across the twenty-six designated business categories diverge in some instances from those calculated in the Texas study. Rates on food services, retail, and wholesale were doubled to adjust for half-rates imposed on those sectors in Texas. The accommodations tax rate was adjusted upward, and the telecommunication tax rate was combined with utilities and thus taxed at a lower rate, a concession to what is likely the first of many lobbying efforts to alter an industry’s category or rate.

After the first year of the Commerce Tax, a partial credit will be offered against MBT liability, limiting the degree to which businesses are subject to taxes on two different measures of liability. By reducing MBT rates as state revenue grows and crediting Commerce Tax payments against MBT liability, the Commerce Tax’s total share of business tax revenue is designed to increase over time.

Revised revenue projections for the Commerce Tax were unavailable at the time of publication, as were estimates of the anticipated number of payers. In a previous iteration, however, when the exemption was set at $3.5 million rather than $4 million, net revenues were projected at $60.7 million and the administration anticipated that up to 10,000 businesses would be subject to the tax. Total liability and number of payers will necessarily be reduced given the higher exemption.

Under that previous iteration, new revenues were estimated at $1.1 billion. The tax package ultimately adopted is estimated to raise $1.4 billion despite narrowing the base of the Commerce Tax and scaling back Business License Fee increases, both of which would reduce the amount of new revenue available. More optimistic economic forecasts, however, have had a strongly countervailing effect, yielding more projected revenue under a slightly smaller tax package. In the absence of new projections, the following table offers a breakdown of new revenue under the prior iteration of the plan with a lower $1.1 billion revenue estimate.

Penalties for non-willful errors with respect to Commerce Tax filing or calculation are waived for the first two years in response to a request by Carole Vilardo of the Nevada Taxpayers’ Association.

Analysis of the Commerce Tax

While the Commerce Tax is not identical to earlier gross receipts tax proposals (including those rejected by legislators in 2003 and rejected by voters in 2014), it is still a gross receipts tax and retains the flaws inherent to such a tax. Such taxes have fallen out of favor since their peak popularity in the 1930s because of the pyramiding and non-neutrality inherent with their structure. Tax pyramiding occurs when taxes are imposed at each stage of production, resulting in multiple layers of taxation on the same goods. Most states repealed taxes similar to the Commerce Tax long ago due to these problems; in the past ten years, four states that still had such taxes (Indiana, Kentucky, Michigan, and New Jersey) eliminated them.

Corporate income taxes are imposed on a corporation’s net income – essentially, on a company’s actual profit margin. Gross receipts taxes, by contrast, are imposed on most or all of a company’s income (less certain statutory subtractions) without regard for profitability. Consequently, some businesses will shoulder much heavier tax burdens than others, and even unprofitable businesses will experience tax liability. Taxing receipts, including business-to-business purchases of supplies, raw materials, and equipment, encourages companies to become less efficient by bringing all those transactions in-house or moving them out-of-state. Innovative in-state businesses that focus on doing one thing in the production chain well are put at a disadvantage because their products will have multiple taxes embedded in the final price to consumers.

In an acknowledgement that different industries experience vastly different average profit margins, the Commerce Tax divides the state’s economy into 26 categories, each with its own tax rate. There is little reason to think that these rates, based on a one-year study of Texas’s economy, are an accurate reflection of comparative profit margins across industries in Nevada. However, even if they captured comparative margins perfectly in the aggregate, they can never be sufficiently granular to reflect the actual experience of any particular company.

The retail sector, by way of example, is subject to a 0.111 percent tax on gross receipts under the Commerce Tax. Even if this rate were a perfect expression of the relative profit margins of the retail industry within the broader economy, the profit margins of subsectors could vary dramatically. Boutique retailers, grocers, and discount stores, for instance, are likely to vary greatly in their average margins. No matter how detailed the business categories, individual businesses will always have their own unique profiles, with profit margins necessarily diverging from the industry average. This is particularly the case when those averages are drawn from a study of a different state’s economy.

Because tax burdens vary substantially across business categories – the highest rate is 6.5 times the lowest – businesses will have an incentive to engage in tax arbitrage, yielding deadweight losses. Companies engaging in activities that span multiple categories (such as trucking and warehousing, accommodations and food services, or professional and administrative services) will have an incentive to restructure to make a less-taxed category the business’s plurality activity, even if the decision would not otherwise be economically justifiable. Such economic distortions are precisely what good tax structures seek to avoid.

Conclusion

Given the inherent structural flaws of gross receipts taxes – flaws that have led to the near-extinction of such taxes – reliance on the Commerce Tax could prove costly for Nevada. All sides in the tax debate share a vision for Nevada, one of a thriving, diversified economy, and one that prominently features the state’s currently dominant gaming and mining industries but also embraces new industries and opportunities. Nevada’s taxes should reflect, not undermine, that vision.