In effect—and this is intentionally a rough description—a resident pays the millionaires’ tax on their Washington taxable income in excess of $1,000,000. (The actual law as currently proposed is significantly more complicated; this description is only meant to orient the reader.)

A Term to Know Before You Look at Residency Rules

Before looking at the residency rules, you need to understand one term: domicile.

Domicile means the primary place you live and intend to live. If you work in Washington state, rent or own a home you live in, plug into the local community here, have children in school here, and generally organize your life around Washington, you are likely domiciled in Washington state. If you always plan to return to Washington state, you are likely domiciled in Washington state.

If you spend time in Washington state and also spend time in another state (for example, Florida or Arizona), your domicile is generally the state where you have the deepest roots and strongest connections. This determination is inherently fuzzy and fact‑specific. (Hopefully, the legislature will provide a clearer definition in the final bill.)

Here is the key takeaway: If you are domiciled in Washington state, you will usually pay the millionaires’ income tax. But domicile alone does not determine whether you pay the tax. The statute separately defines who is treated as a resident for millionaires‑tax purposes, and those residency rules can override domicile in limited circumstances.

The 30‑Day Residency Rule

The first residency concept to understand is the so‑called “30‑day rule.” The proposed statute provides that a “resident” includes an individual:

(i) Who is domiciled in this state during the taxable year, unless the individual (A) maintained no permanent place of abode in this state during the entire taxable year, (B) maintained a permanent place of abode outside of this state during the entire taxable year, and (C) spent in the aggregate not more than 30 days of the taxable year in this state.

This provision is easy to misread. The 30‑day rule is not what makes someone a resident. It is an exception that allows a Washington domiciliary to avoid being treated as a resident—but only if all three conditions are satisfied for the entire year.

Under this rule, even if you are domiciled in Washington state, you are not treated as a resident for millionaires‑tax purposes if:

• You did not maintain any permanent place of abode in Washington state at any point during the taxable year;
• You did maintain a permanent place of abode outside Washington state for the entire taxable year; and
• You were physically present in Washington state for 30 days or less during the year.

Think of this as a narrow “de minimis presence” exception. If you truly live somewhere else, have no place to live in Washington, and are only in the state briefly, the statute treats you as a nonresident—even if domicile might otherwise be arguable.

Important note: Nonresidents may still be subject to the millionaires’ tax on Washington‑source income. For example, a high‑income California resident who owns rental property located in Washington or an interest in a pass‑through business operating in Washington may owe millionaires’ tax on that Washington‑source income. But they would not be taxed on all of their income.

The 183‑Day Residency Rule

For individuals who are not domiciled in Washington state, a different residency rule applies: the 183‑day rule. The statute provides that a resident also includes an individual:

(ii) Who is not domiciled in this state during the taxable year, but maintained a place of abode and was physically present in this state for more than 183 days during the taxable year.

This rule generally targets seasonal or extended‑stay visitors. If someone is not domiciled in Washington but maintains a place of abode here and spends more than half the year in the state, the statute treats them as a resident for millionaires‑tax purposes.

Both elements matter. Physical presence alone is not enough. The individual must also maintain a place of abode in Washington during the year.

Clarification #1: Partial Days Count as Full Days

The statute includes an important clarification regarding day counting:

For purposes of this subsection, “day” means a calendar day or any portion of a calendar day.

This means partial days count as full days when applying both the 30‑day rule and the 183‑day rule. Days can add up faster than many people expect. For example, entering Washington late on a Friday and leaving early Monday morning can count as four days, even if you were physically present for less than 48 hours.

Clarification #2: Partial‑Year Residency

The statute also addresses how residency applies when a person is classified as a resident for only part of the year. It provides:

An individual who is a resident under subsection (a) is a resident for that portion of the taxable year in which the individual was domiciled in this state or maintained a place of abode in this state.

This rule does not change who is a resident. Instead, it limits how much of the year is treated as resident once residency is established.

For example:

• If a Washington domiciliary fails the 30‑day exception (for example, by spending more than 30 days in the state), the individual is treated as a resident only for the portion of the year during which they were domiciled in Washington or maintained a Washington place of abode.

• If a non‑domiciliary is classified as a resident under the 183‑day rule, they are treated as a resident only for the portion of the year during which they maintained a Washington place of abode.

This partial‑year rule provides a measure of fairness by preventing the statute from automatically treating someone as a resident for an entire year when their connection to Washington exists only for part of that year.

Additional Resources

Changing Your Washington State Residency or Domicile

Text of Proposed Washington State Income Tax Bill (as of February 10, 2026)

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Thus, if you’re a business professional selling your services?  You want to know how the new Washington state professional services sales tax works. You want to know where and when it applies. And you also want to understand how you can or should constructively respond. (You have some options here.)

One other remark before I start jabbering. This is still all a little foggy. Who knows how this ends up. Discussions appear to be underway among policy makers about whether this sales tax on professionals was what they intended and whether it should continue to be the law. And now into the details.

How the Washington State Professional Services Tax Works

Normally, states don’t levy sales tax on professional services. And for a long time, Washington state’s tax laws worked the same way.

But as a matter of fact, professional services often fall into a category, digital automated services, that states can and do subject to retail sales taxes.

What is a digital automated service? Here’s the statutory definition: A digital automated service (quoting from the revised code of Washington) “means any service transferred electronically that uses one or more software applications.”

Thus, a plain language reading: Email? Online portals? Video conferencing? Your telephone? All those use one or more software applications to transfer electronically text, files, video or audio. Thus, professionals using those tools to provide services potentially needed to calculate and collect retail sales taxes. Except for one thing: An exclusion applied to this work in past.

Historically while professional services did look like a digital automated service, state law excluded (and here again I quote) “any service that primarily involves the application of human effort by the seller, and the human effort originated after the customer requested the service.”

In April 2025, however, the legislature struck the boldfaced language above using Engrossed Substitute Senate Bill 5814, a couple of weeks later Governor Ferguson signed the bill into law, and now professional services may be subject to retail sales taxes.

Which Firms Need to Deal with New Sales Tax

Probably if you’re a Washington state professional, you need to calculate, collect and remit Washington state sales taxes starting October 1, 2025. (And if you are a Washington state resident, you need to pay Washington state sales taxes when you buy professional services.)

Just to be clear—remember the trigger here is a professional uses software to deliver the service—all of the following items probably count as digital automated services and therefore trigger retail sales taxes:

• A consultant does a bunch of research and then delivers the research results via a streaming video conference. That streaming video conferencing software results in the activity being treated as a retail sale.
• A researcher writes a whitepaper and then emails the paper to the client. The email software triggers classification of the service as a retail sale.
• A tax accountant prepares a tax return and then delivers the return using an online portal. The online portal results in the tax return being treated as a digital automated service.
• A bookkeeper provides remote general accounting services via QuickBooks Online or maybe via a remote desktop connection to the QuickBooks desktop software. Either the QuickBooks Online software or the Windows remote desktop connection software trigger classification of the service as a retail sale.

A clarification: A professional might be able to deliver any of these services in non-digital, non-automated ways. The consultant can deliver a presentation in person (though maybe shouldn’t use PowerPoint?) The researcher can courier or hand deliver the research paper. The tax accountant can print a copy of the tax return and ask clients to pick up that up in person. A bookkeeper might be able to work onsite. These alternatives allow the professional to avoid classification as a digital automated service.

But many professionals? Yeah, they’ve embraced technology. They use software to automate and speed up their work. And at this stage, reconfiguring the workflow to escape the sales tax? That seems impractical.

How Business and Occupation Taxes and Rates Change

Here’s something else to know. The change in the state’s rule about how the tax accounting works delivers some new benefits.

For one thing, the business and occupation excise tax rate probably drops. Retail sales business and occupation (B&O) tax rates run .471 percent (so slightly less than half a percent). Services B&O tax rates usually run 1.5 percent for small businesses and then 1.75 percent for larger businesses.

Furthermore, while the services B&O tax applies to often all of a firm’s revenues, the retail sales B&O tax rate applies to in-state sales.

