City, County and Local Taxes - Module 3 of 5

City, County and Local Taxes - Module 3 of 5


Module 3: City, County and Local Taxes

City, county, district, and other local governments are independent political subdivisions empowered by the states in which they lie to perform certain public duties. Often, these include the assessment and collection of taxes. Local governments levy and assess many common taxes. However, local governments do not have the same degree of constitutional tax authority afforded to states.[1]

Because local governments are given authority by state law, local tax power is limited and varies substantially across jurisdictions. However, there are a number of common taxes levied at the local level that businesses and individuals across the United States pay to support local public services and programs.

Sales and Use Taxes

Starting in the 1930s and 1940s, states began levying personal and sales taxes to fund public services.[2] Over time, these taxes have become crucial sources of state and local tax revenue. Forty-five states levy a general sales tax on goods and certain services, and among them thirty-seven allow local governments to assess their own general sales taxes on top of the state taxes. Sales taxes are important sources of revenue for both state and local services. Local governments collected $118 billion from sales taxes in 2016, and state governments collected $441 billion in sales tax revenues that year.[3]

There are many different types of sales taxes. Most local sales tax revenue originates from general sales taxes, which are taxes assessed on goods and services, either as a percentage of the sales price or a flat per-unit rate. They are assessed on nearly all tangible goods, with the exception of food; only 13 states apply sales tax on groceries.[4] In addition to general sales taxes, most states and many local governments levy selective sales taxes, which are excise taxes on specific goods like alcohol, tobacco, or gasoline.[5]  

General sales tax rates vary from a low of under three percent in Colorado to over seven percent in states like California, Indiana, Mississippi, Rhode Island and Tennessee. Some states, such as New Hampshire, have no general sales tax at all.[6] In some areas, sales taxes create meaningful daily expenses. This is particularly true among people living in cities that assess local sales taxes on top of state sales taxes. In Seattle, for instance, retail customers pay a combined sales tax rate of over 10 percent.[7]

Sales taxes are assessed at a flat rate without respect to income. In other words, consumers must pay the same sales tax rate on goods in the applicable territory regardless of how much money they make. In this manner, sales taxes are a form of regressive tax. This is because people with lesser incomes pay a larger percentage of their money into the sales tax system than people with higher incomes.[8]

Sales taxes may be allocated to the buyer or to the seller, depending on the way the tax is structured. A sales tax structured as a seller privilege tax requires the seller to pay sales tax based upon the amount of goods sold.[9] Often, these taxes are structured as unit taxes. For example, a seller privilege tax on salt may obligate a wholesaler to pay taxes based on how many pounds of salt it sold, regardless of whether the tax is passed on to the end-use customer.

Consumer taxes, on the other hand, are levied on the sale of goods and services at point of sale, which occurs when someone makes a purchase. When a jurisdiction follows a consumer tax structure, the seller collects the taxes owed from the buyer, and then sends these to the state or local revenue office. Most states structure their sales taxes as consumer taxes for simplicity purposes.

Many state and local jurisdictions enforce a use tax in addition to any applicable sales tax. Use taxes are levied on purchases made outside a taxing jurisdiction, but used inside state or local borders, or on items that are exempt from sales tax when purchased but are subsequently used in a taxable manner.[10] Like sales taxes, use taxes can be structured as consumer use taxes or vendor use taxes. Consumer use taxes apply to the purchaser, who is responsible for remitting the tax directly to the revenue agency with jurisdiction. Vendor use tax applies to sales made by a vendor in the jurisdiction.[11] 

Typically, retailers must have a physical presence in a jurisdiction to trigger sales tax liability. This doctrine originates from Supreme Court case law requiring a “nexus” between the business and the state or local government to trigger jurisdictional requirements necessary to impose taxes. However, this has resulted in a great deal of confusion about sales tax liability as more and more people purchase consumer goods online. In 2018, the Supreme Court addressed the question of whether state or local governments could tax online purchases made from vendors outside of the physical jurisdiction. In South Dakota v. Wayfair, the Supreme Court decided that state and local governments should be able to tax online purchases shipped to local buyers.[12] The success of the state law at issue in Wayfair has inspired other states to enact similar laws, and an increasing number of online retailers are voluntarily remitting sales taxes to local revenue offices.[13]

Property Taxes

The authority to levy property taxes is a power reserved to the states, and in many cases, states have authorized local governments to assess and collect property taxes as well.[14] Property taxes are an important source of both state and local revenue, but state treasuries predominantly rely on income tax. As a result, property taxes are one of the most common ways local governments get their funding. Seventeen percent of total tax revenues collected by local governments in 2016, totaling $487 billion nationwide, came from property tax payments. In six states – Connecticut, Maine, Massachusetts, New Hampshire, New Jersey and Rhode Island – property taxes accounted for over 75 percent of local tax revenues. [15]  Property owners in several jurisdictions must pay taxes to both state and local governments every year.

