New Washington State Budget Includes Tax Increases on Royalties, Wholesalers, Internet Sellers and Late Filers

But There Are Some Winners, Too

By now you’ve probably read or heard about the brinksmanship leading up to the enactment of the State of Washington’s operating budget for the 2015 – 2017 biennium. The $38.2 billion budget was passed by the legislature in the wee hours of the morning of June 30, and signed into law by Governor Inslee that night, narrowly avoiding the state government shutdown that would have otherwise resulted.

Among the headline features of the new budget are tuition reductions of 15 – 20% at the state’s public universities and increased funding for K-12 education, which will allow for reduced class sizes in grades K-3 and expanded full-day kindergarten. Some of the funding for these expenditures came from revenue forecasts that were recently revised upwards due to the health of the economy. However, some notable tax increases were enacted as well:

Increase in B&O Tax Rate on Royalties from 0.484% to 1.5%.

Prior to July 1, 1998, royalty income was subject to B&O tax under the broader “service and other activities” classification. At that time, B&O tax was imposed on 100% of royalty income if the recipient was domiciled in Washington. Many taxpayers set up structures so that royalties were paid to an intermediary entity domiciled outside of the state, avoiding B&O tax on the income altogether.

The lowering of the royalties B&O tax rate was intended in part to entice taxpayers to abandon these structures and pay tax on the income, albeit at a lower rate. In 2010, the sourcing rules for royalties were changed by the legislature, so that royalties are now subject to B&O tax only to the extent the underlying use of the licensed intangible occurs in Washington. Thus, the 2015 legislature saw fit to return the royalties rate to its historical parity with the services rate.

Although the impact will be felt by all royalty recipients, this can be seen as another in a series of recent measures to increase the B&O tax burden on out-of-state companies. While there are some owners of patents, trademarks and other revenue-generating intangibles in Washington, many more are located outside of the state. Because of the “economic nexus” law enacted in 2010, any company or person with more than $267,000 of royalties derived from Washington use has a taxable presence in Washington, and will now see their B&O tax bill triple, starting on August 1.

Extension of Economic Nexus to Wholesalers.

The economic nexus provisions enacted in 2010 were limited to recipients of “apportionable income” such as services and royalties, but did not apply to sellers of tangible goods. Those sellers could avoid B&O tax as long as they (and their employees and other representatives) avoided any physical presence in Washington. As of September 1, the economic nexus law is extended to wholesaling, so a wholesaler with more than $267,000 of sales delivered into Washington each year will be subject to B&O tax, whether or not they ever enter the state. Similar to the increase in the royalties rate, this change was politically palatable because the impact will be felt almost exclusively by those who do not vote in Washington elections.

Click-Through Nexus for Internet Sellers.

In recent years, a number of other states passed “click-through” nexus laws, under which out-of-state internet sellers can be required to collect sales tax if they pay a certain amount of commissions on sales to buyers that were directed to the seller’s website from a hotlink, banner ad or similar device on a website operated by an individual or company located in the state. Washington joins this list by passing its own click-through nexus law. Locally based Amazon.com has historically collected Washington sales tax and thus will not feel the direct impact of this change. The state still expects to collect over $28 million in additional sales tax from other internet sellers that will now be required to collect the Washington tax.

Increases in Late Filing Penalties.

Along with taxes on out-of-staters, sin taxes are another popular target for tax increases in Washington and elsewhere. Although the legislature did not touch the taxes on alcohol or cigarettes (and actually tweaked the marijuana taxes in a manner that is expected to slightly decrease tax collections), it saw fit to increase the penalties for filing late B&O and sales/use tax returns. As of August 1, the penalties jump from 5% to 9% if the tax is not received by the due date, from 15% to 19% if the tax is not received by the last day of the month following the due date, and from 25% to 29% if not received by the last day of the second month after the due date.

The Winners.

Although royalty recipients, out-of-state wholesalers / internet sellers and late filers are the clear losers, there are some winners in the new budget as well:

• Software Developers not Named Microsoft. Software developers who sell their product on tangible media have long been considered “manufacturers” under Washington tax law and exempted from sales tax on computers and other equipment used in product R&D, testing and manufacturing. The new law expands who is considered a manufacturer for purposes of the exemption to include persons “engaged in the development of prewritten computer software that is not transferred to purchasers by means of tangible storage media.” Thus, developers whose software is available exclusively via the cloud can now take advantage of this exemption. However, the definition excludes any company that employs more than 40,000 people in Washington and was registered to do business in Washington as of July 1, 1981, which will impact exactly one taxpayer – Microsoft. The Redmond software giant acquiesced to this exclusion, even though it expects to pay tens of millions of dollars in additional sales tax as a result.
• Data Centers and their Owners. The legislation includes a sales tax exemption on server equipment and power infrastructure in data centers for which construction begins between July 1, 2015 and July 1, 2025. It also extends the sales tax exemption for replacement servers at data centers built between 2012 and 2025 from eight to twelve years.
• The Food Processing, Aluminum Smelting and Newspaper Industries. The legislature extended B&O tax exemptions and preferential rates for processing or selling certain processed fruits or vegetables, dairy and seafood products, smelting aluminum, and printing or publishing newspapers. These incentives were generally extended by 10 years, until July 1, 2025 for food processors, until January 1, 2027 for aluminum smelters, and until July 1, 2024 for newspapers.
• Investors Earning Capital Gains. One earlier proposal by Governor Inslee and championed by legislative Democrats earlier in the 2015 session was for a state-level capital gains tax of up to 7% on gains above a certain threshold level. Like numerous previous proposals for a state income tax, the proposal met stiff resistance and was not included in the budget ultimately passed by the legislature and signed by the governor. But considering the substantial revenue such a tax could generate, it would not be surprising to see the gains tax resurface in the future given the significant funding challenges that the state will continue to face.

© Clark Nuber PS and Developing News, 2015. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Clark Nuber PS and Developing News with appropriate and specific direction to the original content.