A professional services firm with $1,000,000 in revenues in past paid a 1.5% or 1.75% services B&O tax on $1,000,000 of revenue. But if half the firm’s services go to out of state customers? The new Washington state professional services sales tax subjects $500,000 to the new lower retail sales .471% B&O tax.

The drop in B&O taxes obviously doesn’t “pay” for the maybe 10 percent-ish retail sales taxes. But it may partially compensate the firm for new compliance costs and the clients it loses due to the effective 10 percent-ish increase in prices. And that’s the next thing to talk about.

Price Elasticity Means Professional Services Firm Will Leak Clients and Revenues

One important practice management point to mention.

If your services cost 10 percent more due to the new sales tax, probably some clients will change their purchasing habits.

In the case of a tax accounting firm, for example? Some clients might move to a retail tax preparer where the preparer delivers a paper copy of the tax return after collecting the numbers. (A paper deliverable saves the sales tax.)

And a tax accountant should not be completely surprised if a client moves to an out of state tax accounting firm. Technically, that firm won’t have to follow Washington state’s sales tax accounting rules unless it provides more than $100,000 of services to Washingtonians. (The Washington client should still pay the tax as a use tax.)

How large will this attrition grow? My guess is 3 percent-ish. That percentage of lost business reflects the usual elasticity of professional services, -.3. (That’s minus 30%.) In other words, a 10 percent price increase to the clients and customers times minus 30% equals a minus 3% change.

Accounting Stuff You Want to Do For Sales Tax

Before I wrap this up, some steps I think you and I take:

1. Get good address information into the accounting system so we can correctly source sales because these sales get sourced to where a client uses the service. (You can use the state’s lookup tool here.)
2. Set up your accounting system to correctly calculate the right sales tax rates on invoices. This will be a headache. Washington segregates the state into hundreds of local sales tax jurisdictions. Hopefully you won’t have more than a few dozen. If you do, use a sales tax service. By the way, in QuickBooks you’ll set up sale tax code items.
3. Alert clients and customers to the new effective higher price if you now need to begin charging sales taxes. We can’t protect our clients from this new cost. We can warn them.
4. Clearly differentiate any remaining services from retail sales on invoices. For example, if you meet with a client on-site, that’s clearly professional service and not retail sales.
5. Explore un-bundling services. A $1,000 tax return for example might be unbundled into a $900 tax return (not subject to sales tax) and then the following delivery options: $100 for portal delivery (subject to sales tax) , $200 for mailed paper delivery (not subject to sales) or free “counter” pickup (also not subject to sales tax). This approach adds risks unless we first get clear guidance from the Department of Revenue. But unbundling might work
6. If you’re reading this blog post before October 1, 2025, complete and bill that work-in-progress before the October 1. Also try to collect for that work before October 1 since while it technically shouldn’t be subject to sales tax unless it was performed after October 1? Gosh, you never know what position the state might take.

Related Articles

Washington state enacted a bunch of changes to state tax laws in April and May of 2025. These two blog posts describe in detail two changes significant for many small business owners:

The changes in the Washington Qualified Family-owned Business Interest Deduction for 2025 and future years.

The bumps in the state’s estate tax rates, which you can explore using our updated Washington estate tax calculator 2025 version

The post Washington State Professional Services Sales Tax appeared first on Evergreen Small Business.

And here’s why: Washington state now levies a seven-percent capital gains tax on (1) the net long-term capital gains residents realize and (2) the Washington-state-y net long-term capital gains that nonresidents realize.

But if you’re a small business owner or entrepreneur? You can probably avoid the capital gains tax on the sale of a small business.  Because the law includes a qualified family-owned small business deduction.

A warning though: Washington state’s new capital gains tax is complicated. And the most complicated bit? The small business loophole you may want to use.

The Washington Capital Gains Tax in a Nutshell

But let me briefly explain how the Washington capital gains tax works. And then I’ll get into the gritty details of the qualified family-owned small business deduction (aka, the “QFOSB” deduction.)

So the big picture on this Washington capital gains tax. The state levies a seven percent tax on the net long-term capital gains an individual taxpayer realizes.

However two wrinkles here: First, the law exempts a bunch of special-case capital gains, including most capital gains on real estate, gains from selling depreciable property, and for specific industry situations. (For a complete list of the exemptions, you can refer to a blog post over at our CPA firm website: Washington State Capital Gains Tax Planning.)

And then the second wrinkle. The law provides three deductions: A standard $250,000 deduction (so the first $250,000 of gain is never taxed). A charitable contribution deduction of up to $350,000, which is an alternative to the $250,000 standard deduction. (You would use the alternative charitable deduction only if it exceeds the standard deduction.) And then a qualified family-owned small business deduction.

Note: Those amounts in the preceding paragraph get adjusted annually for changes in the Seattle-area consumer price index. The actual standard deduction for 2023, for example, should be eight or nine percent higher.

So, that’s the big picture. But you’ll need to understand the gritty details of the QFOSB deduction.

Deduction Detail #1: Gross Revenues $10 Million or Less

A first thing to know about the QFOSB deduction: To be a small business, a firm’s worldwide revenues for the twelve-month period prior to the sale or exchange need to equal $10,000,000 or less. (This value also gets adjusted for inflation. So if you’re looking at a sale in 2023? The value might be closer to $11,000,000.)

But note that the tax doesn’t look at the capital gain, as the following two examples highlight:

Example 1: George developed and patented artificial intelligence software. After several years of development, annual revenues average less than $1,000,000 a year. But a large technology company buys his business for $100,000,000. He should qualify for the full qualified family-owned small business deduction on the $100,000,000.

Example 2: George’s wife Martha starts an ecommerce business and slowly grows the business to $12 million in revenues. After George sells his business, she sells her firm in 2022 for $500,000 based on the firm’s annual profits. (Profits roughly run $200,000 a year.) Probably half of her $500,000 of capital gains, or $250,000, gets taxed. Her business? Too big to use the QFOSB deduction on her tax return.

Deduction Detail #2: Three Families or Fewer Control

The next thing to know. The QFOSB deduction only works for an interest in a family-owned business that meets, and here I use the language of the statute, one of the following characteristics:

• An interest as a proprietor in a business carried on as a sole proprietorship
• An interest in a business if at least 50 percent of the business is owned, directly or indirectly, by any combination of the taxpayer or members of the taxpayer’s family.
• An interest in a business if at least 30 percent of the business is owned, directly or indirectly, by any combination of the taxpayer or members of the taxpayer’s family and at least 70 percent of the business is owned, directly or indirectly, by the members of two families or at least 90 percent of the business is owned, directly or indirectly, by the members of three families.

The Washington capital gains tax law, by the way, says a taxpayer’s family members include ancestors (so parents and grandparents of the taxpayer, for example), spouses and state registered domestic partners, lineal descendants, lineal descendants of a taxpayer’s spouse or state registered domestic partner, and finally, the spouse or state registered domestic partner of a lineal descendant. (These definitions come from Revised Code of Washington Section 83.100.046.)

Example 3: George and his wife Martha along with their good friends John and his state registered domestic partner Abigail start a small business. Initially they each own half. Later on they sell a third of the company to a venture capital fund. If they subsequently sell the business, because their two families together own less than 70 percent, they won’t get to use the QFOSB deduction. Note that had they sold the firm before raising venture capital? Yeah, they would have qualified.

One thing to note here: The new law doesn’t define what a business is. But a reasonable guess is that the definition used for federal income taxes works. For example, the Section 162 standard established in a famous U.S. Supreme Court case, Commissioner v Groetzinger, says a business is an activity conducted in pursuit of profit and carried on with regularity and continuity. (Groetzinger was a professional gambler, by the way.)

One would think that all the common business forms “qualify” for the qualified small business interest deduction: sole proprietorships, partnerships, regular “C” corporations, S corporations, LLCs operating as a proprietorship, partnership or corporation, and so forth.

But an awkward reality: We don’t at this point know for sure how the state defines a “business.” (For example, federal income tax laws say a real estate rental activity may rise to the level of a trade or business. Yet who knows how the state sees this issue.)

