Settlement proceeds may be subject to income tax withholding

Maryland Nonresident Sellers Beware:
Your Settlement Proceeds are Subject to
Income Tax Withholding

By: Jennifer Concino

A nonresident individual seller of Maryland real property may be surprised to learn that the check he walks away with from the closing table will be much less than anticipated; about six (6%) percent less than expected to be exact.

Surprisingly, many agents do not realize that their nonresident sellers may acquire a Certificate of Full or Partial Exemption from the tax, as discussed below. Indeed, we strongly advise agents to assist their nonresident sellers in applying for the Certificate of Exemption as soon as the contract of sale is executed; application for an exemption must be made to the Comptroller of Maryland no later than twenty-one (21) days before closing and with such a Certificate, the nonresident seller can walk away from settlement with all of his proceeds of sale.

In 2003, the Maryland Legislature passed an Act mandating the withholding of income tax on the sale of all real property by nonresident individuals and nonresident entities. Settlement officers are directed to ensure sufficient funds are withheld from the closing and are also required to pay the withheld tax to the recording office at the time the deed is submitted for recordation. The amount of tax currently required to be withheld is six (6%) percent of the "total payment" to a nonresident individual and 7% to a nonresident entity. Indeed, the Clerk of the Land Records office will not accept an instrument for recording unless the withheld tax is paid or the instrument refers to one of the exemptions from the withholding requirement.

Those exemptions are:

1. a certification under penalties of perjury or an acknowledgment in the deed that the seller is a resident of the State of Maryland;
2. a certification under penalties of perjury or an acknowledgment in the deed that the property sold is the seller's primary residence as determined under the Internal Revenue Code;
3. the property is transferred pursuant to foreclosure or a deed in lieu of foreclosure;
4. the property is transferred to the government;
5. a statement in the deed indicating that the consideration paid for the property is zero; and
6. a certificate issued by the Comptroller of Maryland stating that no tax or a reduced amount of tax is due on that particular sale or that the seller has provided adequate security to cover the tax liability.



With regard to exemption to number 6. (six), above, the Comptroller has noted several circumstances under which he will issue such a certificate. A sample of those circumstances are:

* The tax due has already been paid;
* The transfer is made on an installment sales basis under Section 453 of the Internal Revenue Code;
* The seller is a tax exempt entity under Section 501(a) of the Internal Revenue Code;
* The transfer is to a partnership in exchange for a partnership interest so that no gain or loss is recognized under Section 721 of the Internal Revenue Code;
* The transfer is a like-kind exchange under Section 1031 of the Internal Revenue Code; or
* The transfer is between spouses or incident to a divorce in accordance with Section 1041 of the Internal Revenue Code.

Frequently Asked Questions:

Is the amount of tax withheld calculated on the sales price or the net proceeds?
The "total payment" on which the Maryland income tax is withheld is equal to the total sales price for the property less (1) debts of the seller securing the property that are being satisfied at closing; and (2) expenses of the seller arising out of the sale of the property that are disclosed on the settlement statement. However, debts being satisfied at settlement that are secured within ninety (90) days of closing cannot be deducted from the "total payment" calculation.

How are taxes withheld where there are both resident and nonresident joint sellers?
The "total payment" will be divided into as many shares as there are sellers. Each seller's residency will then be separately determined and any share of a nonresident will be subject to withholding.

If income tax is withheld on the sale, does the nonresident seller still have to file a Maryland nonresident income tax return?
Yes.

If a nonresident seller believes too much money was withheld, can he request a refund before filing the nonresident income tax return for that year?
The seller may file an Application for Tentative Refund of Withholding on Sales of Real Property by Nonresidents with the Comptroller sixty (60) days or more after the tax was paid.

Is tangible personal property sold with the property by a nonresident seller also subject to withholding?
Yes.

Have you considered incorporating your real estate business?

Have You Considered Incorporating
Your Real Estate Business

By Stephen J. O'Connor of Tobin O'Connor & Ewing

A corporation or limited liability company (LLC) can be formed quickly and efficiently by filing standardized documents with the appropriate jurisdiction. A corporation that, after being formed, elects to be taxed as a "pass-through" entity under Subchapter "S" of Chapter 1 of the Internal Revenue Code is known as an S corporation.

So, why should you consider forming an S corporation or LLC to operate your real estate business? There are two principal reasons.

1. First, each of these entities may protect you from personal liability for the debts and obligations of your real estate business. By contrast, a self-employed real estate agent (often called a "sole proprietor") can be liable for damages and injuries caused by the business, such as a "slip and fall" incident. The sole proprietor real estate agent also may be legally responsible for the professional errors/omissions or negligent acts of other agents or staff he or she employs or engages. No liability-shielding entity, however, can protect your personal assets from debts and obligations arising out of your own professional errors/omissions or negligent acts.

2. Second, your overall income taxes may be lowered by choosing an entity to operate your real estate business. An LLC or S corporation, for the most part, is not subject to income tax at the entity level. Owners avoid "double taxation" by paying income taxes on the profits of the LLC or S corporation on a flow-through basis like a sole proprietor. While an LLC with just one owner (or "member") is disregarded as a separate entity for tax purposes (and therefore treated as a sole proprietorship), an LLC with multiple members can allocate profits/losses in any way they choose. In an S corporation, shareholders must receive dividends in proportion to their shareholdings, regardless of the amount of time or effort they "invest" in the business. The biggest tax advantage enjoyed by S corporation shareholders is that they pay employment taxes (FICA and Medicare) only on money received by them as wages or salary, but not on profits or dividends (a savings of up to 12.4% compared to an LLC or sole proprietorship). LLC members typically pay employment taxes on the entire amount of LLC profits (regardless of whether or not the profits are distributed to the members).

There are several noteworthy distinctions between an LLC and an S corporation.

For instance, an LLC is not required to hold meetings or to keep formal minutes, while an S corporation may be required to do so. Owners of an S corporation are limited to a maximum of 100 stockholders and cannot include nonresident aliens or other entities, while members of an LLC have no such restrictions. Stockholders of an S corporation may deduct "pass-through" losses only to the extent of their actual investment in the company, while members of an LLC may deduct "pass-through" losses not only up to the amount of their actual investment in the company, but their proportionate share of the company's borrowings as well.

If you are considering the formation of an entity to operate your business, you will want to organize the entity in the jurisdiction (i.e., Maryland, Virginia or the District of Columbia) in which you operate your business (not necessarily where you reside). This may eliminate the need to file tax returns in multiple jurisdictions relating to the business.

Lastly, an LLC is the definite choice of entity to hold your rental real estate. Since rental income is not subject to employment tax, an S corporation is of no avail for this business purpose.

For more information on planning your business, forming an LLC or S Corporation, please contact Stephen J. O'Connor at Tobin O'Connor & Ewing, 202-362-5900.