Washington increases B&O Tax, expanding taxation of services

On May 20, 2025, Washington Gov. Bob Ferguson signed tax legislation that will dramatically affect taxpayers subject to the Business and Occupation (B&O) tax, sales and use tax, and the long-term capital gains (LTCG) tax.¹ The extensive B&O tax amendments include increasing the tax rates for many different types of activities, imposing a surcharge on businesses with Washington taxable income over $250 million, raising a surcharge imposed on certain financial institutions, increasing the advanced computing surcharge, and clarifying the deduction for investment income. The services subject to retail sales and use tax and retail B&O tax are greatly expanded to include such services as information technology training services, custom software development, advertising, and certain digital automated services. Finally, a supplemental LTCG tax is imposed for gains over $1 million, and the estate tax rates are significantly increased for large estates.

B&O tax

Tax rate increases

Effective Oct. 1, 2025, under H.B. 2081, the B&O tax rate for services and other activities for businesses with gross income over $5 million is increased from 1.75% to 2.1%.²

Beginning Jan. 1, 2027, H.B. 2081 increases the B&O tax rate to 0.5% for the following:

• Standard manufacturing, extracting, and wholesaling;³
• Standard retailing;⁴
• Radioactive waste cleanup;⁵
• Retail or wholesale sales of digital goods, digital codes, or digital automated services;⁶
• Research and development by non-profit entities;⁷
• Insurance agents;⁸
• Childcare;⁹
• Treatment of chemical dependency;¹⁰
• Salmon canners;¹¹
• Manufacturing and retailing of tooling, specifically for use in manufacturing of commercial airplanes or components;¹²
• Printing materials, other than newspapers, and of publishing periodicals and magazines;¹³
• Highway and government contractors;¹⁴
• Cold storage warehousing;¹⁵ and
• Radio and television broadcasting.¹⁶

Currently, B&O tax rates for these activities are imposed at either 0.471% or 0.484%.

New surcharge on certain high-grossing large businesses

From Jan. 1, 2026 through Dec. 31, 2029, in addition to all other B&O taxes, H.B. 2081 imposes a new surcharge equal to 0.5% of Washington taxable income over $250 million.¹⁷ However, the following Washington taxable income is exempt from the surcharge: (i) income subject to the manufacturing tax rates; (ii) income attributable to the wholesale or retail sale of products so manufactured by a taxpayer subject to the manufacturing tax rates; (iii) income attributable to retail sales of food and food ingredients, sales of food purchased with food stamps, and prescription drugs that are exempt from sales tax; (iv) income from timber business; and (v) income attributable to the wholesale or retail sale of certain petroleum products. Furthermore, the surcharge does not apply to: (i) a person engaged in business primarily as a farmer or eligible apiarist;¹⁸ (ii) a person subject to the workforce education investment surcharge; and (iii) taxable income for wholesale and retail transactions of fuel.

Surcharge on large financial institutions

Beginning Oct. 1, 2025, in addition any other B&O taxes, H.B. 2081 increases the additional tax imposed on “specified financial institutions” to 1.5% (previously, 1.2%).¹⁹ The additional tax applies to a financial institution that is a member of a consolidated financial institution group that reported on its consolidated financial statement for the previous calendar year annual net income of at least $1 billion, not including net income attributable to noncontrolling interests.²⁰

Advanced computing surcharge

Beginning Jan. 1, 2026, H.B. 2081 increases the workforce education investment surcharge imposed on “select advanced computing businesses” from 1.22% to 7.5% of gross income.²¹ The limit on the combined surcharge paid by all members of the affiliated group is raised from $9 million to $75 million annually.²² A “select advanced computing business” is a person who is a member of an affiliated group with at least one member of the affiliated group engaging in the business of advanced computing, and the affiliated group has worldwide gross revenue of more than $25 billion.²³

Investment deduction clarified

Effective Jan. 1, 2026, in response to the Washington Supreme Court’s decision in Antio LLC v. Washington State Department of Revenue,²⁴ H.B. 2081 amends the statute providing a B&O tax deduction for investment income to provide clarity.²⁵ As explained by the legislature, Antio may cause uncertainty because it affirms that the investment income deduction is only applicable if the income is from investments that are incidental to the main purpose of a person’s business, without providing a bright-line rule for determining this income.

As amended, a taxpayer may deduct investment income that is incidental to the main purpose of the taxpayer’s business.²⁶ Investments are incidental to the main purpose of the taxpayer’s business if the total worldwide income derived from these investments is less than 5% of the taxpayer’s total annual worldwide gross income. However, the following investment income may be deducted regardless of whether investments are incidental to the main purpose of the taxpayer’s business: (i) nonprofit organizations; (ii) collective investment vehicles;²⁷ (iii) retirement accounts and recipients of distributions; and (iv) family investment vehicles and recipients of distributions.²⁸

The Washington Department of Revenue is directed to adopt rules necessary to implement this legislation including, but not limited to, rules that provide examples of investment income from personal investments that is not deductible because it is not income from engaging in business and thus is not subject to B&O tax.²⁹ Also, the rules must include examples of the tax treatment of investment income received by taxpayers investing through different types of collective investment vehicles.