Deduction Detail #3: Sell Substantially All of the Business or the Interest

Another detail you need to know to assure the deduction: The business owner needs to sell at least 90 percent of her or his interest or the owners need to sell at least 90 percent of the business’s real property, taxable personal property, and intangible personal property.

Example 4:  Washington and Adams, a land surveying partnership with two owners, sells all of the assets of their business for a $1,000,000 capital gain. The two owners share the $1,000,000 equally. Assuming all the other requirements are met, each owner shelters their proportional $500,000 gains with the QFOSB deduction because they’ve sold 100 percent of the consulting business.

Example 5: Jefferson and Burr operate a law firm as equal partners. Burr wants to sell his 50 percent interest in the law firm to a young new partner, Clinton, and then retire. When Burr sells his 50 percent interest to Clinton, he realizes a $500,000 capital gains tax and he also avoids the Washington capital gains tax on  the $500,000 gain. The reason? He sells 100% (so more than 90%) of his interest in the business.

Note: The statutory and administrative guidance available from Washington state provide no guidance on whether an existing business might be split into two or more separate businesses. For example, in Example 4, could Washington and Adams split the land survey firm into two businesses—say a Virginia operation and a Massachusetts operation—prior to the sale? And then they could possibly sell substantially all of one of those businesses? I would guess this does work. And here’s why: In  the July 2023 administrative rules’ Example 11, the Department of Revenue describes how a real estate gain potentially subject to capital gains tax can be “moved” into another entity and so escape the tax.

Deduction Detail #4: Hold Interest for Five Years

The usual time frame required to receive long-term capital gain treatment on a federal and most other state income tax returns is more than one year. But to enjoy the qualified family-owned small business deduction, a taxpayer needs to have held her or his interest in the business, either directly or beneficially, for at least five years immediately preceding the sale.  And while a mere change in the form of the business doesn’t necessarily restart the five year countdown, the change in form needs to not change the proportions of any beneficial ownership interest. (This last requirement comes from page 12 of the July 2023 administrative rules.)

Example 6:  James starts a restaurant on January 1, 2020 and operates as a sole proprietor for two years. He then incorporates the restaurant and elects Subchapter S status two years later on January 1, 2022. He sells the restaurant on December 30, 2024 and realizes a $1,000,000 capital gain. Because he sells the business one day short of five years? He will pay the capital gains tax on a portion of the $1,000,000. (Partial days count as full days per the statute. So if he’d sold on December 31, 2024 or later, he could have taken the deduction.) Note that the change in the form of the business ownership—a sole proprietorship for two years and then an S corporation for almost three years—doesn’t matter because James’ ownership percentage doesn’t change when the form of the business changes.

Example 7: John, James’s brother, also started a restaurant on January 1, 2020 and then owned and operated it for a full five years, selling the restaurant on January 1, 2025. John operated the restaurant as a sole proprietorship for the first two years and then as an S corporation the remaining three years. When he elected Subchapter S status, however, he allowed his key employee to acquire a five percent interest in the S corporation. Unfortunately, he fails to qualify for the qualified family-owned small business deduction. Why? Because his changed ownership percentage in the S corporation “form” of the business restarts the five-year holding period.

Deduction Detail #5: Taxpayer or Family Materially Participates

A material participation rule exists for the QFOSB deduction: Either the individual or a family member owning the business needs to materially participate in the business for five of the ten years immediately preceding the sale unless the sale is to another member of your family.

To determine material participation, the Washington statute basically regurgitates Section 469 of the Internal Revenue Code, which says material participation means a taxpayer needs to be involved in the operations of the activity on a regular, continuous and substantial basis. And then the statute says material participation has the roughly same meaning as the Section 469 statute and its regulations. (The actual statute says, “materially participated must be interpreted consistently with the applicable treasury regulations for Title 26 U.S.C. Section 469 of the internal revenue code…” The administrative rules then soften the “consistently” requirement with a rule to “generally” apply the 469 regulations.)

But a note: The Section 469 temporary regulations provide seven methods of achieving material participation. And only the first three methods, which set time-spent thresholds (more than 500 hours a year or more than 100 hours when no one works more or substantially all of hours), appear to work well. The regulations’ other material participation methods appear not to work. Or not to work cleanly. (Two methods, for example, say a taxpayer has materially participated for federal income tax purposes even when she or he hasn’t spent any time working in the preceding five years.)

Deduction Detail #6: Document Material Participation

A related material participation thing. Material participation from any member of the family of the taxpayer apparently counts for the entire family. But surely many family-owned small business owners have not been documenting their participation.

And for a good reason: They haven’t needed to.

Internal Revenue Code Section 469 and the companion Treasury regulations use material participation to determine when individual taxpayers claim passive activity losses and use passive activity tax credits. That’s exactly the opposite of what Washington state wants. The state uses the passive loss material participation regulations to determine if individual taxpayers report taxable income.

The practical problem in this misapplication? Profitable “qualified family-owned small business” businesses probably won’t have been tracking their material participation at least before now. Because they didn’t need to. But now they should. Probably. So they can later prove material participation.

Deduction Detail #7: Consider (Reconsider?) Activity Groupings

One other wrinkle related to Section 469 material participation rules bears mentioning.

Section 469 and its companion regulations provide a way for taxpayers to aggregate their trade or business activities into larger grouped trades or businesses.

As a generalization, trades or businesses (which is what the Washington state statute appears to talk about) might qualify for the family-owned small business deduction if they meet the requirements and follow the rules described here.

But one probably needs to stay alert to the possibility that the state says activity groupings create trades or businesses for purposes of the Washington state capital gains tax.

Example 8: Years ago, for purposes of filing his federal income tax return, Andrew appropriately grouped a warehouse he owns (held in an LLC) with a distribution business he owns (in an S corporation) based on self-rental grouping rules embedded in the Section 469 regulations. Because the IRS sees these two activities as a single activity, one wonders if the Washington Department of Revenue would see them as a single trade or business. That unintended consequence would mean that Andrew would not get a qualified family-owned small-business deduction unless he sells both the warehouse and the distribution business to the same buyer.

A related thought: Even if Andrew sold both the warehouse and distribution business simultaneously, would two sales to different buyers count as a sale or exchange that disposes of substantially all of the assets? The language of the statue talks about the “sale of substantially all of the taxpayer’s interest in a qualified family-owned small business.” Not “sales” plural, then. But a singular “sale.”

And another related thought: If the Washington Department of Revenue would see an activity grouping consisting of a warehouse and  a distribution business as a single trade or business, could the business owner first sell the warehouse? (That would presumably not trigger Washington capital gains because real estate gains are exempt from the tax.) Then later, but perhaps even in the same year, the business owner could sell substantially all of the remainder of the previously grouped activities—so just the distribution business. I would guess this works. For what it’s worth.

Deduction Detail #8: Use Smart Purchase Price Allocations

Some small businesses get sold as a collection of assets: the inventory, furniture and fixtures, maybe the real estate and then the intangible personal property like the goodwill. Because some of the assets fall into exempt income categories, a seller might want to sell assets rather than the entity.

Example 9: Martin owns a small business, Van Buren Inc., that he can sell his stock in for a $750,000 gain. However, he worries he will fail to qualify for the QFOSB deduction because he can’t confidently prove his material participation. Thus, by selling this stock, he might pay the seven percent tax on $500,000 of the gain (assuming the 2022 $250,000 standard deduction). Alternatively, in an asset sale, he can sell the inventory for a $100,000 gain (not taxed because inventory is not a capital asset), sell the depreciated furniture and fixtures for a $200,000 gain (statutorily exempt from the Washington capital gains tax), sell the real estate for a $200,000 again (again, statutorily exempt), and thus completely avoid the Washington capital gains tax.

Note: Some practitioners wondered how the Department of Revenue would handle purchase price allocations. And the July 2023 rule proposals provide helpful guidance. The proposed rules say that taxpayers can use full appraisal reports, assessor valuation if the assessment date closely matches the sale or exchange date, or the purchase price allocation the seller and buyer use to comply with IRC Section 1060. Predictably, the Department of Revenue reserves the right to change or modify what it views as an inappropriate allocation.

