by Mike Nelson
Washington has long had the Business and Occupation (B&O) tax as the primary business tax which brings in roughly a quarter of all state tax collections. Over the years many changes have been made to the B&O tax which have been attempts, in the eyes of the legislature, to attract various industries to the state. Despite these tweaks, many B&O taxpayers have argued that it remains an unfair tax with many unnecessary complications.
The Tax Structure Work Group (TSWG) was founded in 2017 by the legislature and its voting members are primarily legislators from all four caucuses. The purpose of the TSWG is to find revenue neutral ways to make Washington’s tax code more simple and fair. After many rounds of debate, public testimony, and advisory work, the TSWG voted to stop considering personal or business income taxes, as well as some other taxes. As part of this five-year effort, the TSWG is seriously considering recommending that the legislature replace the B&O tax with what many are calling a Texas-style margin tax. A margin tax is a tax levied on the gross receipts of a business entity after a deduction has been applied. The deduction is meant to remove the costs of operating the business and so the tax should be predominantly applied to the “margin” that the business has earned as profit. Typically, four types of deductions are associated with a margin tax: a flat deduction that is meant to exempt small businesses, a compensation deduction, a cost of goods sold deduction, and a single percentage deduction.
Since the TSWG is required to only consider revenue neutral options, the Department of Revenue (DOR) has been assisting the TSWG with advanced modeling of the taxes and the detailed proposals once the TSWG has decided on specific deductions and language. In December, the TSWG will vote whether to recommend any specific proposals to the legislature for their 2023 session (which starts in January).
What would a margin tax look like?
In May the TSWG voted to recommend the following guidelines for a proposed margin tax: consolidate corporate entities; use the current nexus standards; use single-factor apportionment; rate basis based on receipts; maintain current B&O surcharges; maintain the current B&O tax base; eliminate current preferential rates, deductions, credits, exclusions, and exemptions; use a standard deduction; and not include the public utility tax.
Part of the margin tax would be the applicable deduction that a business can select. Building off the Texas tax structure four deductions are being considered: compensation paid, cost of goods sold (COGS), a fixed percentage of gross receipts (30%), and a flat amount ($1 million). DOR requested some clarification around the compensation and COGS deductions to assist in their modeling. At the TSWG meeting on September 21, they decided that for the purposes of DOR’s model, the compensation deduction should be limited to wages reported on IRS Form W-2, not include contractor compensation, cap the deduction up to $400,000 per employee, but not cap the total deduction at a percentage of compensation costs. For the COGS deduction they voted to direct DOR to model COGS based on the IRS calculations but again not cap the total deduction at a certain percentage.
Based on this additional direction from the TSWG, DOR expects to present their models on what a margin tax would look like in Washington and the sort of rates that would be required in order to replace the B&O at the TSWG virtual meeting on November 14.
While the TSWG members voted to direct DOR to model the tax a certain way, the members emphasized that some of the decisions shaping the compensation and COGS deductions would likely be reconsidered for the actual tax proposal.
What role is WSCPA taking in the process?
The WSCPA Advocacy Team and several members have been involved with the ongoing process of the TSWG. As members of the Technical Advisory Group, we participated in the initial economic review of various tax types. We have also met with and provided feedback to workgroup members and DOR on the implications, and potential unintended consequences, of certain tax options that were being considered. Several WSCPA Government Affairs Committee members have been diligently providing this feedback and have been working with other groups and individual firms to provide similar feedback on behalf of the profession. We have expressed a number of concerns with some aspects of the administration of this new tax or decisions that the TSWG may make with certain deductions.
What will happen next?
Some of the issues that will need to be resolved before the final TSWG meeting on December 13 will be: how this impacts local jurisdictions that currently impose B&O taxes; what the rates will be; how certain industries will be impacted and what exemptions may be put into the new tax; the timing of the transition and how long it will take DOR to make rules for aspects of a new tax.
The TSWG has said they will make these decisions and considerations in the one month they have between November 14 and December 13, in order to prepare the legislation for the 2023 Legislative Session. Many business groups in the state have remained cautious about commenting publicly on the margin tax until more details have been determined. Once the proposal goes to the legislature it is not bound by the restrictions placed on the TSWG to remain revenue neutral. During the 2023 session the legislature will be adopting a new two-year budget so this tax proposal could be a part of that process.
For updates related to the margin tax, read the WSCPA Present Value newsletter and All Things Advocacy blog.
Mike Nelson is the WSCPA Manager of Government Affairs. You can contact Mike at email@example.com.
This article appears in the fall 2022 issue of the Washington CPA magazine. Read more here.