Relief is in sight with a Washington State Margin Tax

Relief is in sight with a Washington State Margin Tax

January 23, 2023

Jeanna Schenk, CPA, MST

Washington state is known for its overly complicated Business and Occupation (B&O) tax, but relief is now in sight with the latest proposal from the Washington State Tax Structure Work Group. The current tax is assessed on gross income rather than net income. So, if a business makes zero profit, or has losses, their transactions are still assessed under the B&O tax. Under this current tax, businesses are also unable to deduct business expenses. As one might imagine, this burden is especially felt by small businesses who are just starting to become profitable. Washington is one of a few states in the U.S. that are operating in this outdated structure, along with Nevada and Ohio, but change is in the works…

On November 14, 2022, the Washington State Tax Structure Work Group (which was created in 2017 to help update the state tax code in Washington) met and proposed a margin tax, which would allow business taxpayers to provide a “margin” for expense deductions. If passed, the margin tax would replace the current Washington Business and Occupation tax (B&O) starting in 2025.

A quick refresh on B&O Tax in Washington State

Currently, a company must report B&O tax if they meet any of the following criteria:

  • have more than $100,000 in combined gross receipts sourced to Washington,
  • have physical presence in the state,
  • or were organized/domiciled in Washington.

Fast facts on the B&O Tax:

  • B&O tax is a flat rate structure with different rates depending on the business activity.
  • B&O is not an income tax like many other states; it’s calculated based on gross income from activities.
  • There are no deductions from the B&O tax for labor, materials, taxes, or other costs of doing business.
  • B&O is filed on a monthly or quarterly basis.

The Washington Margin Tax would positively impact businesses

The November 2022 proposal is similar to Texas’s franchise tax, where a margin is calculated by taking gross income, minus the greater of four deductions:

  1. Cost of goods sold,
  2. compensation (capped at 400k per individual),
  3. fixed % of gross receipts, or
  4. a flat amount.

However, unlike Texas, deductions for the compensation and cost of goods sold would be based on federal reporting, rather than a separate calculation. Washington would apply a single sales factor apportionment to the margin to determine the amount attributable to the state. When it comes to attributing Washington income to combined groups, each member will be included if any member has nexus in Washington. Entities that were subject to the B&O tax will also be subject to the margin tax, including corporations, partnerships, LLCs, sole proprietorships, and nonprofits.

Some important items to note about the proposed margin tax:

  • The filing frequency would change to annual, due April 15th.
  • Quarterly estimated payments would be required, first payments due 4/15/2025.
  • Combined reporting would be required for taxpayers that file a federal consolidated return.
  • Taxpayers would carryover earned but unused B&O tax credits for a limited time.
  • A retail sales tax credit would be created for retailers.
  • B&O would be eliminated 1/1/2025 and margin tax would begin for gross income earned in 2025.

If implemented, the new tax would be a simplified replacement for the B&O tax, and small businesses should be able to find some relief in the margins. Along with other items, the proposed Washington State Margin Tax will be discussed and voted upon during the 2023 legislative session. As the tax has earned a lot of support so far, the REDW State and Local Tax (SALT) team is optimistic for the implementation of the tax and will remain watchful over further developments. Please reach out to REDW’s trusted SALT experts with any questions on recent updates and how this change could affect your business.

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Insights from Jeanna Schenk, CPA, MST

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