DC Franchise Tax – The 80% Test

Unincorporated businesses are not subject to DC franchise tax if more than 80% of annual gross income comes from personal services rendered by owners, members or partners of the business. Commonly referred to as the 80% test, this exemption does not apply to corporations. This test applies to a wide swath of DC businesses including law, consulting & lobbying firms.

The 80% test is generally determined based on how much your business paid employees and independent contractors during the year. If total payments to employees and independent contractors exceed 20% of gross income than the business does not meet the 80% test and is subject to DC Franchise tax.

The test is made on an annual basis, so you may meet the 80% test one year and not the next. Year-end tax planning can be very useful; for example If your business is “on the bubble” at year end, effectively timing when you pay contractors can help you meet the 80% test and save substantial DC franchise Tax. This is a major tax issue for many DC businesses that is too often not effectively addressed.