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Washington Legislature Passes Amnesty Bill in Special Session

Posted Monday, December 13, 2010 by Michael A. Larson

alt textThe Washington Legislature in last Saturday’s emergency special session adopted an amnesty program that will apply to all outstanding penalties and interest as of February 1, 2011 on certain outstanding tax obligations. The amnesty applies only to penalties and interest on B&O tax, public utility tax and both the state and local portions of sales or use tax. The amnesty period begins February 1, 2011, but applies to taxes that were required to have been reported and paid by the taxpayer for periods to February 1, 2011.

To qualify taxpayers must file all outstanding or amended tax returns with respect to which amnesty is requested by no later than April 18, 2011 and make full payment of taxes by May 1, 2011. It also appears that in order to qualify, tax returns for January through April of 2011 must also be filed with the Department by the normal due date; a potential trap for unwary amnesty takers. A yet to be developed application for amnesty must also be filed with the Department by April 18, 2011. Also, taxpayers charged with evasion penalties are not eligible for amnesty nor are sellers who misuse reseller permits or resale certificates.

The biggest drawback to the program is the inability to later challenge payments made under the amnesty program. Taxpayers will need to be careful that they adopt the correct classifications and do not inadvertently overpay their tax obligations. There are a number of other provisions that I will discuss in more detail once this bill becomes law, but this is something all taxpayers with outstanding tax liabilities need to be aware of immediately.

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

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Nexus Changes in Washington

Posted Friday, July 23, 2010 by Michael A. Larson

alt textIn the last legislative session Washington adopted “economic performance” as the nexus standard for certain apportionable service activities. However, Washington retained its “physical presence” nexus rules for all other B&O taxes, retail sales taxes and other excise taxes.

“Economic performance” nexus rules provide that a company with $50k of Washington based payroll, $50k of Washington based property or $250k of sales to Washington customers of certain apportionable services (or have 25% of the total of either their payroll, property or sales in Washington) will be subject Washington B&O tax on that apportionable income. Companies with less than these amounts of property, payroll and sales in Washington are deemed not to have nexus with Washington in spite of the physical presence that they maintain within the state, but only with respect to the taxation of these apportionable services.

Meanwhile, “physical presence” nexus continues as the standard for retail sales tax, B&O tax on other activities and other excise taxes. “Physical presence” nexus as interpreted by the Washington DOR requires an extremely limited amount of physical presence satisfied by as little as 2-3 visits by an employee or independent contractor.

Another recent change is that Washington has eliminated its notorious 5 year nexus rule, for Washington B&O tax. This rule provided that a taxpayer was presumed to have nexus in Washington for the year in which nexus was established and for each of the next four years unless the taxpayer could prove that the nexus creating activity was not a factor in making the sales in the future years. This proved to be a difficult, if not almost impossible, burden of proof to sustain with almost all Washington auditors. The recent legislative changes reduce this “trailing” nexus to one year, but only for Washington B&O taxes, not for retail sales tax collection.

These changes could lead to some bizarre situations where taxpayers have nexus for B&O tax for some sales, but not for others and still different nexus for retail sales tax. Let’s look at the following hypothetical.

In year 1 Taxpayer sells $4M of retail goods to Washington consumers over the internet. Taxpayer also provides $200k of training and support services to Washington customers, of which $20k are performed in WA on four separate days in Year 1 by an independent contractor hired by Taxpayer to teach four different customers how to use the retail products. This is the only physical presence in WA for the taxpayer ever. Taxpayer has -0- Washington payroll for any of its employees and -0- property in Washington during years 1 through 5. Taxpayer has total sales over $12M everywhere, which includes 2M of training and support services. Taxpayer provides no training services in WA in years 2 through 5, but provides $200k of online support and training for WA customers in year 2, $300k in year 3, 200k in years 4 and 5. Otherwise, Taxpayer continues to make similar online retail sales and service sales throughout the remainder of the five year period.

Year 1 - Taxpayer has nexus for retail sales tax (RST) and Retailing B&O tax (RBO) because the temporary physical presence of the independent contractor trainers creates physical presence nexus, but taxpayer does not have economic presence nexus for the apportionable services which consequently are not subject to services B&O tax (SBO) as there is only $20k of WA payroll, -0- WA property and $200k of WA apportionable service sales and less than 25% of totals for WA payroll, property and sales.

Year 2 - Taxpayer has trailing physical presence nexus for RST & RBO, but no nexus of any type for SBO.

Year 3 - Taxpayer has trailing physical presence nexus for RST & economic performance nexus for SBO ($300k of sales of apportionable services), but no nexus of any type for RBO.

Year 4 - Taxpayer has trailing physical presence nexus for RST & trailing economic performance nexus for SBO, but no nexus of any type for RBO.

Year 5 - Taxpayer has trailing physical presence nexus for RST, but no nexus of any type for RBO & SBO.

How is that for complicated?

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

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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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