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Update on Washington B&O Taxation of Director Fees

Posted Friday, July 9, 2010 by Michael A. Larson

alt textOn June 22 the Washington Department of Revenue (DOR) issued a revised special notice on B&O taxation of director fees. I recently attended a meeting with senior members of the DOR where the notice was discussed in more detail. The notice may be accessed at: http://dor.wa.gov/docs/pubs/specialnotices/2010/sn10directorsfees.pdf.

As expected, the DOR has concluded that taxable director fees include all compensation received by a director, including expense reimbursements and the value of any compensatory stock options received. The DOR has also concluded that directors who are also employees are only taxable with respect to any “nonemployee” director fees that are received by the employee. During our meeting the DOR elaborated on these points.

On the matter of expense reimbursements, the DOR indicated that any amounts received by the director as a reimbursement of expenses should be included in the tax measure. The DOR did not have a clear answer for expenses of a director that are paid directly by the corporation as opposed to being reimbursed to the director. A suggestion was made that the DOR limit the tax measure to the amounts that must be reported on the Form 1099-MISC that corporations are required to file with the IRS to report director compensation or that the DOR not require inclusion of any expenses directly paid by the corporation. Under the IRS rules travel reimbursements need only be included on Form 1099-MISC where the director does not properly account to the corporation separately for the travel expenses. Expenses paid directly by the corporation are never included on the Form 1099-MISC as compensation. The DOR agreed to examine the matter in more depth before adopting a comprehensive policy.

We can only hope that the DOR adopts the sensible policy of including only Form 1099-MISC amounts. The federal policy draws a clear line between expenses that represent the corporation’s cost of holding the meeting and expenses that are the responsibility of the director. This sensible approach provides a bright line, prevents abuses and reduces corporate compliance costs. If this approach is not taken, further regulation will be needed to determine which expenses of a meeting are treated as company expenses and which expenses will be treated as director expenses. This will not only lead to numerous future clashes with DOR auditors, but will also result in significant additional recordkeeping costs while providing scant additional revenue to the State.

With respect to compensatory stock options the notice specifically limits inclusion as compensation to the amounts reported on Form 1099-MISC. Options granted prior to the July 1 effective date of the new rules are not subject to B&O tax.

The DOR also confirmed another point included in the special notice that corporate directors would only be subject to tax in Washington if they have nexus under the new “economic performance” nexus rules. Thus, nonresident directors could avoid paying tax on director fees earned in Washington that do not exceed $250,000 (the sales threshold necessary to confer nexus on the nonresident directors) provided that the Washington director fees were not more than 25% of the director’s total nonemployee compensation. (This also assumes that nonresident directors would not have $50,000 of property or payroll in Washington.) This is true even if the director has clear physical presence nexus in Washington.

The DOR indicated that it would also apply this interpretation to other service businesses.

The special notice also confirmed that director fees will be apportioned to the state where the corporation is headquartered. The DOR warns taxpayers that in some cases a director could become taxable on a portion of director fees earned from corporations headquartered in other states if at least some of the activity of the corporate director is performed in Washington and the director is not taxable on the director fees in the other state. Based on the rules for being treated as taxable in another state, this circumstance should rarely occur.

There was substantial discussion in the meeting of procedural requirements. The DOR indicated that if corporations wished to report and pay taxes on behalf of directors that the corporations should contact the DOR’s Taxpayer Account Administration Division at (360) 902-7047 for information on how to accomplish this reporting. The DOR indicated that they may also offer some type of reporting relief in the future for taxpayers that are required to use monthly or quarterly reporting, but receive payments for their services only once or twice per year. No details are yet available on how this might work.

For more information, please contact Ron Bueing at 206-340-2008.

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Service Apportionment Opportunities for Washington Based Businesses

Posted Wednesday, June 16, 2010 by Michael A. Larson

alt textOne of the biggest changes adopted by the Washington Legislature in 2010 is the requirement for “receipts factor” sourcing for businesses earning gross income from certain “apportionable activities.” Prior to the new law, businesses only apportioned gross income from services and the method used for such apportionment was based loosely on where the taxpayer’s costs of doing business were incurred.

Under the new law, taxpayers that are not taxable in another state (see explanation below) will continue to pay B&O tax on 100% of their gross income from these apportionable activities. However, the B&O tax liability for out of state businesses that engage in apportionable activities with Washington based customers is likely to increase dramatically. On the other hand, the B&O tax liability of Washington based businesses that engage in apportionable activities and are “taxable in another state” could be reduced substantially.

What are Apportionable Activities?

Apportionable activities are a specifically enumerated set of activities that include:

  • Real estate brokers
  • Nonprofit corporations and associations 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
  • Hospitals
  • Inspecting, testing, 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

In addition, apportionable activities also include any activities that are taxable as “service and other activities” under the catchall provision at RCW 82.04.290 for business activities not otherwise specifically included in any other classification. Most of these “apportionable activities” would fall into a service activity, but this category does not include retail service activities such as, repair and installation services, abstract services, title insurance, escrow services and credit bureau services.

What is Receipts Factor Sourcing?