Deduction Detail #9: Consider Domicile of Owners

A Washington state domiciliary (basically what tax law usually thinks of as a resident) pays taxes on essentially all of her or his net long-term capital gains. (I’m ignoring the credit for taxes paid to another state if some net long-term capital gains get sourced outside Washington.)

For nonresidents, however, only tangible personal property sold or exchanged from a location in the state gets hit with the Washington capital gains tax.

Tangible personal property, per the administrative rules means “personal property that can be seen, weighed, measured, felt or touched”. Tangible personal property, then, does not include an interest in a partnership or shares of a corporation. Thus, an out-of-state small business owner might optimize by selling her or his interest in the partnership or the corporation instead of having the partnership or corporation sell its assets.

Example 10: Martin’s wife Hanna, also owns a small business, Hannah Hoes Corporation. After Martin sells his business, he and his wife move to Nevada. And then, after establishing residency there, Hannah sells her interest in her Washington corporation for a $1,000,000 gain. She avoids Washington capital gains tax.

Deduction Detail #10: Avoid Section 338(h)(10) Treatment

The modest guidance from the Department of Revenue, at least at the time we’re writing this, suggests to us that taxpayers might want to avoid common but more complex transaction structures.

As one example of this, I’d think a taxpayer wants to avoid applying Section 338(h)(10) to a qualified stock purchase transaction. Section 338(h)(10), by the way, treats a sale of stock as a sale of assets. The issue with Section 338(h)(10) is, one might not know how to handle the transaction on a Washington capital gains tax return.

Deduction Detail #11: Reconsider Section 754 Elections

A technical point.

I’m not necessarily a fan of making Section 754 elections. (The work required to make the election and then the resulting annual tax return adjustments often exceeds the tax savings.) However, taxpayers and their tax advisors probably want to reconsider Section 754 elections for appreciated property held inside a partnership at the time when a partner dies and receives a Section 1014 step-up in basis.

The reason? The step-up in basis may eliminate, or at least minimize, a taxpayer’s long-term capital gains. And that will probably eliminate or minimize Washington state’s taxation of long-term capital gains.

Deduction Detail #12: Consider Using Trust or Estate Ownership

A final, weird tangential comment: The list of pass-through entities which confer beneficial ownership for an individual excludes estates as well as trusts other than grantor trusts. That means if a nongrantor trust or estate realizes a long-term capital gain, the individuals who are beneficiaries of the estate or trust don’t pay the seven percent tax.

Thus, some small business owners may want to move an interest in a small business into a trust or sell an interest held in an estate before realizing the gain. (This gambit also works for capital assets other than interests in small businesses.)

Additional Resources for Qualified Family-Owned Small Business Deductions:

As noted earlier, we’ve got a “general” blog post over at the CPA firm website that discusses the mechanics of the Washington state capital gains tax including some common tax planning tactics: Washington State Capital Gains Tax Planning

The actual statute appears here: https://lawfilesext.leg.wa.gov/biennium/2021-22/Pdf/Bills/Senate%20Passed%20Legislature/5096-S.PL.pdf?q=20210426052154

The most recent July 2023 draft of the administrative regulation appears here: https://dor.wa.gov/sites/default/files/2023-06/20-XXXcr1frmdraftjune23.pdf?uid=64aac2f8dc5d9

The post The Qualified Family-Owned Small Business Deduction appeared first on Evergreen Small Business.

You maybe need to file a Washington state capital gains tax return with your 2022 federal tax return.

Specifically, if you realized long-term capital gains in 2022 of more than $250,000 and you’re a Washington resident. you need to file a Washington state capital gains tax return.

And if you’re not a resident but you realized more than $250,000 of long-term capital gains inside Washington state, you need to file the return.

Unfortunately, the whole process is tricky. And messy. So let’s go over the details. And quickly. You don’t have much time.

When You Need to File

 The statute and the Washington State Department of Revenue says you only need to file the income tax return if you have to pay the new capital gains tax.

Thus, if you can wriggle out from under the tax by using one of the exemptions or deductions? (See this blog post at our CPA firm website for more information: Washington State Capital Gains Tax Planning.) Even though your long-term capital gains cross that $250,000 threshold? You can skip this goat rodeo.

Note that this approach differs from the way federal and most other state’s income tax laws work. Usually if your gross income is high enough, you file. Even if in the end you don’t owe tax due to deductions or credits.

Confusingly, this approach also differs from the way Washington state handles state estate tax returns and other excise tax returns like the business and occupation tax. (Washington state requires estates to file a state estate tax return if the gross estate exceeds the $2,193,000 threshold.)

Getting Ready to File Washington State Capital Gains Tax Return

Reflecting the state’s inexperience with administering an income tax, Washington State requires taxpayers to use their poorly designed, cumbersome SAW system for filing capital gains tax returns.

In a nutshell, the process works like this if a taxpayer will delegate the return preparation to a tax accountant:

1. A taxpayer creates a SAW account (Details here: https://dor.wa.gov/manage-business/my-dor-help/set#saw.)
2. The taxpayer registers a capital gains account for her or his SAW account (Details here: Capital Gains – My DOR help | Washington Department of Revenue )
3. The taxpayer adds the tax accountant as a user to the SAW account. The Department of Revenue suggests you add your tax accountant as an “Account Manager” user. That won’t work well for any situation where your accounting firm employs more than one accountant. You want to add your tax accountant as an “Administrator.” (Details here: Information on electronic filing for tax preparers | Washington Department of Revenue )
4. Engage your tax accountant to prepare the tax return.
5. When the tax return is complete, sign on to your SAW account, access your capital gains account, review the tax return and then, if it’s correct and complete, you then both file the tax return and pay the capital gains tax.

ABCs of Preparing Capital Gains Tax Return

You can tell the Washington State Department of Revenue doesn’t really understand how the federal income tax return works. And that’ll probably create all sorts of confusion as they process the capital gains tax returns.

In a nutshell, though, you enter the long-term capital gains information that shows up on the summary Schedule D form in the federal 1040 return. Then—and I kid you not—you enter each capital gains transaction that Washington state taxes.

If you invest using a rebalancing strategy (like Betterment), you or your accountant may have hundreds or even thousands of transactions to enter. By hand. The system doesn’t provide a way (yet?) to import transactions.

And then this friction point: The Department of Revenue’s instructions say you enter the detail that shows up on the Form 8949. But as any experienced tax accountant and many taxpayers know, most capital gain transactions don’t actually appear on the 8949 form. I can’t imagine that misunderstanding on the part of the Department of Revenue will produce good results for taxpayers.

What I think you ought to do is use the IRS instructions for preparing the 8949 and then complete the Washington state capital gains tax return as best you can.

If You Have Trouble with the Website

If you have trouble with the website or the process? Don’t call your tax accountant. Sorry. She or he can’t solve the problem.

Rather, call the Washington State Department of Revenue. Here’s the telephone number: 360-705-6655.

Another suggestion? If you do have trouble with the process? Like you can’t easily use the SAW system? Or the capital gains webpages don’t work well? Call or write your state legislators. (Contact information here: Washington State Legislature Member Information. ) Seriously. These men and women probably aren’t ever going to experience the system they decided you need to now use. Any feedback you can give them will encourage them to work to improve the process.

Extending the Due Date of the Return

One final suggestion: The state says if you extend your federal income tax return you automatically extend your Washington state capital gains tax return too. You probably want to do that.

Here’s why: The Supreme Court decided on March 25, 2023 you would need to file this tax return by April 18, 2023. But that late notice doesn’t give you or your accountant time to learn the law. Or if you’ve got a lot of transactions, time to manually enter the data.

But this caution: You need to have really good proof you extended. Probably you want to have your tax accountant electronically extend the federal tax return. If you don’t use a tax accountant, you should probably make an extension payment for your return to get extension documentation you can show state. (You can use this IRS web page to make an extension payment: Make an IRS Payment.)

The post Filing Washington State Capital Gains Tax Returns appeared first on Evergreen Small Business.

B&O Basics

Washington’s B&O tax recognizes three main categories of businesses, which it treats differently and subjects to different tax rates:

• Retailers
• Wholesalers
• Service businesses

That last category is often referred to as “apportionable activities,” and in addition to service businesses, it also includes royalty income and a hodgepodge of other seemingly-random industries. [See RCW 82.04.460(4)(a) for more on apportionable activities.]

