“My vision for our city is to become the technology capital of the world….  We want to attract and retain leaders in the fields of e-government, e-commerce, e-business, and technology,” said then-mayor Anthony Williams.

New E-Conomy Transformation Act

The District’s final rulemaking for the Act, setting out terms of qualification for the Act’s various tax benefits to qualifying businesses, can be found here.

Among many other tax incentives, the Act granted tax benefits to “Qualified High Technology Companies” (QHTCs), those DC-based, for-profit organizations that make most of their revenue from the sale of products and services related to information technology.  The category includes a large list of broadly defined “high technology activities”, for example (from the Act):

“Website design, maintenance, hosting, or operation; Internet-related training, consulting, advertising, or promotion services; the development, rental, lease, or sale of Internet-related applications, connectivity, or digital content; or products and services that may be considered e-commerce”.

Other qualifying activities include:

“Internet-related services”, “Information and communication technologies”, “operating and application software”, “Advanced materials and processing technologies”, and “Engineering, production, biotechnology and defense technologies that involve knowledge-based control systems and architectures”.

DC Tax Credits

QHTCs can claim tax benefits related to the “high technology” aspects of their businesses.  Those aspects include employees, and specifically “disadvantaged” employees of these companies, defined by the Act as District of Columbia residents who currently receive or have recently received benefits under the District’s “Temporary Assistance for Needy Families” program or who were released from prison within 24 months before gaining employment at the company.  Also included are employees who qualify for the District’s “Welfare to Work Tax Credit” or “Work Opportunity Tax Credit”, background on both of which can be found here.

QHTCs may claim tax credits for training programs completed by disadvantaged employees, including programs at accredited colleges and universities and programs conducted by nonprofit organizations.  These credits are limited to $20,000 per qualifying employee during the first 18 months of employment.

QHTCs may also claim tax credits for relocation expenses provided for employees, not limited to disadvantaged employees.  The amount of the credits varies from $5,000 to $7,500, depending on whether the employee relocates his or her residence to the District in addition to employment with the QHTC.

In addition, QHTCs may claim tax credits for up to 50% of wages paid to disadvantaged employees, capped at $15,000 per year per employee.  Similar credits may be claimed by QHTCs for up to 10% of wages paid to non-“disadvantaged” employees, capped at $15,000 per year per employee.  The credits are limited to the first 24 months of employment.

Most of the above credits apply only for employees working at least 35 hours per week, may be taken only after the relevant employee(s) have worked at least 6 months with the company, and require at least 2 employees for eligibility.   In addition, the above credits are not available with respect to employees who are “key employees”, including owners of the business (or relatives) or members of a company’s board of directors.

Reduced Corporate and Franchise Taxes

Another benefit for QHTCs is a reduced DC corporate franchise tax rate of 6%, and complete exemption from the corporate franchise tax for the first 5 years of business for QHTCs located in certain defined geographic areas known as “High Technology Development Zones” (listed geographically in this DC Government publication).   QHTCs that are LLCs and other non-corporations are exempted permanently from the District’s unincorporated franchise tax.  QHTCs also need not include capital gains from sales of capital assets in gross income for purposes of DC’s corporate income tax.

Exemption from DC Sales Taxes

Lastly, QHTCs are exempt from most sales taxes, including most purchases of computer software and hardware of all kinds.

Additional Materials and Applying for Credits

Businesses that wish to qualify for QHTC status and applicable credits and reduced taxes should review and complete the information and forms available through the District’s Office of Tax and Revenue, particularly Publication 399, available here.

Kate Tummarello is a Research and Social Media Intern with Mirsky & Company and a reporter at Roll Call/Congressional Quarterly.  Follow Kate on Twitter @ktummarello.  Andrew Mirsky of Mirsky & Company contributed to this post.

In 2008, New York State enacted legislation which may still be the broadest attempt yet to collect sales taxes from out-of-state vendors, basing its legal argument on the networking, linking and affiliate relationships common to many online vendors and particularly, to Amazon.com.

The states may very well be reacting to Amazon’s own aggressive tactics.  In “Sorry, Shoppers, but Why Can’t Amazon Collect More Tax?” (NY Times, 12/26/09), Randall Stross argued that Amazon exploits a tax technique called “entity isolation” to avoid having to collect sales tax in all but 5 of the 18 or more states in which it (and, importantly, its subsidiaries and affiliates) does business through a physical presence such as a warehouse, distribution center, administrative office, or call center.