Receipts factor sourcing is a method for apportioning gross income from business activities that sources gross income to Washington using a ratio of Washington gross income over gross income from everywhere. The resulting percentage is applied to gross income from everywhere to determine the gross income that must be reported for Washington excise tax purposes. Those persons who have a basic grasp of algebra will immediately see that this results in essence in a tax on 100% of Washington gross income.

In many cases, the single sales factor sourcing will simply result in a tax on the Washington gross income. However, Washington also adopted a “throwout” rule that must be used in computing gross income from everywhere for purposes of the denominator of the receipts factor. The throwout rule requires that the denominator of the receipts factor be reduced by the amount of gross income sourced to a state in which the taxpayer is not taxable if any part of the activity to earn the gross income is performed in Washington. This can result in businesses paying B&O tax on gross income in excess of the Washington gross income.

When is a Taxpayer Taxable in another State?

A taxpayer is taxable in another state when a taxpayer is actually subject to a business activities tax by another state on its income received from engaging in apportionable activities. A business activities tax would appear to include state and local income taxes as well as gross receipts taxes like the Ohio CAT and Michigan MBT and taxes based partially on gross income, such as the Texas Margins tax. It is unclear if business activities taxes will include hybrid sales tax systems like the New Mexico Gross Receipts tax or the Hawaii General Excise Tax, for while these taxes are measured in whole or in part on gross income or receipts, the law specifically excludes from the definition sales and use taxes and similar transaction taxes.

A taxpayer is also treated as taxable in another state if the taxpayer is not subject to a business activities tax but the state would have jurisdiction to subject the taxpayer to a business activities tax under the economic nexus standards recently adopted by Washington.

Planning Opportunities

Washington based businesses should examine their apportionment methodologies for service income to determine if the new rules will reduce their liability for Washington B&O taxes. Businesses with service operations in WA, but substantial customers outside of Washington could benefit dramatically. Financial institutions based in Washington should especially pay attention to the recent law changes as similar changes have been devised for financial institutions that previously paid tax under the three factor formula required by WAC 458-20-14601.

A Note of Caution

Should the economic nexus provisions of the new law be successfully challenged as unconstitutional, the receipts factor sourcing will be automatically be voided. This could result in a requirement to repay taxes saved by reason of the receipts factor apportionment. While this result is clearly speculative, it may be prudent to establish reserves for this possibility.

For more information, please contact Ron Bueing at 206-340-2008.

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Washington B&O Tax on Board Director Compensation

Posted Thursday, May 27, 2010 by Michael A. Larson

alt textRecently, Governor Gregoire signed into law 2ESSB 6143, an omnibus revenue raising tax bill. One provision that has drawn a number of questions involves the taxation of fees earned by persons serving as directors on corporate boards. In a nutshell the law provides the following.

• Prior to July 1, 2010, the B&O tax does not apply to fees received by an individual from a corporation as compensation for serving as a member of that corporation’s board of directors (“board compensation”).

• Nonetheless, prior to July 1, 2010, refunds are not allowed for directors that paid tax on their board compensation in prior years.

• On or after July 1, 2010, board compensation is subject to B&O tax at the services and other rate, which was temporarily raised in this same bill to 1.8%.

Practical Considerations

The B&O tax on board compensation is imposed on the board director. There are no special reporting requirements at the state level for the payor corporation and no withholding requirements are imposed on the payor corporation. In the absence of any special rules, Directors earning more than $12,000 per year will be required to register with the Department of Revenue.

Some companies may “gross up” the amounts paid to a board member to compensate for this additional B&O tax obligation. In this case, the gross up amount itself must be included in the gross receipts to be reported by the board member. In addition, the Department of Revenue will likely require that any other “reimbursements” including travel expenses be included in the measure of the B&O tax. The Department of Revenue has also indicated that board compensation under the law will include stock based compensation. Regulations that have yet to be promulgated will answer such questions as when stock option compensation will be recognized and how such options will be valued.

The B&O tax rate for services increases from 1.5% to 1.8% effective on July 1, 2010 and will continue at this rate until at least June 30, 2013. The frequency of tax reporting required of Board Directors will depend on the total amount of tax owed by the director. If the annual tax liability is less than $1,050, the director will report annually. Directors owing between $1,050 and $4,800 will be required to report quarterly. Directors with tax liability exceeding $4,800 must file monthly.

Sourcing of the board compensation is a bit murky at this time. Under 2ESSB 6143, board compensation is sourced to the location where the customer primarily receives the benefit of the service. Some persons have speculated that under this rule the benefit of the service is received where the board meetings are held and holding the board meetings outside of Washington might be effective tax planning. Others speculate that the benefit is received by the corporation and the benefit is primarily received at the corporation’s commercial domicile or headquarters. I believe that the latter approach will likely be adopted.

It should also be noted that if the place of primary benefit cannot be ascertained, the default rules come into play and the board compensation will likely end up being sourced to the corporation’s headquarters under the application of the default rules, as this is the most likely place from which the service is ordered or payment is sent. The Department of Revenue is currently considering the various options available.