When Do I Have B&O Nexus in Washington?

For wholesalers and apportionable activities, Washington defines nexus for B&O tax purposes in RCW 82.04.067(1):

1. A person engaging in business is deemed to have substantial nexus with this state if, in the current or immediately preceding calendar year, the person is:
   1. An individual and is a resident or domiciliary of this state;
   2. A business entity and is organized or commercially domiciled in this state; or
   3. A nonresident individual or a business entity that is organized or commercially domiciled outside this state, and the person had:
      1. More than fifty-three thousand dollars of property in this state;
      2. More than fifty-three thousand dollars of payroll in this state;
      3. More than two hundred sixty-seven thousand dollars of receipts from this state; or
      4. At least twenty-five percent of the person’s total property, total payroll, or total receipts in this state.

For all other types of business activities, mainly retail, a business has nexus if its physically present in the state, or if it meets the gross receipts part of the nexus test described above [RCW 82.04.067(6)].

And one final note: those specific dollar amounts listed in (1)(c) are adjusted every year for inflation. As of this writing, the current thresholds, for both apportionable sales and wholesale sales, are:

• $57,000 of property
• $57,000 of payroll
• $285,000 of gross receipts

Finally, note that WAC 458-20-194(2) contains a more detailed explanation of the Washington Department of Revenue’s interpretation of nexus rules, including several examples.

What Counts as “Engaging Within the State”?

Per RCW 82.04.066:

“Engaging within this state” and “engaging within the state,” when used in connection with any apportionable activity as defined in RCW 82.04.460 or selling activity taxable under RCW 82.04.250(1), 82.04.257(1), or 82.04.270, means that a person generates gross income of the business from sources within this state, such as customers or intangible property located in this state, regardless of whether the person is physically present in this state.

What Counts as “Property in the State”?

The definition of “property” for the purpose of determining nexus is from RCW 82.04.067(2):

Property counting toward the thresholds in subsection (1)(c)(i) and (iv) of this section is the average value of the taxpayer’s property, including intangible property, owned or rented and used in this state during the current or immediately preceding calendar year.

In most cases, you determine the value of property you own by simply using the original price you bought it for [RCW 82.04.067(2)(b)(i)]. For property you rent, you determine the value by multiplying your annual rent by eight [RCW 82.04.067(2)(b)(ii)]. If your business makes loans, there are special rules for determining the value of those assets. And computer software and other digital goods get a special loophole in RCW 82.04.067(2)(e).

What Counts as “Payroll in the State”?

The definition of “payroll” for the purpose of determining nexus is from RCW 82.04.067(3):

Payroll counting toward the thresholds in subsection (1)(c)(ii) and (iv) of this section is the total amount paid by the taxpayer for compensation in this state during the current or immediately preceding calendar year plus nonemployee compensation paid to representative third parties in this state. Nonemployee compensation paid to representative third parties includes the gross amount paid to nonemployees who represent the taxpayer in interactions with the taxpayer’s clients and includes sales commissions.

That point the law makes about “representative third parties” exists to close a potential loophole for determining nexus. One trick that some businesses tried in the past was to call all of their workers in a state “independent contractors,” not “employees.” The idea was that without any employees in the state, the business didn’t have nexus in the state.

However, in Scripto, Inc. v. Carson (362 U.S. 207, 1960) the Supreme Court determined that this trick didn’t work. Scripto, Inc. was an Atlanta-based business that hired 10 salesmen as independent contractors to regularly solicit sales in Florida. In response to Scripto’s argument that it had no nexus in Florida because it had no employees, the Court had this to say:

True, the “salesmen” are not regular employees of appellant devoting full time to its service, but we conclude that such a fine distinction is without constitutional significance. The formal shift in the contractual tagging of the salesman as “independent” neither results in changing his local function of solicitation nor bears upon its effectiveness in securing a substantial flow of goods into Florida… To permit such formal “contractual shifts” to make a constitutional difference would open the gates to a stampede of tax avoidance.

What Counts as “Receipts from the State”?

The definition of “receipts from the state” for the purpose of determining nexus is from RCW 82.04.067(4). Generally speaking the rules for sourcing sales of tangible property, whether retail or wholesale, are the same for B&O tax purposes as for sales tax purposes—i.e., it’s destination based.

For apportionable activities, you use the same value for “receipts attributable to Washington” as you would use in Washington’s apportionment formula, described later in this article. Washington uses a tiered system, but for now it’s enough to know that for a service business you generally attribute receipts based on the location where the customer received the benefit of the service your business provided.

What About Public Law 86-272?

So, here’s the awkward thing about P.L. 86-272. It only applies to income taxes. And the tax base for Washington’s B&O tax isn’t income, it’s gross receipts. So multistate businesses can’t use Pub. Law 86-272 to claim they don’t have nexus for B&O tax purposes.

How Does B&O Allocation and Apportionment Work?

If your business doesn’t have B&O tax nexus in Washington, then you don’t need to worry about paying Washington B&O tax on any of your business’ revenues. But if your business does have nexus in Washington, your next step is to figure out how much of your business’ revenue is Washington’s “share” to tax.

For sales of tangible personal property, you calculate Washington’s “share” of your business’ gross receipts using the destination-based sourcing rules in RCW 82.32.730. For examples of the application of these rules, see WAC 458-20-193. You’ll notice that these tangible property sourcing rules for B&O are the same sourcing rules as apply for retail sales tax, as we described in our last blog post.

On the other hand, for apportionable activities (e.g. service businesses and royalty income), you calculate these “shares” using Washington’s apportionment formula, described below.

What’s the Apportionment Formula?

Per RCW 82.04.462, the apportionment formula for determining what portion of gross receipts are subject to Washington B&O is:

WA Receipts = Apportionable Receipts × (Receipts Attributable to WA)/(Total Receipts – Receipts Attributable to a State Business Doesn’t Pay Tax To)

One significant thing to note about this formula is that if a business only has nexus in Washington State, and no other state, then 100% of the business’ gross receipts will be subject to Washington B&O, even if the business has out-of-state customers. This is because, in such a situation, the denominator of the “receipts factor” will equal the numerator.

What Does it Mean for Apportionable Income to be Attributable to Washington?

Under Washington’s tax laws, apportionable income—which again, is mostly service income and royalty income—is attributed to states under a tiered system. Essentially you apply the first rule in the list if you can, and if applying that rule is impossible, you move on down the list until you get to a rule that’s decently workable.

What Does it Mean for Income to be “Taxable in Another State”?

Per RCW 82.04.460(4)(b):

“Taxable in another state” means that the taxpayer is subject to a business activities tax by another state on its income received from engaging in apportionable activities; or the taxpayer is not subject to a business activities tax by another state on its income received from engaging in apportionable activities, but any other state has jurisdiction to subject the taxpayer to a business activities tax on such income under the substantial nexus standards in RCW 82.04.067(1).

How Do I Know My B&O Tax Rate?

Once you know whether or not you have Washington B&O tax nexus, and which receipts count as Washington receipts, you’re largely past the difficult part. Your last step is to simply multiply your Washington gross receipts for the taxing period (usually a month) by your B&O tax rate.

The general rates for the major categories of businesses are:

However, note that many industries in Washington State have successfully lobbied for special, lower tax rates. The Washington Department of Revenue has a helpful list of such rates here.

When it’s time to file your tax return and pay your B&O tax, you’ll take care of it on the same tax return you use to file and pay sales tax. You file this combined excise tax return using the Washington Department of Revenue’s online portal, MyDOR (this is the same account you used when you applied for a Washington business license). If you use QuickBooks, this can make accounting for B&O payments a bit tricky, but we provided some ideas on how to deal with that issue in this prior blog post.

The post B&O Tax Nexus in Washington appeared first on Evergreen Small Business.

This blog post is the first in a two-part series. This post explains how Washington State sales tax works for multi-state businesses. Another blog post next week will explain how Washington’s B&O tax works for multi-state businesses.