Taxation of services expanded

Effective Oct. 1, 2025, under S.B. 5814, for purposes of the retail sales and use tax and the retailing B&O tax, “sale at retail” or “retail sale” is expanded to include the following service-based activities:

• Information technology training services, technical support, and other services, including, but not limited to, assisting with network operations and support, help desk services, in-person training related to hardware or software, network system support services, data entry services, and data processing services;³⁰
• Custom website development services;³¹
• Investigation, security services, security monitoring services, and armored car services including, but not limited to, background checks, security guard and patrol services, personal and event security, armored car transportation, and security system services and monitoring;³²
• Temporary staffing services;³³
• Certain types of advertising services;³⁴
• Live presentations including, but not limited to, in-person or remote interactive lectures, seminars, workshops, or courses;³⁵ and
• The sale of or right to use custom software, and customization of prewritten computer software.³⁶

“Sale at retail” or “retail sale” does not include the following sales listed above if they are between members of an affiliated group: (i) information technology training services; (ii) custom website development services; (iii) investigation and security services; and (iv) advertising services.³⁷

S.B. 5814 broadens the definition of digital automated services that are already subject to retail sales and use tax and the retailing B&O tax, in part to take into account other services that will be taxable under the expanded definition of “sale at retail” or “retail sale.” As a result, exclusions from the term “digital automated services” will no longer be available for: (i) any service that primarily involves the application of human effort by the seller, and the human effort originated after the customer requested the service; (ii) live presentations; (iii) advertising services; or (iv) data processing services.³⁸ However, these exclusions remain available in the case where such services occur between members of an affiliated group.³⁹ Exclusions from the definition of “digital automated service” have been created for telehealth and telemedicine services.⁴⁰

LTCG tax 

Under existing law, Washington imposes a 7% excise tax on the Washington-allocated LTCG of individuals over $250,000 resulting from the sale of certain capital assets held for at least one year.⁴¹ Beginning Jan. 1, 2025, S.B. 5813 imposes a supplemental LTCG tax of 2.9% of an individual’s Washington capital gains exceeding $1 million.⁴² Accordingly, LTCG over $1 million are now subject to an excise tax of 9.9%.

Estate tax

For estates of decedents dying between July 1 and Dec. 31, 2025, S.B. 5813 increases the amount excluded from estate tax from $2 million (which had reached an inflation-adjusted amount of $2,193,000 for estates of decedents dying prior to July 1, 2025) to $3 million.⁴³ The $3 million exclusion will continue to be adjusted for inflation in 2026 and beyond.⁴⁴ However, the tax rates are increased for estates that exceed the exclusion amount. As amended, for estates of decedents dying on or after July 1, 2025, the estate tax rates range from 10% to 35% (previously, 10% to 20%).⁴⁵ The highest estate tax rate is applicable for decedents with a taxable estate value of more than $9 million.

Commentary

The recent Washington tax legislation makes sweeping changes primarily directed at large businesses and high-income individuals that will be felt for years to come. The broad expansion of services subject to the retail sales and use tax and retail B&O tax also will affect many businesses, especially those that provide technologically advanced service-based offerings to their clients. This legislation, which is intended to raise nearly $9 billion in tax revenue over the next four years in response to a very large projected state budget deficit, was passed by the legislature within 10 days of being introduced.

The B&O tax changes will broadly impact many businesses with market presence in Washington. While this tax has always taken the specific industry of a business into account in setting tax rates and the scope of the tax base, the legislation is designed to increase the disparity in how businesses are taxed. In many instances, the disparity is being enforced through targeted rate increases and surcharges on certain businesses over a gross income threshold, some large businesses and financial institutions, and businesses engaged in advanced computing activities. At the same time, the legislation provides that the general B&O tax rate generally will be increased to 0.5% for a broader swath of businesses. Ultimately, taxpayers will need to consider whether activities that may no longer be exempt from the B&O tax or will be subject to higher surcharges are an unavoidable cost of doing business and potentially lead to higher prices charged for their products and services.

Likewise, the services subject to retail sales and use tax and the retailing B&O tax will be substantially expanded in October, leading to markedly higher costs incurred on transactions that are likely to be felt by the ultimate consumer. Major services such as information technology services, security services, temporary staffing services, advertising services, and custom software that have grown in scope through technologically-driven advancements will be subject to tax. Also, certain digital automated services will no longer be excluded from tax. Because the changes are effective soon, entities providing these newly taxable services should begin to consider their approach in adjusting their tax software systems to reflect the changes adopted in this legislation.

The controversial LTCG tax also is addressed by this legislation, with LTCG over $1 million now being subject to a total tax rate of 9.9%. As this legislation is retroactive to the beginning of 2025, certain Washington taxpayers that sold significant amounts of property subject to the LTCG prior to the enactment of this legislation, perhaps as a means to capture preferential federal capital gains tax rates (or perhaps through an uncontrolled event), may now be subject to an even higher LTCG tax than previously expected.

Given looming budget deficits, the lack of a dedicated personal income tax, and the uncertainty as to how the enacted legislation along with external influences might affect Washington’s economy, more drastic measures that would directly affect the very wealthiest of Washington residents are likely to be evaluated. For example, at the very end of the legislative session, the Washington Senate passed legislation, S.B. 5797, which would have imposed a new wealth tax on individuals with financial assets worth more than $50 million. The legislation was passed too late to be enacted during this legislative session, but it may be considered by the legislature next year, especially if Washington’s precarious fiscal condition does not improve.