In computing taxes on director compensation there is also the matter of applying the small business tax credit, which was recently raised from $35 per month to $70 per month. This effectively exempts $46,694 of gross receipts from the B&O tax annually. The credit is slowly phased out as income exceeds the small business credit.

For example, assuming no other B&O taxable gross receipts are earned by the director, at a board compensation level of $50,000 the B&O tax before credit is $900 with an expected small business credit of $790 for a net B&O tax liability $110. At a board compensation level of $76,200 the B&O tax before credit is $1,372 with an expected small business credit of $325 for a net B&O tax liability of $1,047. At a board compensation level of $100,000 the B&O tax before credit is $1,800 with an expected small business credit of $-0- for a net B&O tax liability of $1,800.

It is important to remember that the new legislation, while dealing specifically with board of director compensation, reaffirms that “all income of all independent contractors is subject to business and occupation tax unless specifically exempt under the Constitution or laws of this state or the United States.” Thus, anyone who receives compensation other than in the capacity of any employee is subject to B&O tax on that compensation.

Planning Considerations

Board compensation paid prior to July 1, 2010 is exempt from B&O tax. Companies may wish to accelerate payment of board compensation in some cases to eliminate or reduce B&O tax obligations for directors for at least 2010.

For more information, please contact Ron Bueing at 206-340-2008.

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Pivotal Law Opening Includes Appearance on King 5's "Get Jesse"

Posted Tuesday, May 4, 2010 by Michael A. Larson

alt text Monday, May 3, 2010 was the official opening of Pivotal Law Group. As a bonus roll-out event, attorney Mike Larson appeared on King 5’s “Get Jesse” segment on the 11 pm news.

Mike is on the State Bar’s Real Property Probate and Trust Section’s Executive Council. When King 5 TV contacted the State Bar Association for a speaker on the Jesse Jones regular segment on the 11 pm news, Mike was selected to comment and advise on the legal aspects of the story. Jesse Jones is the Consumer Reporter for King 5.

The story involved a tenant that sued a former landlord in small claims court and was awarded a judgment for the tenant’s security deposit that was not returned at the end of the lease. Mike was asked if the small claims judgment was enforceable and about Mike’s experience with misplaced appeals by the court system.

Mike got his moment of fame and Pivotal Law Group was in the news the first day the law firm opened. See what made the final cut in the news segment.

For more information, please contact Michael Larson at 206-340-2008.

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"I just received a letter from the Washington Department of Revenue requesting that I fill out a 'Washington Business Activities Questionnaire!' What should I do?"

Posted Monday, March 29, 2010 by Michael A. Larson

alt textThe Washington Department of Revenue has a very aggressive tax discovery program that uses a variety of information sources to identify businesses that are not registered in Washington. You have been identified as an unregistered taxpayer. Washington is now seeking to determine if you are required to register and pay taxes to Washington.

First some background may be helpful.

Washington does not have an income tax. Instead, Washington imposes a business and occupation (B&O) tax on the gross income from business activities in Washington. The B&O tax is a gross receipts tax. It is measured on the gross receipts from business activities deemed to occur in Washington. There are very, very few deductions from the B&O tax. Unlike an income tax there is no deduction for labor, materials, taxes, or other costs of doing business.

The B&O tax rate varies significantly by classification, anywhere from .138% to 1.63%. There are a number of different classifications and you are taxed in the most specific classification to your business activity. Taxpayers may be subject to tax in more than classification, depending on the nature and variety of the business activities that they perform in Washington.

Perhaps most importantly, however, is that because Washington does not impose an income tax, the nexus requirements are different. Washington has traditionally used a physical presence test for nexus for the Washington B&O tax. This physical presence can be satisfied not only by very limited visits by sales personnel, but also by the presence of inventory or other property and even by the solicitation, warranty or other business activities conducted on behalf of a company by independent contractors. Washington is even considering expanding nexus under proposed legislation to include mere “economic presence” nexus.

While Washington will be primarily focused on the B&O tax, the auditor will also consider whether there is an obligation for uncollected retail sales taxes.

So what do you do next? The following checklist may be of assistance.

  1. Determine whether you are already paying B&O tax. In some cases, due to the use of dba names, the Department of Revenue may not realize that the company is already registered.
  2. Ascertain the nature and level of activities performed in Washington by employees and independent contractors.
  3. Determine the correct classifications for Washington business activities and estimate the tax exposure for the seven prior calendar years for which Washington will seek taxes.
  4. Carefully, but accurately, answer the questions in the Washington Business Activities Questionnaire.
  5. Consider whether any local B&O taxes are implicated by your Washington business activities. While the State of Washington will not consider a voluntary compliance agreement after contacting the taxpayer, timely action at the local level can avoid the application of the 10 year look back period employed by local jurisdictions, limiting exposure to interest and taxes for the last four years.
  6. Consider consulting an experienced Washington excise tax professional, such as Ron Bueing, a tax attorney with over twenty five years of experience on Washington excise taxes. There are a number of unique rules involving nexus, imported products, etc. that can have a dramatic impact on an unregistered taxpayer’s liability. Ron has successfully negotiated on behalf of hundreds of businesses located outside of Washington.

For more information, please contact Ron Bueing at 206-340-2008.

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