Introduction to the Concept of “Nexus”

Steve discussed the concept of nexus in more detail in this older blog post. But the short version is, states can impose rules on businesses and collect taxes from those businesses if the business has enough of a connection to the state. This connection is referred to as “nexus,” and frustratingly, the case law on nexus is different for different types of taxes.

If your business has any amount of activity in Washington State (such as customers in Washington State, inventory located in Washington State, an office in Washington State, or people working in Washington State on your behalf), then you want to get up to speed on the nexus rules for both Washington sales tax and Washington B&O tax. And if your business is primarily based in Washington, but also does business in other states, you’ll want to know how Washington’s tax laws deal with that out-of-state activity.

How Washington’s Sales Tax Works in a Nutshell

You’re probably familiar to some degree with how sales tax works because you’ve seen it on sales receipts as an ordinary consumer.

A consumer who makes a taxable purchase in Washington pays the tax, and the business that makes the taxable sale collects the tax on the state’s behalf. Then, periodically, the business remits the tax to the Washington Department of Revenue.

The sales tax a consumer pays has both a state-level component, which is always 6.5%, and a local component, which can be as high as 3.6%, depending on what the voters in the locality have chosen. For example, the City of Seattle sales tax rate is currently 3.6%. Thus, when you purchase goods in Seattle, you pay a total sales tax rate of 10.1% (6.5 + 3.6). On the other hand, the City of Snohomish only has a local rate of 2.6%, so when you purchase goods in Snohomish, you pay a total sales tax rate of 9.1% (6.5 + 2.6). The Washington Department of Revenue has a comprehensive list of both current and historical local sales tax rates available here.

Bookkeeping for Sales Tax

When a business collects on a sale to a customer, it collects both the sale price for itself, and the sales tax for the government. However, the business only has to count the sales price portion as income in its books. The sales tax portion is instead described as an increase to a current liability account (often this account is called something like “Sales Tax Payable”). Then, when the business remits the sales tax to the state, in the books that payment decreases the liability account for sales tax.

Even though a business may owe sales tax for many local governments, the business remits the entirety of the sales tax it’s collected for Washington State jurisdictions to the Washington Department of Revenue. It reports this sales tax payment on a Washington Excise Tax Return. On this return, the business needs to do a careful job at noting which localities get which portion of the sales tax payment that’s being made with the return. Businesses file this combined return using the Washington Department of Revenue’s MyDOR portal. (It’s the same account your business uses to track its Washington business license.)

Therefore, a business needs to do the following in order to get sales tax right in Washington State:

• Identify when a sale is subject to sales tax in Washington
• Identify which local jurisdiction gets to tax the sale in Washington, if the sale is taxable
• Have an accounting system that can effectively track sales tax liabilities (not just the amount of the liability, but also which jurisdiction the tax is for)

I discuss these three issues later in this article.

One Quick Aside: Understanding Use Tax

I want to take the time to mention use tax in this article because it is an important loophole-closing provision in Washington State’s sales tax regime, and understanding it is essential for understanding the tax obligations both of your customers, and of your own business.

We all know the “trick” for getting out of paying Washington sales tax, right? Take a day trip to Portland, OR, where there is no sales tax, and take care of your major purchases there. Clever, no?

Well, you probably won’t be surprised to hear that, like any other state that collects sales tax, Washington knows this trick. And it’s closed this loophole with a response that’s pretty standard for states that charge sales tax: use tax.

Here’s how it works. Washington State says, “sure, Seattle resident, you can go buy your nice new TV in Portland. And no, the Portland business that sold it to you doesn’t need to collect Washington sales tax on the sale. But when you bring that TV back to use in your Seattle apartment, you need to pay use tax on the TV. What’s use tax? It’s 10.1% of what you paid for the TV in Portland, same as the amount of sales tax you would have paid if you had purchased the TV in Seattle.” (Consumers pay use tax using the Washington Department of Revenue’s MyDOR portal.)

This issue of use tax replacing sales tax explains why Justice Kennedy spoke about Wayfair rather scathingly in the Supreme Court’s recent South Dakota v. Wayfair decision:

Wayfair offers to sell a vast selection of furnishings.  Its advertising seeks to create an image of beautiful, peaceful homes, but it also says that “‘[o]ne of the best things about buying through Wayfair is that we do not have to charge sales tax.’”… What Wayfair ignores in its subtle offer to assist in tax evasion is that creating a dream home assumes solvent state and local governments.

It makes you wonder how the former justice would feel about the headline to this ad campaign from Portland’s tourism department.

When Do I Have Sales Tax Nexus in Washington?

If one or more of these four criteria apply to your business, then your business needs to collect and remit Washington State sales tax:

• Your business has a physical presence in Washington State, however slight [WAC 458-20-193]
• Your business has $100,000 or more in annual gross sales, or 200 or more annual transactions, in Washington State [emergency ruling] (this is essentially a copy of the South Dakota law upheld in the Wayfair case, linked above)
• Your business has a referral agreement with one or more Washington State residents, and your total referrals from all Washington residents exceeds $10,000 [RCW 82.08.052] (this is essentially a copy of New York’s Amazon law).

However, it’s important to note that Washington has a use tax reporting law, in addition to its regular sales tax laws. (These use tax reporting laws are sometimes referred to as “Colorado laws” because Colorado was the first state to use the trick.)

Washington’s use tax reporting law says that if your business has $10,000 or more in annual gross sales in Washington State, then your business needs to file a report with the Washington Department of Revenue detailing who each one of your Washington customers was and how much those customers bought (RCW 82.13.020). This is so the Department of Revenue has the information it needs to collect use tax from those customers. In addition, your business would also have to notify Washington customers with a detailed explanation of their use tax obligations, and how to pay that use tax.

If a business doesn’t want to provide this information to the Department of Revenue or its customers, it can opt out by voluntarily collecting sales tax. (In other words, if a business collects sales tax even when it doesn’t have to, it gets out of the use tax reporting requirement.)

What Counts as “Physical Presence”?

The Washington Department of Revenue lists on its website some examples of what it considers physical presence. The most obvious ways to have physical presence in Washington are to own property in the state, lease property in the state, or have employees working for you in the state. Note that owning property in the state includes stuff like storing your inventory in an Amazon warehouse in Washington State.

What Counts as a “Washington Sale”?

The sourcing rules for sales and use tax are in RCW 82.32.730, if you want to get into the nitty-gritty of it. But the short version is that Washington uses destination-based sales tax for sourcing retail sales. So, if you deliver goods to customers in Washington State who will presumably use those goods in Washington, then it’s a Washington sale.

What Types of Sales Are Subject to Sales Tax?

If you know your business has sales tax nexus in Washington State, your next step is to determine whether the sale is of a type subject to sales tax.

In general, any transaction that’s considered a “retail sale” of tangible personal property under state law is subject to sales tax [RCW 82.08.020]. Washington’s sales tax laws define “retail sale” as “any sale, lease, or rental for any purpose other than for resale, sublease, or subrent” [RCW 82.08.010(11)]. The definition of “retail sale” for sales tax also includes any sale that counts as a “retail sale” for B&O tax [RCW 82.08.020(1)(e)].

Among accountants, the common definition of “tangible property” is property that exists in the physical world, as opposed to “intangible property” like patents, copyrights, and trademarks. And “personal property” is any property that isn’t real estate. These are the definitions you’ll see on sites like Investopedia.

However, state laws have gotten more creative in the recent past about how they define “tangible property” as a way of expanding their sales tax base.

For example, Washington State’s sales tax laws define “tangible personal property” to include electricity, water, gas, steam, and prewritten computer software [RCW 82.08.010(7)]. And the state takes special care to clarify that personal property includes digital goods, digital codes, and digital automated services unless the context clearly indicates otherwise [RCW 82.08.010(10) and 82.08.020(1)(b)].

Businesses subject to Washington sales tax rules must charge customers sales tax on the full sales price. Washington’s sales tax laws define “sales price” to include things like delivery and installation charges, even if those charges are separately itemized [see RCW 82.08.010(1) and 82.08.145].

