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Washington revises service business surcharge

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Jamie C. Yesnowitz
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On Feb. 10, 2020, Washington Gov. Jay Inslee signed into law S.B. 6492, which modifies the Business and Occupation (B&O) tax workforce education surcharge that became effective Jan. 1, 2020.1 Under S.B. 6492, service businesses with more than $1 million in annual gross receipts will be subject to an increased B&O tax rate of 1.75%, from the current rate of 1.5%, effective April 1, 2020. In addition, “advanced computing businesses” with more than $25 billion in annual worldwide revenue will be subject to a revised surcharge of 1.22%, effectively increasing the service B&O tax rate to 2.72% for these businesses, effective April 1, 2020. S.B. 6492 also revises the workforce education surcharge enacted in H.B. 2158 last year.2

Washington B&O tax Washington’s B&O tax generally is imposed on gross receipts attributable to business activities conducted within the state, without any deduction for the costs of doing business. The B&O tax rate varies depending on the classification of a taxpayer’s business activities. For example, businesses reporting under the retail classification are taxed at a rate of 0.471%,4 while manufacturers, wholesalers and distributors are taxed at a rate of 0.484%.5 Currently, businesses reporting under the service and other activities classification are taxed at a rate of 1.5%.6

Original workforce education surcharge – H.B. 2158 Previously, on May 21, 2019, Inslee signed into law H.B. 2158, adopting a new “workforce education surcharge” on select businesses reporting under the service and other activities B&O tax classification, for purposes of funding higher education.7 The surcharge was scheduled to become effective Jan. 1, 2020, but the Washington State Department of Revenue suspended administration of the surcharge in anticipation of legislation that would amend or replace it. Under H.B. 2158, the surcharge was based on a three-tiered system of graduated rates.

Washington revises service business surcharge
Tier 1 Tier 1 of the surcharge applied to 43 types of service business activities, including architecture and engineering services, legal services, insurance carriers, financial services, medical services, software publishing, scientific research, electronic shopping, telecommunications services, and other services.8 Specifically, the surcharge was imposed on select businesses based on their primary business activity.9 An activity was considered to be “primary” if more than 50% of the cumulative gross income of the business was generated by such activity in the entire current or preceding calendar year.10 The surcharge was equal to 20% of the total taxes payable under the service and other activities B&O tax rate (resulting in a tax rate increase from 1.5% to 1.8%).11

Tiers 2 and 3 Tiers 2 and 3 applied to advanced computing businesses, with the tiers differentiated by the level of worldwide gross revenue thresholds.12 Specifically, the term “advanced computing” is defined as “designing or developing computer software or computer hardware, whether directly or contracting with another person, including modifications to computer software or computer hardware, cloud computing services, or operating an online marketplace, an online search engine, or online social networking platform.”13 An annual $4 million minimum surcharge and a $7 million cap applied to amounts paid by an affiliated group with at least one member engaged in the business of advanced computing, with worldwide gross revenue of more than $25 billion during the current or preceding calendar year.14

Tier 2 of the surcharge was imposed on advanced computing businesses with worldwide gross revenue of more than $25 billion but less than $100 billion. The surcharge was 33.33% of the total taxes payable under the service and other activities B&O tax rate (resulting in a tax rate increase from 1.5% to 2%).15 Tier 3 of the surcharge was imposed on advanced computing businesses with worldwide gross revenue of more than $100 billion. The surcharge was 66.66% of the total taxes payable under the service and other activities B&O tax rate (resulting in a tax rate increase from 1.5% to 2.5%).16

Revised Surcharge – S.B. 6492 Following the enactment of H.B. 2158 last year, the complexity in the three-tier surcharge system generated concerns that it would be difficult to administer, and the projected revenue from the bill was also adjusted downward. In response, legislators began drafting proposals to modify the surcharge. S.B. 6492 is intended to address the challenges of administering the surcharge, while also raising increased revenue to fund higher education.17

First, effective retroactively to Jan. 1, 2020, S.B. 6492 eliminates Tier 1 of the surcharge that was previously applicable to 43 different types of service businesses. This surcharge is replaced with a higher overall B&O tax rate of 1.75% for service businesses, effective April 1, 2020.18 This revision removes the need to determine whether a taxpayer is primarily engaged in one of the previously enumerated service activities, while effectively broadening the rate increase to reach all service businesses. However, the existing service B&O tax rate of 1.5% will continue to apply to hospitals, businesses with less than $1 million in gross receipts in the previous calendar year, and advanced computing businesses (which will continue to be subject to an additional B&O surcharge).19 The $1 million threshold applies to the aggregate gross income subject to the tax for an affiliated group. In this context, the control element of the affiliation is defined as more than 80% of the power to direct management and policies,20 versus more than 50% within the definitions for the advanced computing business surcharge.21

Second, S.B. 6492 consolidates Tiers 2 and 3 of the surcharge imposed on advanced computing businesses to a single surcharge equal to an additional 1.22% B&O tax rate on the service-related income of advanced computing business with over $25 billion in annual worldwide income.22 Combined with the 1.5% tax rate on service and other business activities, the surcharge results in an effective service and other activities B&O tax rate of 2.72%.23 S.B. 6492 also eliminates the minimum annual surcharge of $4 million and increases the maximum annual surcharge to $9 million for advanced computing businesses.24

