Legal Bulletins

The Maryland General Assembly recently enacted the Maryland Tax Reform Act of 2007, which significantly raised the State’s major taxes. You should be aware that there are numerous planning opportunities for avoiding or minimizing the effects of this new legislation and we would very much like to work with you in addressing these issues. This legislation will: (1) expand the tax base for the Maryland state and local real estate recordation and transfer taxes,

(2) (a) increase the corporate income tax rate, and (b) impose additional income tax reporting requirements on corporations doing business in Maryland,

(3) increase individual income tax rates, and (4) (a) increase the Maryland sales and use tax rate, and (b) expand its application to certain computer services.

This Legal Bulletin summarizes these four key parts of this legislation.

Real Estate Recordation and Transfer Taxes – Sale of Controlling Interests

A very significant part of the Tax Reform Act for many of our clients was the expansion of the recordation and transfer taxes so that transfers of a “controlling interest” in a “real property entity” are now explicitly subject to tax beginning on July 1, 2008. The Maryland state government imposes a 0.5% transfer tax on the gross sales price of real property within the State. Every local jurisdiction imposes corresponding transfer and recordation taxes so that three different taxes are all imposed on a sale of real estate located within Maryland. For example, Baltimore City imposes a 1.5% transfer tax and a 1% recordation tax for an aggregate state and city tax rate of 3% of the gross sales price of real property located within the city. Prior to the effective date of this legislation, sales of entities that own real estate within Maryland were almost always exempt from these taxes.

• Overview of Controlling Interest Tax: The recordation and transfer taxes will be imposed on the “consideration payable” for the transfer of a “controlling interest” in a “real property entity” that possesses, directly or indirectly, a controlling interest in real property located in the State of Maryland. This rule is designed to cause the tax consequences of a sale of a controlling interest in a real property entity to mimic the tax consequences of a direct sale of real property that was conveyed by a deed recorded in the local land records or a similar instrument filed with the Maryland State Department of Assessments and Taxation (SDAT).
• “Real Property Entity” Defined: Generally, the Tax Reform Act defines a “real property entity” as any corporation, partnership, association, limited liability company, other type of unincorporated form of doing business, or trust that directly or beneficially owns real property located in Maryland which (i) constitutes at least 80% of the value of the entity’s assets, and (ii) has a gross value of at least $1,000,000.
• “Real Property” Defined: For purposes of transfer and recordation taxes, “real property” encompasses all real property located in the State of Maryland as well as leases with terms greater than 7 years, but does not include mortgages, deeds of trust, or other liens on or security interests in real property.
• “Controlling Interest” Defined: “Controlling interest” is defined as more than 80% beneficial ownership of the entity that owns real property in Maryland.
• “Consideration Payable” Defined: The recordation and transfer tax imposed on transfers of controlling interests will be calculated based on the “consideration payable” for the transfer of the controlling interest. The “consideration payable,” in addition to the actual purchase price for the interests in the real property entity, is to be increased by the amount of all debts owed by the real property entity and all liens against the entity’s real property. The “consideration payable” is then reduced by the amount allocable to the assets of the real property entity other than its Maryland real property.
• Transfers Excluded from the Tax: The following transactions are deemed not to be a transfer of a controlling interest: (i) a pledge of ownership interests as security for a loan, except for the foreclosure or execution on such an ownership interest; and (ii) the admission to the real property entity of new owners incident to the raising of additional capital through a public or private offering of stock or other interests in the real property, provided that the effective management of the real property entity is not substantially changed and none of the new members is expected to participate in the day-to-day management of the real property entity.
• Transfers Exempted from the Tax: The following transfers of a controlling interest in real property are exempt from the tax:
  • a transfer that would be exempt from recordation tax if it were a transfer by deed from the transferor to the transferee of the controlling interest;
  • a transfer that is completed over a period of more than 12 months or is not made in accordance with an intentional plan to transfer a controlling interest;
  • a transfer in which the transferee is an entity owned by the same persons and in the same proportions as owned the real property entity prior to the transfer;
  • a transfer in which the transferor, transferee, and real property entity are each wholly owned by a common parent corporation or are such common parent corporation; and
  • a transfer in which the transferee of the controlling interest is a Maryland non-stock corporation and registered with the Department of Aging as a continuing care retirement community.
• Reporting Requirements: Each single transfer of a controlling interest or a series of transfers that in the aggregate constitute a controlling interest that is completed within a period of 12 months must be reported to SDAT by the real property entity within 30 days of the last transfer that caused a controlling interest to be sold.
• SDAT Regulations: The legislature has directed the SDAT to issue regulations for administering the new controlling interest tax and “to assure that: (i) a tax is imposed when a transaction is structured involving a controlling interest in a real property entity to avoid payment of the recordation tax; (ii) exemptions provided by law when real property is transferred by an instrument of writing are applicable; and (iii) there is no double taxation of a single transaction.”