Most property tax revenues go to local revenue offices. Property tax revenues typically go to fund public services, including public schools, police, fire fighters and emergency services. However, tax laws vary substantially by jurisdiction. For example, what qualifies as taxable property varies by jurisdiction; some states allow local governments to impose taxes on real estate only, while others allow local taxes on items that would be considered personal property.[16]

Real property taxes are assessed on real estate only. These are levied as a percentage of the total value of the property, as assessed by local or state offices. The amount of this assessment is critical to determining a property owner’s tax liability, so taxpayers have a vested interest in ensuring their assessed property value is as low as possible for tax purposes. Land assessors typically assign a piece of property a higher value if it has access to public services or has potential to be developed. Assessors also review relevant information surrounding a certain property, such as the comparative value of similar properties or what the replacement cost of the property would be under current market conditions.

Assessors in some jurisdictions will even consider the amount of money a homeowner could expect to earn if the property were rented out. If the property is older, sometimes assessors will adjust for depreciation. Once assessed, real property is taxed at the rate determined by the board, council or legislature with jurisdiction. Most local property taxes are payable on a quarterly basis, and property tax information is maintained as a matter of public record.[17]   

State and local policymakers understand that property taxes can be a significant burden. In 2016, American homeowners paid almost $278 billion in property taxes. This averages out to about $3,300 in property taxes for each single-family homeowner in the country. However, many property owners pay far more than that. In nine counties spread across New York, New Jersey, and Connecticut, annual property taxes average more than $10,000. Homeowners in New Jersey tend to pay the highest property taxes in the nation; the average local property tax assessed in Trenton, the state’s largest city, amounted to over $8,100 per year, as of 2019.[18]

To ease the impacts of property taxes on their residents, many states limit property tax rates, the revenue that can be collected from property taxes or increases in assessed property values. These policies are meant to reduce the tax burden on property owners and reduce local and state governments’ reliance on property taxes as major sources of revenue. For example, California has limited its property tax rate to 1 percent and annual assessment increases to 2 percent until a property is resold.[19] Of course, these tax policies can create inequity, as people with similar houses may have different tax liabilities depending on when they purchased their homes.  

Other methods state and local governments use to manage property tax rates include assessment limits, individual exemptions and tax credits.[20] Assessment limits prevent a property’s assessed value from increasing over a fixed percentage between assessment periods. Property tax breaks like homestead deductions and exemptions decrease the taxable value of real property. Currently, 41 states have homestead exemptions that reduce the value of the assessed property subject to state and local property tax.[21] Some jurisdictions have adopted a parcel tax to supplement property tax, which is a flat tax assessed on every land owner in the area. These taxes are particularly common in states that are seeking alternatives to high property tax rates.[22]

Some state and local property tax policies are also directed at providing social benefits. For example, “circuit breaker” programs provide relief for elderly and low-income residents with property tax liabilities above a specified percentage of their income. In these programs, relief is typically provided via an income tax credit based on the value of prior property tax payments. Most states currently offer some type of circuit breaker program for property taxes and several more offer property tax deferrals and other benefits that help elderly and disabled homeowners make their property tax payments.[23]

 Other Local Taxes

Local governments collect taxes to fund public projects, utility services, infrastructure improvements, schools, emergency services, and other crucial government services. Often, local property and sales taxes are insufficient to cover the cost of these public services. In these cases, local governments might pass additional tax measures targeted at funding key government activities.

