In 2019, Washington State Enacts Major Tax Increases, New Economic Nexus Threshold and Stringent Requirement for Nonresident Exemption

The Washington State Legislature concluded the 2019 legislative session by enacting major tax increases. The largest of which came in the form of a Business and Occupation (B&O) surcharge levied on service-oriented and high-tech businesses. Large financial institutions and commercial property owners are also subject to higher tax rates. Other new laws specify the threshold for triggering economic nexus, require nonresidents to pay tax and apply for refunds on exempt items and simplify the methodology for apportioning local service income for purposes of municipal B&O taxes.

The following is a brief summary of the key tax provisions of the 2019 legislative session.

Service and Other Activities B&O Tax Increase (HB 2158)

The service and other activities B&O tax classification is a catch-all provision of the Washington B&O tax code that applies to businesses who provide personal or professional services and do not fall under another classification. Beginning January 1, 2020, in order to fund workforce education initiatives, Washington will impose a tiered Workforce Education Investment surcharge on the business activities reporting services and other B&O tax by certain business activities in tier 1 and Select Advanced Computing businesses in tier 2 and 3.

Washington calculates the surcharge owed based on a percentage of the current 1.5% rate for Service and Other Activities prior to application of tax credits. The surcharge ranges from an additional .3% to an additional 1%. The surcharge applies if a business engages in specific enumerated activities listed and the gross income attributable to these activities exceeds 50% of the business total receipts in the current or prior year. Further, any ambiguity in the act will be construed in favor of the Washington Department of Revenue (DOR) in collecting this added B&O surcharge until January 1, 2022. Practically, Washington has enumerated over 60 business activities that determine the additional surcharge.

Tier 1 specified companies must pay a 20% B&O surcharge equivalent to an additional 0.3% to the rate for Service and Other Activities (an increase in B&O tax rate from 1.5% to 1.8%). The surcharge applies prior to application of tax credits. This treatment will apply to 43 enumerated activities including, but not limited to, professional services, computer software publishing, research and development, information technologies, and banking and financial services.

Tier 2 Select Advanced Computing businesses are subject to an effective 2% B&O tax rate. The Tier 2 surcharge rate applies to an affiliated group of Select Advanced Computing businesses generating annual worldwide gross revenue between $25 billion and $100 billion. Such groups will be subject to a 33.3% surcharge equivalent to an additional 0.5% to the rate for Service and Other Activities prior to application of tax credits (an increase in B&O tax rate from 1.5% to 2.0%). The tax is payable by each member of the affiliated group on all activities taxed under Service and Other Activities. Select Advanced Computing includes designing or developing computer software or computer hardware including, but not limited to, cloud computing services or operating an online marketplace, search engine, or social networking platform.

Tier 3 Select Advanced Computing businesses are subject to an effective 2.5% B&O tax rate. The Tier 3 surcharge rate applies to Select Advanced Computing businesses generating over $100 billion of worldwide gross revenue annually. These businesses will pay a 66.6% surcharge equivalent to an additional 1% to the rate for Service and Other Activities prior to application of tax credits (an increase in B&O tax rate from 1.5% to 2.5%).

The law also provides that for Select Advanced Computing businesses, a minimum tax of $4 million and maximum of $7 million annually would be owed for a combined affiliated group. However, it is questionable whether Washington could constitutionally impose a minimum tax on these businesses.

Additional B&O Tax Imposed on Specified Financial Institutions (HB 2167)

Beginning January 1, 2020, Washington will impose a 1.2% tax on gross income of any consolidated financial institution group that reported at least $1 billion of net income from controlling interests on its consolidated financial statement during the prior year. This tax applies in addition to any other tax owed, including the new Service and Other Activities surcharge.

Narrowing Exemption for International Investment Services (SB 6016)

Beginning July 1, 2019, Washington limited the scope of activities and persons qualifying for the preferential international investment management services (IIMS) B&O tax rates by narrowing the definition of qualifying IIMS. Previously, Washington set a lower B&O tax rate if the taxpayer was primarily engaged in an investment management business and if 10% of its gross income was derived from qualified clients. Washington added additional criteria to qualification for the lower rate including a minimum number of employees, threshold amounts of assets under management, threshold income amounts, membership in an affiliated group, number and location of offices, and percentage of Washington based employees.