  Corporate Income Tax – Increase in Rate and New Reporting Requirements

  (a) The Maryland state corporate income tax rate is increased from 7% to 8.25% effective as of January 1, 2008.

  (b) Generally, for Maryland corporate income tax purposes, affiliated corporations must each file a separate state corporate income tax return and their respective incomes are not aggregated in determining their tax liabilities. The legislature considered adopting a unitary tax system that would require an affiliated group of corporations to aggregate their Maryland state taxable incomes and file a single return but this proposal to require combined corporate reporting was defeated. Instead, the legislature created a commission that will review Maryland’s current business tax structure and make specific recommendations for changes to the state’s business tax structure in future years. To gather information for this commission, Maryland imposed new and onerous reporting requirements on corporations “doing business” in Maryland that will enable the commission to compare how much Maryland state corporate income tax is paid under the current system with how much would be paid if the state adopted a unitary corporate income tax system. In effect, corporations will be reporting their incomes under both systems and paying tax using the current system during the term of the commission.

  Individual Income Tax – Increase in Marginal Income Tax Brackets

  For the first time in more than 40 years, Maryland is increasing its marginal individual state income tax rates. Prior to the Tax Reform Act of 2007, individuals who earned more than $3,000 per year paid a flat Maryland state income tax rate of 4.75% and a corresponding additional local income tax that is generally imposed at rates of between 2% and 3%. Under the new legislation, the following three additional individual income tax brackets were created:

  • 5%: Single filers who earn more than $150,000 and joint filers who earn more than $200,000 will pay income tax at a rate of 5%;
  • 5.25%: Single filers who earn more than $300,000 and joint filers who earn more than $350,000 will pay income tax at a rate of 5.25%; and
  • 5.5%: Single filers and joint filers who earn more than $500,000 will pay income tax at a rate of 5.5%.1

  Sales and Use Tax
  (a) Maryland’s sales and use tax will increase from 5% to 6% on January 3, 2008.2

  (b) Maryland’s sales and use tax base was expanded to include “computer services.” Under the Tax Reform Act, “computer services” include custom computer programming; computer facilities management and operation; computer system planning and design that integrate computer hardware, software, and communications technologies; computer disaster recovery; data processing, storage, and recovery; and hardware or software installation, maintenance, and repair. “Computer services” does not include Internet access; typing or data entry on word processing equipment; computer training; the installation, maintenance, or repair of tangible personal property other than computer hardware or software that includes computer hardware or software as a component part; or a “computer service” that is provided in connection with (i) electronic fund transfers, financial transactions, automated teller machine transactions, or other banking or trust services; (ii) business management, account management, personnel, payroll, employee benefit, or other administrative services; (iii) educational, legal, accounting, architectural, actuarial, medical, medical diagnostic, or other professional services; or (iv) telecommunications services.

There are numerous planning opportunities for avoiding or minimizing the effect of these new tax increases and we would like to assist you in dealing with these issues. If you have questions about the Tax Reform Act or would like to discuss planning opportunities in contemplation of the new taxes, please contact a member of our Tax Practice Group.

This Bulletin is designed to inform you of current legal developments and should not be construed as legal advice or opinion concerning specific factual situations.

1 The Tax Reform Act increases the individual income tax exemptions for lower- and middle-income individuals, while phasing out the exemptions for individuals with higher income levels. The new exemption amounts are as follows: ·$3,200: Single filers who earn up to $100,000 and joint filers who earn up to $150,000 will receive a $3,200 exemption.
·$2,400: Single filers who earn more than $100,000 and joint filers who earn more than $150,000 will receive a $2,400 exemption.
·$1,800: Single filers who earn more than $125,000 and joint filers who earn more than $175,000 will receive an $1,800 exemption.
·$1,200: Single filers who earn more than $150,000 and joint filers who earn more than $200,000 will receive a $1,200 exemption.
·$600: Single filers who earn more than $200,000 and joint filers who earn more than $250,000 will receive a $600 exemption.

2 Generally, a vendor is entitled to keep 0.9% of the sales and use tax it collects as reimbursement for the expenses associated with collecting and remitting this tax. Effective January 3, 2008, Maryland reduces the vendor credit against sales and use tax by capping it at $500 per month.