For example, some jurisdictions levy a local income tax. Most people earning a wage in the United States must pay federal and state income tax. However, 14 states have passed laws allowing city and county governments to assess local income taxes. In these jurisdictions, workers often see federal, state and local withholdings from each paycheck. Two of these states – Ohio and Pennsylvania – also allow local governments to impose school district taxes based on residents’ income, to help fund public schools.[24] 

Recently, state and local governments have been getting more and more creative in their tax policies. For example, some municipalities assess so-called “head taxes” based on the number of workers a company has on its payroll.  Local governments often impose excise taxes on specific goods, as well. In states where marijuana has been legalized, counties and cities will often levy their own “marijuana taxes.” Popular tourist destinations often charge local taxes on restaurants, hotels, entertainment venues, and other goods and services frequented by non-residents. All of these less-common local taxes supplement the tax revenues cities and counties receive from traditional sales taxes, property taxes and income taxes.[25]

Federal Laws Affecting Local Tax Revenues

The Tax Cuts and Jobs Act of 2017 created a suite of new policies that affect local governments. First and foremost, the law limited the deduction taxpayers could take off of their federal tax liability for the payments they made to state and local tax agencies.[26] By allowing taxpayers to write off state and local tax payments, the federal government offered a valuable subsidy to those living in high-tax areas. The Act capped the state and local tax deduction at $10,000 for all state and local income, sales and property taxes, a limitation that increases federal tax liability for some homeowners in high-tax areas.[27] Because state and local taxes are becoming more costly for some taxpayers, local revenue agencies are being forced to find alternative means to collect sufficient public revenues without unfairly burdening certain residents.

However, the Tax Cuts and Jobs Act also created new “opportunity zones,” which are economically-distressed communities where the government is encouraging new investments by offering the possibility of preferential tax treatment. This economic development tool is designed to spur economic development and job creation in downtrodden communities by allowing select local investors to defer tax payments on prior capital gains that are invested into a “qualified opportunity fund.” A qualified opportunity fund is an investment tool set up as either a corporation or a partnership specifically for the purposes of investing in an eligible property that is located in a qualified opportunity zone.[28]

The potential tax benefits of investing in a qualified opportunity zone are substantial. If the qualified opportunity fund is held for at least five years, investors may exclude 10% of the deferred gains. This increases to a 15% exclusion for gains from investments kept over seven years, and after ten years the investor becomes eligible for an increase in the cost basis of the qualified opportunity fund investment up to its full fair market value.  

However, capturing these tax benefits is not a simple process. Opportunity zones must be nominated for designation by the state in which they are located, and the nomination must be certified by the Secretary of the Treasury. The first set of opportunity zones established under the Tax Cuts and Jobs Act was designated on April 9, 2018, and, as of 2019, there were official opportunity zones in each of the fifty states.[29]

Conclusion

When authorized by their states, local revenue offices predominantly collect taxes from income, real property and sales in addition to miscellaneous taxes and fees assessed at the local level. Some local taxes, such as “head taxes,” are levied on employers specifically. However, the taxes associated with the employment of personnel are predominantly a subject of state and federal jurisdiction. The next module discusses the common types of tax liability that arise when an individual or company hires employees.  

 

 



[1] Internal Revenue Service, What are Government Entities and their Federal Tax Obligations? (June 28, 2018), https://www.irs.gov/government-entities/federal-state-local-governments/government-entities-and-their-federal-tax-obligations.

[2] U.S. Department of the Treasury, State and Local Taxes, (Dec. 5, 2010), https://www.treasury.gov/resource-center/faqs/taxes/pages/state-local.aspx

[3] The State of State (and Local) Tax PolicyTax Policy Center, Urban Institute & Brookings Institute Briefing Book (2016),  https://www.taxpolicycenter.org/briefing-book/how-do-state-and-local-sales-taxes-work.

[4] Elaine S. Povich, Decried as Unfair, Taxes on Groceries Persist in Some States, The Pew Charitable Trusts (Aug. 16, 2016), https://www.pewtrusts.org/en/research-and-analysis/blogs/stateline/2016/08/16/decried-as-unfair-taxes-on-groceries-persist-in-some-states

[7] Howard Gleckman, From Head Taxes to Parcel Taxes, Cities and States are Looking for New Ways to Raise RevenueTax Policy Center, Urban Institute & Brookings Institution, TaxVox: State and Local Issues(June 14, 2018), https://www.taxpolicycenter.org/taxvox/head-taxes-parcel-taxes-cities-and-states-are-looking-new-ways-raise-revenue

[8] Id.  The State of State (and Local) Tax Policy, Tax Policy Center, Urban Institute & Brookings Institution Briefing Book (2016),  https://www.taxpolicycenter.org/briefing-book/how-do-state-and-local-sales-taxes-work

[9] See, e.g. Arizona Department of Revenue, Transaction Privilege Tax (2019), https://azdor.gov/transaction-privilege-tax-tpt

[10] See, e.g. Illinois Department of Revenue, Sales & Use Taxes, https://www2.illinois.gov/rev/research/taxinformation/sales/Pages/rot.aspx

[11] What is the difference between sales tax and use tax? Sales Tax Institute (2019),https://www.salestaxinstitute.com/sales_tax_faqs/the_difference_between_sales_tax_and_use_tax  

[12] South Dakota v. Wayfair, Inc. , 138 S.Ct. 2080 (2018).