In addition, S.B. 6492 includes the following changes:

  • The Washington State Department of Revenue has the authority to request information from taxpayers identifying all affiliates or certifying that no affiliates exist.25
  • Revises the definition of an advanced computing business to exclude “financial institutions” as defined in Wash. Rev. Code Sec. 82.04.29004.26
  • Revises how the select advanced computing business receipts threshold of more than $25 billion is measured to consider only the immediately preceding calendar year, rather than the preceding calendar year and the current calendar year.27
  • Amends the law by providing that if the Department establishes by clear, cogent, and convincing evidence, that one or more members of an affiliated group intended to evade the surcharge imposed on select advanced computing businesses, the Department must assess against the person or group, a penalty equal to 50% of the amount of the total surcharge payable by all members of that group.28 Previously, under H.B. 2158, the penalty was the removal of the $7 million cap for such groups.29
  • Requires select advanced computing taxpayers to pay the surcharge on a quarterly basis.30

Commentary S.B. 6492 addresses many of the administrative concerns raised by the original surcharge enacted by H.B. 2158 by imposing a general increase in the service B&O tax rate to 1.75%. Although the legislation broadens the reach of the rate increase to all service-type businesses, it preserves the current service B&O tax rate of 1.5% for hospitals and taxpayers with gross income of less than $1 million per year.

According to the Department’s fiscal note, approximately 89,000 businesses were subject to the surcharge under H.B. 2158.31 The fiscal note estimates that S.B. 6492 will affect approximately 14,800 taxpayers, with 10,400 of these taxpayers subject to a lower tax rate.32 The remaining 4,400 taxpayers are not subject to the surcharges created by H.B. 2158, but will pay the higher service and other activities enacted by S.B. 6492. The relatively small number of taxpayers that qualify as advanced computing businesses will be subject to a substantially higher tax rate than under H.B. 2158.

It is worth noting that the definition of an advanced computing business remains largely unchanged under S.B. 6492. An affiliated group may be deemed a select advanced computing business due to certain activities of a single member of the group, and the law does not require the member to be primarily engaged in such business activity. The revised law also does not require Washington nexus for the affiliates within this definition. While the Department’s fiscal note estimated only a small number of businesses will be impacted by the higher advanced computing surcharge,33 the law retains ambiguities which may impact a larger number of taxpayers than anticipated.


 
1 Ch. 2 (S.B. 6492), Laws 2020.
2 Ch. 406 (H.B. 2158), Laws 2019.
3 For the first two taxpayer categories, these are the tax rates applied to most service businesses. H.B. 2158 listed 43 specific types of business activities and applied a “primarily” test, but did not have a threshold or application to affiliated groups.
4 WASH. REV. CODE § 82.04.250.
5 WASH. REV. CODE § 82.04.270.
6 WASH. REV. CODE § 82.04.290(2).
7 For additional information, see GT SALT Alert: Washington Enacts Legislation Establishing Surcharge on Service Businesses.
8 Former WASH. REV. CODE § 82.04.299(2)(a)-(qq). 43 different service categories were described, generally corresponding to the businesses classified under the “Service and Other Activities” category for B&O tax purposes.
9 Former WASH. REV. CODE § 82.04.299(2).
10 Former WASH. REV. CODE § 82.04.299(3)(a)(i).
11 Former WASH. REV. CODE § 82.04.299(1)(a).
12 Former WASH. REV. CODE § 82.04.299(4).
13 Former WASH. REV. CODE § 82.04.299(4)(f)(i). Exceptions applied for persons primarily engaged in the provision of commercial mobile service and the operation and provision of access to certain transmission facilities using wired telecommunications networks. See former WASH. REV. CODE § 82.04.299(4)(f)(vi). Note that S.B. 6492 recodified WASH. REV. CODE § 82.04.299(4) as WASH. REV. CODE § 82.04.299(1).
14 Former WASH. REV. CODE § 82.04.299(4)(b).
15 Former WASH. REV. CODE § 82.04.299(4)(a)(i).
16 Former WASH. REV. CODE § 82.04.299(4)(a)(ii).
17 Fiscal Note for S.B. 6492, Washington Department of Revenue, Feb. 7, 2020.
18 WASH. REV. CODE § 82.04.290(2).
19 Id.
20 WASH. REV. CODE § 82.04.290(2)(f)(ii).
21 WASH. REV. CODE § 82.04.299(1)(f)(v).
22 WASH. REV. CODE § 82.04.299(1)(a).
23 Id.
24 WASH. REV. CODE § 82.04.299(1)(b).
25 WASH. REV. CODE § 82.04.290(2)(d)(i).
26 WASH. REV. CODE § 82.04.299(1)(f)(vi).
27 Id.
28 WASH. REV. CODE § 82.04.299(1)(e)(ii).
29 Former WASH. REV. CODE § 82.04.299(4)(e).
30 WASH. REV. CODE § 82.04.299(1)(d).
31 Fiscal Note for S.B. 6492, Washington Department of Revenue, Feb. 7, 2020.
32 These taxpayers will pay 1.75 percent rather than 1.8 percent under H.B. 2158.
33 Fiscal Note for S.B. 6492, Washington Department of Revenue, Feb. 7, 2020.



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