Stross’s Times colleagues have lampooned Amazon’s policy argument against having to collect state and local taxes on its estimated $22 billion in sales, an argument which might be distilled to “it’s too complicated”.  Wrote Saul Hansell in the “Bits” Blog 2 years ago (“Amazon Plays Dumb in Internet Sales Tax Debate”, NY Times 2/13/08):

“[I]t is certainly an unwieldy mess of rules. But this is the sort of problem that is handled by technology: there is a finite set of variables — location, goods purchased, amount, date, whatever else — and a set of rules to come up with a tax rate. When you look at all the things Amazon does every day — such as the recommendations it offers about goods to buy, or the way it optimizes its warehouse operations — figuring out sales tax looks like a job for the summer intern.”

Stross quotes Amazon founder Jeff Bezos from a 2000 speech, in which Bezos acknowledged the basic premise of state sales tax collection: “You have to charge sales tax to customers who live in any state where you have a business presence.”  Different states charge different rates of sales tax and apply different interpretations (often, widely different) of what is a “business presence”.  Online retailers, too, vary widely in their compliance or more accurately, their view on whether their businesses are subject.

Amazon has, to this point, argued that its sales business directly operates only in 5 states (Washington State and 4 others where it has distribution centers).  So for example, its division which developed and manufactured the Kindle is in California, but structured as a separate legal entity subsidiary with no sales operation.  In Amazon’s view, this “entity isolation” distinguishes it from, say, the online sales of BarnesandNoble.com.  Barnes & Noble collects tax on sales in California and New York and elsewhere based on the physical presence of its stores in those states.

As mentioned above, New York State has taken exception to this argument and is attempting to force Amazon to collect sales tax.  New York argues, essentially, that Amazon’s claim of no business “presence” in New York State is ludicrous in the totality of the circumstances.  In simple terms, New York points to the massive network of “affiliate” sellers of books and other products operating under the Amazon umbrella, many or most of whom sell exclusively or nearly exclusively through Amazon.

Stross reports that Amazon has filed legal challenges to New York and the issue is therefore unsettled.  What is not unsettled is the aggressively upward trajectory of state efforts to collect revenue from online commerce, wherever it is physically located, based on the incidence and (as clearly in the case of Amazon) the volume of traffic in the particular state.

Draws versus Salaries

In an S-Corp, the shareholders are required to take salaries, not draws.  If an S corp shareholder takes out salary of $20,000, she will still pick up that $20,000 as W-2 income.  Taxes would have to be withheld, and shareholders would receive a W-2 at the end of the year.

In an LLC, members take “draws” rather than salaries, and taxes are not withheld on those draws.  A draw means an owner is just taking money out of the bank against the balance sheet account called partner draw (liability).  Instead, if an owner takes out $20,000 in an LLC, it doesn’t affect her ownership income, and she’ll receive a K-1 at the end of the year showing that $20,000 in income.

Unlike salaries in an S corp, LLC ownership draws do not reduce the company’s income.  A draw is not an expense, so although cash is decreased by the amount taken out as a draw, the payout of the draw does not constitute an expense that would lower net income of the company.  A salary is an expense account on the income statement that reduces your net income and your cash account.

Profits and Losses of the Company

In either case, shareholders or members will receive a K-1 from the company at the end of the year.  If the business has net income for the year (including deduction for salaries paid but excluding deduction for any draws) then that income will pass through to the owners on a K-1.

Therefore, while a company’s owners could reduce taxable income through salary payments in an S corp, they’re going to recognize the same total 1040 income through the combination of salaries and profit distributions via K-1.  Self-employment taxes (discussed below) will effectively cost them the same, and the only possible variable will be varying effects of marginal tax rates and capital gains treatment of profits versus salary.  (More on that last point under a separate posting coming soon.)

Self employment (SE) taxes

In an S-Corp, a shareholder is still (effectively) going to pay the full SE tax.  A shareholder cannot avoid SE taxes by taking salary rather than a draw, because while the company would indeed pay half of the SE tax, since the shareholder is essentially the company, the shareholder is effectively paying all of it.  And that would then be the same as if an LLC owner received all of here income on via owner draws.