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Tax on indemnity mortgages draws fire from business groups

ANNAPOLIS — Robert M. Bauman says no single measure passed by the General Assembly is particularly lethal to business in Maryland. But that doesn’t mean he thinks the legislature’s cumulative actions aren’t potentially deadly.

Robert M. Bauman, president of Trusted Systems Inc. in Taneytown, says the cumulative effect of actions by the Maryland General Assembly on business ‘is death by a thousand cuts.’

“This is death by a thousand cuts,” said Bauman, president of Trusted Systems Inc. in Taneytown. “They’re just slicing away at little pieces along the way.”

Bauman, president of the 26-year-old company that makes security cabinets for computer equipment, echoed the sentiment of some lawmakers — mostly Republicans but also some Democrats — and state business groups who vehemently opposed the result of a special legislative session that concluded Wednesday with $262 million in various tax increases.

Leading those increases was an income tax hike on Maryland’s wealthiest residents — individuals earning $100,000 or more and couples earning better than $150,000 annually. But the revenue package also taxes indemnity mortgages of more than $1 million and repeals a tax credit for real estate owned by telecommunications companies.

Richard Clinch, director of economic development for The Jacob France Institute at the University of Baltimore, said all of the tax increases are a serious concern for the state’s economy.

“We’re raising taxes at a time when we need to attract more business,” said Clinch, citing the potential future loss of jobs because of fiscal belt-tightening at the federal level. “We could see very disruptive changes over the next few years.”

But that doesn’t mean a budget that contained some $500 million in spending cuts to education, public safety and some tax credits — the “doomsday” budget that was enacted when lawmakers couldn’t agree to a tax package on the final day of the legislature’s regular session — would have been any better, Clinch said.

“These decisions, however hard, do have a business impact. But so did the ‘doomsday’ budget,” Clinch said. “I’m not sure which one would have been worse. But, clearly, raising taxes is problematic in the long run.”

Business aid or loophole?

That includes the new tax on indemnity mortgages, Clinch said.

Under an indemnity mortgage, a lender agrees to loan money to a borrower if a third party guarantees repayment of the loan and then executes a mortgage on real property. The special mortgage — often used by developers and business owners looking to expand — allows borrowers to get a larger loan than they might otherwise.

“It’s exactly the type of thing we shouldn’t be taxing at this point,” Clinch said. “If you tax development, you get less development.”

The new tax raises $36 million for local jurisdictions, helping to offset the cost of a four-year, phased-in shift of half the cost of teacher pensions to counties.

But it also makes residential and commercial development significantly more difficult, said Tom Ballentine, a lobbyist for NAIOP, a trade group for commercial developers.

“Our members use this for construction loans,” Ballentine said. “That’s a real drag on construction loans, at a time when everybody is trying to find ways to spur commercial construction activity.”

Some Democrats called indemnity mortgages a tax loophole through which borrowers could establish a limited liability company and then avoid paying the recordation tax, which is a fee charged to record a mortgage or deed. Ballentine disagrees.

“I would argue against the notion that it’s a loophole,” he said. “These transactions operate exactly the way the law intended it to. It has certainly mitigated against how overly broad and repetitive the recordation tax is.”

Ballentine said if recordation mortgages are taxed, the owner of a commercial property will have to pay that tax each time he refinances — something that happens every three to seven years for many properties.

Developers aren’t the only group that will feel the tax’s impact. Republican members of the General Assembly said indemnity mortgages were a useful tool for small business owners seeking to expand because it allows them to take out larger loans for real property than they might otherwise be able to.

Bauman, the security container company president, agreed. He leases his office space in Carroll County because he fears real estate investment in a still-slow economy, but said he’s long been interested in owning a space.

However, the legislature just made that option more expensive and less likely, he said.

“We’re holding our cash near and dear, as a lot of small businesses are,” Bauman said. “I can see where that would be of significant value, because you are able to borrow more when there is mortgage insurance involved.”

Owning real estate shows commitment to an area, Bauman said, which in turn leads to positive business growth. By tacking on additional cost to that ownership, he said, the legislature discouraged such growth.

“If you can’t grow, you can’t hire. You can’t hire first and then grow,” Bauman said. “You’ve got to have the capital; you’ve got to have the marketplace. You’re not going to expand your business until you have the business there to do it. It doesn’t work the other way around.”

The tax may ultimately be undone. A provision in the budget package calls for a work group that will study the tax’s impact. The results of that study will be reported to the legislature before the 2013 legislative session, when Ballentine hopes the tax will be repealed.

“In the interim, it makes it more difficult for small businesses and commercial real estate companies to access capital,” Ballentine said. “It makes it more difficult and more expensive. It certainly will expose small business and real estate companies to heavy recordation taxes in a way that deserves serious evaluation.”

Repeal of 1997 tax credit

Not slated for review is the repeal of a 1997 tax credit for telecommunications companies that own real estate in Maryland.

Ron Wineholt, vice president of the Maryland Chamber of Commerce and former director of the state Department of Assessments and Taxation, said lawmakers passed legislation creating the tax credit to end “discriminatory levels of taxation on their real property.”

Before 1997, companies such as Verizon and AT&T paid a real estate tax about 2.5 times higher than their competitors in the satellite and cable industry, Wineholt said. That’s because the phone companies were being taxed at the rate of a regulated utility, such as a power company.

In exchange for an equal real estate tax rate, Wineholt said the phone companies agreed to be subjected to the corporate income tax, which raised telecommunications’ companies’ tax bill but leveled the playing field on real estate with competitors who, in the late 1990s, were just beginning to branch into telecommunications.

“The traditional telecommunications companies are facing even more competition than ever,” Wineholt said. “Homeowners are dropping their land lines and going to wireless service. And these companies are now subject, once again, to the discriminatory levels of taxation on their real property.

“Every argument [made in 1997] is even more persuasive now.”

‘It makes you cut back’

Nevertheless, the budget package has passed to Gov. Martin O’Malley to sign into law, despite the mostly symbolic rebellion of some Democratic members of the legislature, who joined Republicans in voting against tax increases.

Some Democrats voted against the increases because they felt they did not raise taxes enough. Others, like Sen. Bobby Zirkin, D-Baltimore County, said he saw too much unnecessary spending in the state’s budget to believe that tax increases were proposed solely to fund education and other state priorities.

Zirkin noted more than $100 million was included for the Red Line and Purple Line mass transit projects, despite those projects being years away.

“I am for mass transit, but that’s not something you go and dig deeper in tax dollars for,” Zirkin said. “That’s a lot of money. That’s not essential spending.”

O’Malley said the budget reflected spending that was important to the state.

“What we were able to pass in this budget session is a budget that is good for Maryland,” the governor said. “A budget that increases our investment in public education … We’ve been able to make college education more affordable, even though in other states they’re making college education more expensive. We’ve protected important competitive advantages we have in life science, biotech research and development that allows us to create jobs in the new economy.”

Del. Tom Hucker, D-Montgomery, agreed with O’Malley, saying that increasing higher education tuition at a higher rate and reducing public schools spending would have had a more detrimental effect on state business than any tax increase.

“It’s a pretty modest price to pay,” Hucker said. “It’s not good for business if there’re new cuts. You would … have employees within a workforce that’s less trained and less skilled.”

But Bauman said he doesn’t understand that logic. From where he sits, increased taxes are harmful to business and the economy, period.

“It does take out more money than I have for investment, for growth within the business,” Bauman said. It is discretionary income that’s now not going to be spent within the economy. It just makes you cut back a bit more.

“Right now, my biggest concern is my employees and what impact that has on our ability to survive as a company.”