Implementation of Graduated Real Estate Excise Tax (SB 5998)

Beginning January 1, 2020, real estate excise tax (REET) will be applied on a graduated scale. With the exception of timberland and agricultural real property, which continues to be subject to a state REET rate of 1.28%, the excise tax rate on the sales of real property will be:

• 1.1% if $500,000 or less;
• 1.28% if between $500,000 and $1.5 million;
• 2.75% if between $1.5 million and $3 million; or
• 3% if over $3 million.

Washington mandated the DOR adjust this scale every four years depending on future markets. The legislature also extended the REET definition of sale as the transfer or acquisition of a controlling interest in an entity with an interest in real property in Washington from 12 to 36 months.

State Nexus Provisions, Collection of New Tax Revenue as a Result of Wayfair (SB 5581)

As a result of the United States Supreme Court decision in South Dakota v. Wayfair, Washington enacted legislation to clarify its position on nexus for out-of- state sellers. Wayfair, decided in 2018, held businesses without a physical presence in a state can be subject to sales tax collection obligations solely as a result of their economic activity within the jurisdiction. The new law specifies that any nonresident individual or commercially organized business activity domiciled outside the state is deemed to have substantial nexus if it has more than $100,000 of cumulative gross receipts, in the current or immediately preceding calendar year, from Washington or more than the slightest presence in Washington.

Changes to Nonresident Sales and Use Tax Exemption (SB 5997)

Beginning July 1, 2019, nonresidents must pay retail sales tax to the seller at the time of purchase and request remittance from the Washington DOR afterwards. This is a departure from the seller maintaining records of nonresident exemption when he or she displayed identification or an exemption certificate at the time of sale. A remittance request, limited to one per year, will require proof of the purchaser’s status as a nonresident, receipt of purchase, and details of qualified sales.

Simplified Municipal B&O Tax Apportionment (HB 1403)

Beginning January 1, 2020, Washington simplified the administration of municipal B&O taxes by updating its sourcing and apportionment rules. The new law amends the service income apportionment rules to adopt a market-based sourcing model, includes a throw-out provision for service income not taxed elsewhere, and adopts consistent rules for both taxpayers and local tax administrators to request alternative allocation and apportionment of receipts.

With respect to businesses deriving income from activities taxed as services, Washington municipalities currently are required to apply a standard two-factor apportionment formula to source such income for B&O tax purposes. The two-factor formula consists of service income and payroll.

Apportionment of Service Receipts

For purposes of the local B&O tax service-income factor, service income is currently sourced to the customer location based on the physical contacts of the business with the customer. If the income-producing activity is performed in more than one location, service income is sourced to the location where the greater proportion of the income-producing activity is performed by the business, based on costs of performance.

Under the new rule, customer location is now defined using a hierarchy for sourcing gross receipts as follows:

• For a customer not engaged in business:
  1. the location where the service is performed if the customer must be physically present;
  2. the customer’s residence; or
  3. billing address if the customer must be physically present.
• For a customer engaged in business:
  1. the location where services are ordered from;
  2. the customer’s billing or mailing address; or
  3. the customer’s commercial domicile.

Throw-Out Provision

Additionally, Washington adopted new calculation rules related to the services-income factor effectively implementing a throw-out calculation for service income attributed to a location where the taxpayer is not subject to tax. The purpose of the throw-out rule is to avoid a situation in which a business has receipts that are not being taxed by any jurisdiction. Gross income of a business engaged in an apportionable activity must be excluded from the denominator of the service-income factor if at least some of the activity is performed in the city or locality, and the gross income is attributable to a city or unincorporated area of a county within the United States or to a foreign country in which the taxpayer is not taxable.

The term not taxable in the city was updated and no longer requires physical contacts with customers to be tracked. The amended service income sourcing rules may have a significant impact on in-state taxpayers operating in cities imposing B&O tax. Under the new rule, provided that the in-state company’s services are delivered predominantly to outside of the state marketplace, the service income factor should decrease and likely reduce total tax due.

The Takeaway for Washington and Out-of-State Businesses

Businesses providing services to Washington customers must understand whether their business activities are subject to the new surcharges or whether their local reporting will change based on revenue sourcing. Please contact Andersen if you would like to discuss the impact of these changes to your business.