[13] Sarah Horn, Jill McNally, and Rebecca Newton-Clarke, How States Responded to South Dakota v. Wayfair in 2018, Thomson Reuters (Dec. 21, 2018), https://tax.thomsonreuters.com/blog/how-states-responded-to-south-dakota-v-wayfair-in-2018/; State and Local Finance Initiative, General Sales Tax, Urban Institute https://www.urban.org/policy-centers/cross-center-initiatives/state-and-local-finance-initiative/projects/state-and-local-backgrounders/sales-taxes

[14]The State of State (and Local) Tax Policy, Tax Policy Center Urban Institute & Brookings Institution Briefing Book (2016), https://www.taxpolicycenter.org/briefing-book/how-do-state-and-local-property-taxes-work

[15] The State of State (and Local) Tax Policy, Tax Policy Center, Urban Institute & Brookings Institution Briefing Book (2016)   https://www.taxpolicycenter.org/briefing-book/how-do-state-and-local-property-taxes-work

[16] U.S. Department of the Treasury, State and Local Taxes, (December 5, 2010), https://www.treasury.gov/resource-center/faqs/taxes/pages/state-local.aspx

[17] Chris Seabury, How Property Taxes Are Calculated, Investopedia (Feb. 6, 2019), https://www.investopedia.com/articles/tax/09/calculate-property-tax.asp

[18] Constance Brinkley-Badgett, Comparing average property taxes for all 50 states and D.C. USA Today (Apr. 16, 2017), https://www.usatoday.com/story/money/personalfinance/2017/04/16/comparing-average-property-taxes-all-50-states-and-dc/100314754/

[19] Legislative Analyst’s Office, Understanding California’s Property Taxes (Nov. 29, 2012), https://lao.ca.gov/reports/2012/tax/property-tax-primer-112912.aspx

[20]See, e.g. Illinois Department of Revenue, Property Tax Relief- Homestead Exemptions, https://www2.illinois.gov/rev/localgovernments/property/Pages/taxrelief.aspx

[21] The State of State (and Local) Tax Policy, Tax Policy Center, Urban Institute & Brookings Institution Briefing Book (2016),  https://www.taxpolicycenter.org/briefing-book/how-do-state-and-local-property-taxes-work

[22] Howard Gleckman, From Head Taxes to Parcel Taxes, Cities and States are Looking for New Ways to Raise Revenue, Tax Policy Center, Urban Institute & Brookings Institute, TaxVox: State and Local Issues (June 14, 2018), https://www.taxpolicycenter.org/taxvox/head-taxes-parcel-taxes-cities-and-states-are-looking-new-ways-raise-revenue

[23] Aidan Davis, Property Tax Circuit Breakers in 2018, Institute on Taxation and Economic Policy (Sept. 17, 2018), https://itep.org/property-tax-circuit-breakers-in-2018/

[24]Julia Kagan, Local Tax, Investopedia (May 14, 2018),  https://www.investopedia.com/terms/l/localtax.asp

[25] Howard Gleckman, From Head Taxes to Parcel Taxes, Cities and States are Looking for New Ways to Raise Revenue, TaxVox: State and Local Issues (June 14, 2018), https://www.taxpolicycenter.org/taxvox/head-taxes-parcel-taxes-cities-and-states-are-looking-new-ways-raise-revenue

[26] Tax Cuts and Jobs Act of 2017, Pub. L. No. 115-97, 131 Stat. 2054 (2017).

[27] Scott Ahroni, Biagio Pilato, and Benjamin Silliman, Congress and the SALT Deduction: Past, Present, and Future, CPA Journal (Jan. 2018), https://www.cpajournal.com/2018/01/22/congress-salt-deduction/

[28] Mary Childs, What One of the First Qualified Opportunity Funds Is Doing, Barron’s (Apr. 9, 2019) https://www.barrons.com/articles/what-one-of-the-first-qualified-opportunity-funds-is-doing-51554816569

[29] Internal Revenue Service, Opportunity Zones Frequently Asked Questions, (2019), https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions

 

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