Exceptions to the General Rule

Know that Washington’s sales tax laws contain numerous exemptions. Many of these exemptions are pretty random, and are surely the result of successful industry lobbying efforts. But the most common exemptions fall into four major categories:

• Wholesale sales
• Non-Washington sales
• Sales handled by what’s called a “marketplace facilitator”
• Sales of basic needs like prescriptions and groceries

Note: it may be worth taking a brief skim though RCW 82.08 to see if there’s an exemption listed that applies to your business.

Exemption for Wholesale Sales

If your business sells items wholesale, then you don’t need to collect sales tax on the sale as long as you can prove that the sale wasn’t a retail sale. But note that under state law, the burden of demonstrating that a sale is a wholesale sale rather than a retail sale falls on the seller (see RCW 82.08.050, 82.04.470, and 82.08.140). So how does a business prove that its sales are wholesale? By collecting and saving reseller permits.

Save reseller permits for at least five years after the date of sale. If you aren’t careful about saving reseller permits and you get audited by the Washington Department of Revenue, they’ll charge you sales tax on the sales to any customers who you didn’t save a permit for.

Exemption for Non-Washington Sales

If you sell and deliver a product to a customer outside of Washington State, then you don’t need to collect sales tax as long as you document it properly. Note that non-Washington sales include sales to customers in other U.S. states, Native American tribes, and foreign countries (WAC 458-20-192, 458-20-193, and 458-20-193C).

In addition, non-residents of certain states are exempt from Washington sales tax if the property they purchase will be used outside of Washington (RCW 82.08.0273), even if you don’t deliver the sale out of state. These are called “qualified nonresident sales,” and you can read more about them on the Washington Department of Revenue’s website.

Sales Handled by a Marketplace Facilitator

Note that if you have what the law calls a “marketplace facilitator” collecting and remitting sales tax for you, then you don’t need to worry about collecting and remitting sales tax yourself on those sales (see RCW 82.08.0531(4) and 82.13.020). A marketplace facilitator would be a company like Amazon.com or the Apple App Store.

Exemptions for Basic Needs

The most common exemptions are for things like food and prescriptions; things that are clearly necessities, and thus have been exempted from sales tax to make the tax less regressive. The Washington legislature will sometimes change the rules on borderline cases: things that you’d probably find in a grocery bag, but aren’t really necessities, such as bottled water or candy.

The Washington Department of Revenue has a page that explains a bit about various exemptions and tax breaks here.

How Do I Determine the Correct Local Sales Tax Rate to Use on a Receipt?

Once you’ve determined that a sale is subject to sales tax in Washington State, your next question to answer is, what local rate do I need to add on top of the 6.5% state tax rate for this sale?

Remember that Washington State uses destination-based sales tax. That means the answer to this question usually depends not on where your business is located, but where your customer is located. Say you operate a furniture store in Duvall. A customer makes a purchase in your Duvall store location, but needs you to deliver the furniture to their residence in Bellevue. What’s the correct local rate?

You (and your customer) might hope that you only need to charge Duvall’s 2.1% local rate. But because the destination of the furniture is Bellevue, you actually need to charge Bellevue’s 3.5% local rate. And, accordingly, your furniture business needs to have an accounting system that can track customer destinations and is capable of applying the correct sales tax rate for every possible destination (i.e., every local jurisdiction your business is willing to deliver to).

How Do I Even Begin to Comply with This?

If you’re a traditional brick-and-mortar retailer with only one or two shops, then complying with sales tax is easy. This is because as long as you don’t deliver products to your customers, and only transfer goods you sell in your store, you only ever charge the sales tax rate for the physical location your store is in. Your customers, if they take the items purchased to a jurisdiction with a higher sales tax rate, may need to pay use tax on the difference. But dealing with the complexity of that falls onto the consumer, not you.

On the other hand, if your business does deliver products to consumers (say, because you’re an online retailer), complying with Washington’s sales tax laws is a real headache. The sales tax rate you charge is based on where you deliver the product and where the customer will use it, and Washington has hundreds of sales tax jurisdictions. There’s no way around it: you need to spend money on sales tax software that your brick-and-mortar competitors don’t need to spend. In this situation, your major options for dealing with sales tax include AvaTax, TaxJar, and QuickBooks Online’s new Automated Sales Tax.

QuickBooks Desktop Sales Tax Tracking

If your business is a traditional brick-and-mortar shop that only makes sales and transfers goods to customers at a handful of store locations, then your sales tax solution can probably be cheap and simple. Desktop versions of QuickBooks have had sales tax tracking for a long time, though the system requires some manual effort from the bookkeeper.

To use this solution, you’ll need to enter sales tax rates yourself, update them yourself each time the rate changes, and identify for yourself which rate applies to each sale. However, if you only have a few rates to keep track of because you don’t deliver products to your customers, those drawbacks aren’t too bad. Note, also, that the Washington Department of Revenue has files with sales tax rates in them which you can import into desktop versions of QuickBooks.

Automated Sales Tax Solutions

E-commerce businesses and other shops that deliver goods to customers probably need a sales tax solution that’s more automated than the sales tax tracking available in QuickBooks desktop. We know of three automated sales tax options that are designed to work for these types of small businesses:

• AvaTax
• TaxJar
• QuickBooks Online Automated Sales Tax

The common thread among all of these programs is that they try to automate several aspects of tracking sales tax that would otherwise leave the typical small business owner overwhelmed.

For example, one common feature among such programs is keeping track of which jurisdictions use destination-based sales tax (e.g. Washington), which use origin-based sales tax (e.g. Illinois), and which use their own odd system (e.g. California). Then, the program will use information like the customer’s shipping address to automatically look up the correct sales tax rate for the relevant jurisdiction (out of a database containing the approximately 10,000 different sales tax jurisdictions across the U.S.)

Often these programs will also try to help small business owners identify when they have physical presence in a state—and thus sales tax nexus (even under pre-Wayfair rules)—because the business stores inventory in that state. (This is a common scenario for business who participate in Amazon’s FBA program; such a business might have nexus in 40 or so states under the physical presence standard.)

These programs will also typically offer help with preparing sales tax returns, so the business can file all of their sales tax reports through one software program using one user login, rather than needing to create and keep track of dozens of different logins for all of the jurisdictions the business has nexus in.

The post Sales Tax Nexus in Washington appeared first on Evergreen Small Business.

But let me explain what’s what and then walk you through the steps for doing the bookkeeping.

What’s the issue with Washington state sales tax?

Sales tax isn’t the only type of excise tax Washington State levies on businesses. It also levies a tax on gross receipts, often referred to as “B&O”.

To minimize the administrative burden of these taxes, Washington’s Department of Revenue doesn’t make businesses file a separate tax return and make a separate payment for each type of tax. Instead, it has businesses calculate each type of tax owed on one return, and has the business submit all the taxes owed as a single payment. (Experienced QuickBooks users can already see the problem…)

What Intuit has done in QuickBooks—again, to try and make things easy for small business owners—is it’s come up with a system for how it can take care of most the bookkeeping for sales tax behind the scenes.

The QuickBooks Excise Tax Approach

The QuickBooks system is to have a special feature, called “sales tax tracking,” to automatically calculate correct sales tax on invoices and sales receipts, as long as sales tax jurisdictions have already been set up, and as long as the person recording the invoice can identify which sales tax jurisdiction to use when recording the transaction. Then, when a business remits sales tax to the proper taxing agency, the bookkeeper records this event with a special type of transaction. QuickBooks calls this transaction a “sales tax payment.” In order for QuickBooks sales tax tracking to work properly, the business must record every sales tax payment as, well, a “sales tax payment,” and it must record only sales tax payments as sales tax payments.

You can see how this approach collides with how Washington State collects sales tax. Two systems that were supposed to make things easier have come together to make things much more complicated and difficult for Washington small business owners.

Luckily, there are two workarounds to this conundrum.

Workaround #1: Record Sales Tax and B&O as Two Separate Payments in QuickBooks

The upside: this is easy to record, and easy to make accrual vs. cash basis accounting work correctly in QuickBooks (assuming your version of QuickBooks allows you to track Accounts Payable).

