A look at the B & O, Economic Nexus, Elimination of Physical Presence and Amnesty
In the current economic environment, states have a tightrope to walk between balancing the need to increase revenues with the need to save and create jobs. The state of Washington probably thinks it has found a creative way to do both.
Prior to June 1, 2010 many of WA’s in-state companies that provided services were at a competitive disadvantage to out of state companies. In instituting an economic nexus standard in addition to changing the apportionment method for certain companies to “single factor receipts apportionment” WA has leveled the playing field. In fact, many WA companies with out of state sales will see their taxes go down, some substantially.
On the other hand, out-of-state companies who have never worried about the B & O before will now be subject to the WA tax, even if they don’t have a physical presence. Common sense tells us that WA will look at ways to not only make up for the tax relief they have provided their domestic companies, but also to bring in the additional revenues all states are looking for. Increased enforcement of both the B & O and the sales and use tax are two of the most logical ways to do this. Out-of-state companies who are not paying the B & O seem to be likely (and lucrative) targets. The current amnesty program is a useful tool that many taxpayers may or may not take advantage of for a multitude of reasons.
However, if you currently provide a service in WA or receive a royalty out of WA and are not paying the B & O, this may be your best opportunity to become compliant as well as avoid all the penalties and interest.
Before we take a look at amnesty, let’s explore the B & O, economic nexus and the ramifications of single factor receipts (sales) apportionment.
What is the B & O?
B & O is short for business and occupation tax. Washington does not have an income tax and instead uses the B & O which is a gross receipts tax. A gross receipts tax is different from an income tax in that it is not levied on profits but instead on the total revenue of all goods and services. Since we are talking about gross income there are no deductions from the B&O tax for labor, materials, taxes, or other costs of doing business. The tax rate is different depending on the classification of your business.
What is Washington’s Economic Nexus?
Washington’s economic nexus, which became effective on June 1, 2010, is applicable only to income that would be taxable under one of the “apportionable” classifications. In addition to the “catch-all” category of “Service and Other Activities”, WA is now including the following:
- Real estate brokers
- Nonprofits engaging in R&D
- Travel agents and tour operators
- International steamship agents, international customs house brokers, etc.
- Stevedoring and associated activities
- Low-level waste disposal
- Insurance producers, title insurance agents, and surplus line brokers
- Inspecting, labeling, and storing canned salmon
- Independent resident managing general fire or casualty insurance agents
- Contests of chance and horse races
- International investment management services
- Aerospace product development for hire
- Royalties from granting intangible rights
- Boarding home room and domiciliary care
- Certain radioactive waste cleanup activities
- Newspaper and printer/publisher advertising
If your income attributable to WA is derived from one of these apportionable classifications the need for a physical presence is eliminated and you are subject to the economic nexus thresholds. The thresholds, based on a calendar year, for businesses outside of WA are:
- More than $50,000 of payroll in Washington
- More than $50,000 of property in Washington
- More than $250,000 of gross income in Washington
- At least 25 percent of your total property, payroll, or income in Washington
If you meet any one of the above minimum thresholds, then according to WA, you have economic nexus; no physical presence is needed. As such, you would be required to register your business with the Washington State Department of Revenue and report and pay Washington B&O tax. (If you need help determining if you have Nexus or need help registering click here.)
What is apportionment and why is the change to a single factor receipts (sales) method important?
Apportionment can be defined as the method by which a taxpayer divides its income among the states in which they have established nexus due to their specific business operations within each state. It is expressed as a ratio and is often referred to as a formula. Historically, WA has used a cost apportionment formula; however in 2000 they added a three factor apportionment formula for financial institutions. The single factor receipts apportionment formula will replace both of those existing formulas.
To keep things simple we will forgo how the ratios are structured and instead concentrate on the benefits. (Click here to contact us for more detail on ratios.) The biggest benefit of the change by far is the ability of in-state companies to attribute apportionable income to the state where the benefit is received rather then where the costs were incurred. This is a tremendous opportunity for in-state service providers. Some of our clients have been able to reduce their tax burden in excess of 50%. If you are in a service business with customers outside WA, we suggest you reexamine how you are calculating your B & O obligations.
Right now there is a lot of confusion as to what you can exclude from your formula due to some awkward wording on the WA DOR website. Many CPA’s have contacted us for guidance in how to best position their clients. Based on what we see, many taxpayers are still not correctly applying the new method, thereby overpaying their taxes and creating an ever growing refund opportunity. If you would like us to review your process or would like see if you have a potential refund click here.
IS the WA amnesty a good deal?
In general we usually prefer Voluntary Disclosure Agreements (VDAs) over amnesty programs. Our reasons are outlined in our previous article, “You Missed the Tax Amnesty Express Don’t Worry. You are probably better off with a VDA anyway!” However, as Tax amnesties go this is a worthy program. It began on February 1, 2011 and runs through April 30, 2011. Don’t let that April 30th date confuse you though. That is the date by which all taxes must be paid. The real cutoff date is April 18, 2011 which is the date by which you must submit an application and file all outstanding or amended returns.
The amnesty is good for the following taxes:
- State business and occupation (B&O) tax,
- State public utility tax,
- State and local sales and use tax including:
- General retail sales and use taxes
- Rental car taxes
- King County food and beverage tax
- Additional sales and use tax on motor vehicle sales/leases
- Lodging taxes, but not including tourism promotion area lodging charges
- Brokered natural gas use tax
The amnesty program waives penalties and interest as well as limits the look back period to 4 years plus the current. However, in order to take advantage of the amnesty, you must waive your right to a refund or an appeal of any taxes paid under the amnesty. This is an amnesty program that may be worth your time and effort, however it may or may not be in your best interests. We suggest you examine all the alternatives and weigh them against your particular set of circumstances. If you would like help with this process let us know. The most important item to remember is that if you have exposure, act now. States make it a practice to substantially step up enforcement actions after an amnesty and they are usually not in a forgiving mood. Add this to the fact that they already needed to make up the revenue lost on the breaks being given to domestic service companies and the numbers start to stack up against you.
In summary, there are a great many changes happening in Washington. Depending on your circumstances they may have positive implications or negative implications. The bottom line is if you are selling in or into Washington, or have clients doing either, you need to keep abreast of what’s going on. I don’t know if the breaks for the domestic service companies will create more jobs, but I do know that the changes will keep accounting professionals of all types very busy.
In order to help you stay current on specific state events, Peisner Johnson & Company will be offering a series of free one hour state specific webinars that provides for CPE credit. To register click here.