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1of6Ben Kaminsky roasts beans at the Ritual Coffee roastery in San Francisco, Calif. on Thursday, June 7, 2012.Paul Chinn/The Chronicle
2of6Eileen Hassi (left), owner of Ritual Coffee Roasters, talks with employee Kaleena Stoddard at the company's roastery in San Francisco, Calif. on Thursday, June 7, 2012.Paul Chinn/The Chronicle

San Francisco Mayor Ed Lee will present a plan to overhaul the city's business tax to the Board of Supervisors on Tuesday with the hope they will place it, or a similar version, on the November ballot.

The plan would replace the city's payroll tax with a tax on gross receipts, which is another name for sales or revenues.

Today, the city charges businesses a flat 1.5 percent of what they pay their employees in San Francisco. Companies with less than $250,000 in San Francisco payroll are exempt, but if they exceed that limit by even $1, they owe 1.5 percent on their entire city payroll.

Although the payroll tax is relatively simple to calculate and audit, it's politically unpopular in an era when jobs are in short supply. Critics say it raises the cost of labor and discourages hiring in San Francisco.

Under a proposal put out by the controller's office May 10, the city would scrap the payroll tax and charge businesses a tax based on their gross receipts generated in San Francisco.

The gross receipts tax would be far more complex and thus easier to game than the payroll tax. But proponents say it would be more equitable because instead of taxing only labor, it effectively would tax all of the inputs that go into a company's product or service - including property and equipment.

It would put labor-intensive and capital-intensive companies on a more level playing field.

Some firms that are exempt from the payroll tax would be subject to the gross receipts tax. By broadening the tax base, the city could cut taxes for many firms and raise the same amount of revenue.

San Francisco is the only California city with a payroll tax. About 35 of the state's 50 largest cities have a gross receipts tax.

The payroll tax brings in about $400 million a year, or 12 percent of San Francisco's general fund. It is the city's second-largest revenue source after property taxes, which account for 36 percent of the general fund.

The May 10 plan is designed to bring in the same revenue as the payroll tax, but a newer version that has not been made public yet would raise an additional $13 million by increasing the annual registration fees that larger businesses pay, says Tony Winnicker, a senior adviser to Lee. The additional revenues would help fund a housing trust Lee wants to create.

Plan at a glance

Here's how the May 10 plan would work:

-- Instead of a single rate, there would be six rate schedules for companies in six broad sectors. Retailers would pay the lowest rates; those in private education/health/insurance/administrative services would pay the highest. A business that operates in two sectors would pay different rates on revenues from each sector.

-- Instead of a flat tax, the gross receipts tax would be progressive, like an income tax. Large companies would pay a higher effective rate than small ones in the same sector.

-- Companies that do business inside and outside the city would apportion their gross receipts using one of three different formulas. For example, revenue from services would be allocated based on a company's payroll. If a law firm had 60 percent of its payroll in San Francisco, 60 percent of its revenue would be subject to the gross receipts tax.

This would seem to have the same negative effect on hiring as a payroll tax. But Ted Egan, the controller's chief economist, says, "It is much less negative than the payroll tax because it is not directly raising the cost of labor."

-- Small businesses with less than $100,000 in annual San Francisco gross receipts would be exempt from the tax but would pay an annual registration fee of $150.

Under the new, unpublished plan, the small-business exemption would be raised to $1 million in gross receipts. The annual registration fee would range from $75 a year for companies with less than $100,000 in gross receipts to $20,000 a year for companies with more than $100 million in gross receipts, Winnicker says.

Today, registration fees range from $25 to $500.

Egan warns that the plan is "a work in progress" and that it could change before it reaches supervisors and voters.

Who wins

Even if the plan is revenue neutral, taxes would go down for many businesses but up for some, which is why it must be submitted to voters. It needs a simple majority to pass.

Labor-intensive companies - such as retailers, restaurants and hotels - would generally see their share of the tax burden go down under the gross receipts plan. So would professional, scientific and technical services firms.

Startups with personnel but little or no revenues would fare much better.

Eileen Hassi, owner of Ritual Coffee Roasters in San Francisco, was stunned when she received a bill for almost $4,000 in payroll taxes for 2006, her first full year in business. At the time, she had only $11,000 in her bank account and couldn't pay the tax on time, which resulted in a hefty late penalty.