The downside: it makes working in the bank feed and reconciling the bank account more complicated, because the single payment that posts to the bank’s ledger won’t match the two separate payments you recorded in QuickBooks.

Workaround #2: Record the B&O Portion of Sales Tax as a “Sales Tax Adjustment”

The upside: this method won’t complicate working in the bank feed or reconciling the bank account

The downside: this method is more complex to enter, and WA B&O payments won’t show up properly on accrual-basis financial statements.

The tutorial at the end of this article will show you how to use this second workaround, and it will also illustrate the limitations of this workaround.

A quick clarification: Which sales tax system are we talking about?

QuickBooks Online has two different sales tax systems: old and new.

The old system is like what’s available in QB desktop, where the user manages their own sales tax rates. This system works just fine for brick-and-mortar shops that don’t deliver their goods to customers and only have a handful of locations.

The new system, called “Automatic Sales Tax,” appears to be Intuit’s answer to AvaTax and TaxJar, but it doesn’t cover as many jurisdictions yet. This system is designed to work better for stores (whether online or brick and mortar) that deliver goods to their customers, and thus have hundreds, or maybe even thousands, of sales tax jurisdictions to keep track of.

As of this writing, new QuickBooks Online accounts start off using the new, more-automated sales tax system. Accordingly, the images in this article illustrate the new system (because that’s what we had to work with when we created a demo account for this tutorial). If you use the old system, stuff will conceptually work much the same way, but the interface will look a little different and fewer tasks will be automated.

Note: these images come from QuickBooks Simple Start. If you use a different version of QuickBooks Online, or if Intuit has just updated the user interface since we published this article, then what you see in the software might be a little different then what we show below.

How to set up sales tax and WA B&O in QBO

If you’ve already set up sales tax in QBO, skip ahead to the next section. But if you’re just getting started, this section is for you.

As I mentioned earlier, if you’re setting up sales tax in a brand-new account from scratch, QuickBooks Online will guide you through the process of setting up Automatic Sales Tax.

First, navigate to Taxes in the left navigation menu (between Reports and Accounting). You’ll see this screen, or something close to it:

Perhaps obviously, click the green “Set up sales tax” button. The next few screens you’ll see will look something like this:

The address you use for this step is important, because it tells QuickBooks what taxing jurisdiction you’re in. For example, our hypothetical coffee shop is located in Redmond, WA. That means that, as of this writing (and for the purposes of this example), its sales are subject to a state sales tax rate of 6.5% and a local sales tax rate of 3.5%.

Note that if you’re using QuickBooks’ old sales tax system, or if you’re using sales tax tracking in QuickBooks desktop, you’ll need to look up these rates yourself and add them to the program manually. You’ll also need to update the rates manually any time they change. But if you’re using Automatic Sales Tax in QuickBooks Online, QuickBooks will use the address of the sale location as the jurisdiction for the sale.

Three other quick points before I move on.

First, in Washington State, we have what’s called “destination-based sales tax.” That means if your business operates in, say, Duvall, but you sell a product to a customer in Redmond and deliver the product to the customer, you need to use the Redmond sales tax rate for the sale. If, on the other hand, you have a bricks-and-mortar shop in Duvall, and you don’t deliver to customers (i.e. you only sell and transfer title to your goods at the Duvall location), then you use the Duvall rate.

Second, note that even if two jurisdictions use the same local rate (for example, both the City of Redmond and the City of Bellevue have a local rate of 3.5%), you can’t just use the same sales tax item for Bellevue sales and Redmond sales. This is because when you go to file your sales tax return with the Washington Department of Revenue, the form is going to ask how much of the sales tax you’re remitting is Washington State’s share, how much is Bellevue’s share, how much is Redmond’s share, and so on. So, you’ll need your accounting system to provide you data not just on how much sales tax to collect, but which jurisdictions you’re collecting it for. The Washington Department of Revenue keeps a list of current and historical local sales tax rates here. It even has a file you can use to import tax rate information if you’re using a desktop version of QuickBooks.

This isn’t an issue to worry about if you’re using Automatic Sales Tax in QBO (or a similar product like AvaTax or TaxJar), but if you’re using an older, less-automated version of sales tax tracking in QuickBooks, it’s a mistake that novice small business owners can sometimes make.

Finally, if you’re in a business where you sell tangible goods and deliver them to out of state customers, you want to get up to speed on the recent Supreme Court case South Dakota v. Wayfair. You may have an obligation to collect sales tax not just in Washington, but in other states as well.

After this initial setup, QuickBooks will ask you how frequently you file sales tax in Washington State (see below). Your business’ filing frequency is based on your estimated sales tax liability. In our example, the combined state and local sales tax rate is about 10%. So, a business with about 48,000 or more in monthly taxable sales would need to file monthly, whereas a business with smaller sales volume might be able to file quarterly or even annually.

Once you’ve finished setup, here’s what the Sales Tax Center looks like in QuickBooks Online:

Note that you can edit your sales tax settings after the fact from this screen by clicking “Sales tax settings” in the upper right corner. That will bring up a page that looks something like the image below; just click the “Edit” button for the particular agency you want to edit settings for:

All right, that’s sales tax set up. But for Washington State businesses, there’s one final step you’ll need to take to get things really working right for recording payments, and that’s creating an account in the chart of accounts for Washington B&O (see below).

How to Record a Sales Receipt with WA Sales Tax in QBO

Once you’ve set up sales tax in QuickBooks Online, you’re ready to start recording sales receipts that include sales tax.

To do so, first, click the Plus icon, then click Sales Receipt.

The next screen you’ll see will look something like this:

As illustrated in the above image, what’s nifty about automated sales tax tracking is that it will take the location of the sale (see in upper right corner) and use it to calculate sales tax on the sale, assuming you’ve checked the checkbox under the “Tax” column to indicate that the sale is subject to sales tax. (Sales of tangible property are generally subject to sales tax, while sales of services generally aren’t.)

If you’re curious about where QuickBooks is getting its calculation from, you can click the blue Sales tax label and it will bring up an overlay of the details, as shown below:

How to Record Paying Sales Tax and WA B&O Using the Sales Tax Adjustment Method

Okay, we’ve set up sales tax and we’ve been recording our sales receipts in QuickBooks to automatically calculate sales tax. And now a month has gone by, and we have to record the tax payment made to the Washington DOR. How do we do that?

Well, here’s what it will look like when you use the sales tax adjustment method in QuickBooks Online.

When a sales tax return is fileable, you’ll see a button in the sales tax center that lets you record the payment. Click this button and you should see a screen that looks something like the image below.

What you’ll do to get WA B&O working right is click the “+ Add an adjustment” button. That will bring up the overlay shown below. For the reason, indicate “Other”, and for the account, choose B&O. Then, enter the amount of B&O you owe for the tax period. (For most retailers, B&O is 0.471% of gross receipts.)

Once you’ve added the adjustment, the amount QuickBooks indicates for Tax Due should be the same as the amount you actually paid with your Washington Excise tax return when you filed it using MyDOR. (We have more information on MyDOR accounts in this article on our blog.) If the amount looks correct, click the green “Select filing method” button.

As of this writing, QBO’s automatic sales tax doesn’t support e-filing for WA sales tax (and if they did, this workaround probably wouldn’t be necessary). So, choose “File manually” as your filing method. Then, be sure to scroll down far enough so you can see where to enter information about when you paid sales tax. Enter the date paid and which bank account you paid it out of, then click “Record Payment.”

This is the last screen you’ll see, and it just confirms you recorded the sales tax as paid in QuickBooks.

Limitations of the Sales Tax Adjustment Method

There’s a lot to like about the sales tax adjustment method as a workaround for dealing with Washington B&O. It’s not too much work, it gets the right number in the right account, and because it records a single payment in the register for your business bank account, it keeps bank account reconciliations and working in the bank feed easy.

The one major drawback to be aware of is that, using this method, Washington B&O expense will only show up as an expense as of the date the expense was paid, regardless of whether or not you’re generating reports on cash or accrual basis. In other words, you won’t be able to track B&O accrual’s properly with this method (as shown below).

And there you have it, that’s how you deal with Washington sales and B&O tax in QuickBooks Online.

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