The recent introduction of Senate Bill 316 in the 2002 Maryland General Assembly session, a bill seeking to impose recordation and transfer taxes on the transfer of controlling interest in certain business entities that own real estate, creates an important opportunity to review the subject of recordation and transfer taxes in Maryland.

Recordation Tax

The State of Maryland imposes a recordation tax on instruments of writing recorded with the clerks of the circuit courts or filed with the Department of Assessments and Taxation. The State allows Baltimore City and the counties to set their own tax rate and to establish exemptions within their jurisdictions. For instruments conveying title to real property, the tax is imposed on the actual consideration paid; for instruments creating a security interest in real or personal property, the tax is imposed on the principle amount of debt secured. Current rates range from $1.65 to $5.00 per $500 of consideration or secured debt.

The counties are allowed to keep the amount of tax collected, less the State’s cost in administering and collecting the tax. Annual recordation tax revenues range from $120,000 in Somerset County to $21.8 million in Montgomery County.

Transfer Taxes

In addition to recordation tax, the State imposes a transfer tax on transfers of real property. The State transfer tax rate is 0.5% of the consideration payable for an instrument of writing (one conveying title to or a leasehold interest in real property); however, in the case of a first-time Maryland home buyer purchasing a principal residence, the transfer tax rate is 0.25%, to be paid by the seller. The State uses the revenue derived from the State transfer tax to finance Program Open Space and other land preservation programs. The State’s annual transfer tax revenue last year was $71.2 million.

The State also has authorized many counties to impose a transfer tax on instruments of writing. Sixteen counties and Baltimore City impose a county transfer tax. Code counties are authorized by statute to impose a transfer tax with a maximum rate of 0.5%. In other counties, the transfer tax rate typically ranges between 1.0 and 1.5%. Transfer tax revenues for those counties that collected them last year from $120,000 in Caroline County to $37.4 million in Montgomery County.

Entity Ownership of Real Property

Simply put, an entity is any organization or being that possesses a separate existence for tax, limited liability or other purposes. An entity is separate from its owners, and it may make contracts, conduct business, and own real or personal property. Examples include corporations, partnerships, and limited liability companies.

Corporations

A corporation is an artificial person or legal entity created under the authority of the laws of a state. The law treats a corporation itself as a person; it is distinct from the individuals who own it (its stockholders). A corporation can sue and be sued; it can own real or personal property; and it can survive the deaths of its investors, since its shares are usually transferable. Because a corporation is treated as a distinct legal entity, the corporation’s shareholders and its managers are protected from the corporation’s debts and liabilities. However, a corporation must file tax returns apart from the returns of its shareholders and must pay corporate income tax.

Partnerships

Partnerships can take more than one form, but they are an agreement by two or more persons who associate to carry on business as co-owners for profit and who are personally liable for debts of the partnership. Unlike shareholders of a corporation, general partners are jointly and severally liable for all the debts of the partnership. In other words, each partner is personally liable for all the debts of the partnership, and any one or more or all of the partners could be sued for the total amount of any of the partnership’s debts. A partnership is not taxed separately like a corporation.

Limited Liability Companies

The newest form of Maryland business entity, authorized for the first time in 1992, is the limited liability company. The LLC is somewhat of a hybrid of corporation and general partnership. It offers the same shield from liability given by a corporation but with the option for pass-through taxation enjoyed by a partnership or proprietorship. Unlike a general partnership, members are not personally liable for the obligations of the LLC; unlike a corporation, an LLC can be structured so as to avoid a separate income tax.

Transfer of Ownership of the Entity

The ownership of an entity is typically transferable. In general, stockholders of a corporation can sell their stock, partners can sell their interests in a partnership, and members of an LLC can sell their membership interests in the LLC without liquidating or dissolving the entity. When real property is owned in the name of the entity, whether it is a corporation, partnership, or LLC, the actual ownership of that property can effectively be transferred without changing its legal ownership. Ownership remains in the name of the entity; however, the entity can change ownership. In other words, once real property is under entity ownership, the property can be effectively transferred by a transfer of an interest in the entity instead of by direct transfer of the property. Under current Maryland law, a transfer of an interest in an entity owning real property, as distinguished from a transfer of the real property, is not subject to recordation or transfer taxes.

For example, individuals A and B form a corporation, C Corp, to purchase and manage real property. A and B purchase real property in the name of C Corp. C Corp records its deed and pays the appropriate recordation and transfer taxes. Later, A and B decide to sell the real property to individual D. Instead of causing C Corp to sell the property to D, a taxable event, A and B sell their shares of stock in C Corp to D. D in effect owns the real property because she now owns all the shares of C Corp. Had D purchased the real property from C Corp, recordation and transfer taxes would have been imposed on the transfer. However, because the title to the real property remains in C Corp, no deed had to be recorded and, thus, no taxes paid on the transfer.

Conversion from Other Business Forms to an LLC

In recent years, the General Assembly enacted legislation to facilitate the conversion from other business forms to the LLC form without the payment of recordation and transfer taxes that would otherwise be imposed on the transfer of real property from the predecessor entity to the LLC.

Senate Bill 316

S.B. 316 now pending before the General Assembly seeks to significantly alter tax policy in Maryland by imposing recordation and transfer taxes on the transfer of a controlling interest in certain business entities that own real estate. Currently, tax is only imposed for the privilege of recording instruments (e.g., deeds, mortgages, etc.) within the recording system maintained by the clerks of court. The recording system operates so a property owner can give public notice to anyone interested that he or she has received a deed to the property.

But S.B. 316, if enacted, would impose transfer and recordation taxes on the transfer of intangible interests in business entities without regard to whether the clerks’ recording system is utilized in the transaction. Specifically, the legislation imposes tax when 50% or more of such interests are conveyed in an entity when real estate constitutes 80% of its assets. The bill presents a host of technical problems (not the least of which is how the proposed system could be administered given the thousands of transfers taking place annually that will now be burdened with tax and reporting requirements), but the threshold issue remains the greatly expanded taxes on business and the significant change in tax policy that expansion represents.

The clear purpose of the bill (in a year that the Governor has proposed transferring millions of dollars from Program Open Space to make up budget short falls in other areas) is to raise revenue by taxing business transactions that are today not subject to tax.

S.B. 316 is pending before the Senate Budget and Taxation Committee. If you want to express your views on this new tax, you should promptly call or email your senator and delegates, the members of the committee, and the committee chair.