"This was an enormous burden for a new business," she says. Hassi figured that her tax for 2006 would have been only $900 under the May 10 gross receipts plan - about one-fourth of her payroll tax burden.

In 2011, when her coffee roasting and cafe business was much bigger, her gross receipts tax would have been about half of her payroll tax.

"Even the most successful businesses are generally in a very precarious situation in their first year or two. Or five or 10," Hassi says. "Having a tax based on gross receipts would be much more equitable and less likely to push a business teetering on the edge into failure."

Who loses

Finance, real estate and insurance firms would fare worse under the plan. They would pay a larger share of the city's gross receipts tax than the payroll tax.

Commercial landlords would be especially hard hit. Right now, their payroll tax is minimal because they can manage a large building with a handful of people. Most services - such as engineering, security and maintenance - are outsourced. But under the May 10 plan, their rental income would be subject to the gross receipts tax.

Ken Cleaveland, a vice president with the Building Owners and Managers Association, says the owner of an average office building would pay 10 times more under the May 10 proposal.

Cleaveland says his association has not taken a stance on the plan yet. One reason it might not oppose it: At least 50 percent of the tax increase would be passed on to tenants. Commercial leases typically let building owners pass on operating costs, including taxes, after the first year.

Broader base

Some business groups like the plan because it would broaden the tax base.

Only 8 percent of the 96,000 business entities registered in San Francisco pay the payroll tax. The other 92 percent are exempt because they are nonprofits, have less than $250,000 in payroll or qualify for one of myriad exemptions.

The city cannot tax banks because the state Constitution prohibits it, although it can tax their non-banking activities. It also cannot tax intrastate trucking companies or insurers, but it can tax insurance agents and brokers.

Under federal law, the city cannot levy a payroll tax on companies in federal enclaves, such as the Presidio (home of the George Lucas complex) or Fort Mason.

City exemptions

The city has voluntarily granted temporary payroll tax exclusions for firms in biotech, clean technology and the Mid-Market Street area. It is also waiving the tax on certain stock-based compensation for companies going public between 2011 and 2017.

The gross receipts tax, by comparison, would apply to 35 percent of business entities under the May 10 proposal.

Sole proprietors and partnerships with no payroll would be liable for the gross receipts tax. So would companies on federal land.

But many entities would still be exempt, including nonprofits, banks, insurers, truckers and companies with less than $100,000 in gross receipts.

Businesses that have been granted temporary payroll tax exemptions would calculate what that exemption would have saved them and deduct that amount from their gross receipts tax until the exemption sunsets.

Rich Gunn, a partner with accounting firm Burr Pilger Mayer, compared what 19 of his clients would owe under the May 10 proposal versus the payroll tax.

The clients are in a variety of industries and have six to 286 employees. He found that only three of the 19 would have owed more under the gross receipts tax - two in real estate and one in the Presidio. The others would owe less.

Under the newer plan, with the $1 million small-business exemption, 20 percent of business entities would pay the gross receipts tax and 80 percent would be exempt.

Job creation?

Egan estimates that over 20 years, there would be an average of 2,400 more jobs in the city under the gross receipts tax than under the payroll tax. That's not a huge increase on a base of 600,000 jobs.

But ending the maligned payroll tax would send the message that San Francisco cares about job creation. "It's symbolic," says Scott Hauge, owner of Cal Insurance and president of Small Business California.

Whether such benefits outweigh the added complexity of a gross receipts tax is debatable. If approved, the new tax would be phased in over five years, adding to the complexity.

Hauge says he likes the gross receipts plan with the $1 million exemption.

San Francisco Citizens Initiative for Technology and Innovation, a coalition of tech companies, supports the gross receipts tax, although it's not clear that all tech firms will benefit.

"I do think small tech companies will be winners," Egan says. But "the biggest stars of the tech world will have huge gross receipts on fairly low payroll."

The San Francisco Chamber of Commerce "has always favored the concept of getting rid of the payroll tax, but the devil is in the details," says chamber Senior Vice President Jim Lazarus.

"Even if it's revenue neutral to the city, there will be winners and losers. The question is whether everyone at the table can work out a plan that minimizes" the gains and losses.

Kathleen Pender is a San Francisco Chronicle columnist. Net Worth runs Tuesdays, Thursdays and Sundays. E-mail: [email protected] Blogging at Twitter: @kathpender