Washington State Limits B&O Tax Deduction

Washington state generally allows a B&O tax deduction for amounts derived from investments. The deduction is not allowed for businesses involved in banking, lending, and sales of securities. Recently, in Antio LLC v. Washington State Department of Revenue, the Washington Supreme Court held that investment amounts derived from primary business activities are not allowed as a B&O deduction and only investments that are incidental to such activities are deductible as amounts derived from investments.

Background

From 1970 to 2002, Washington law provided the following deduction from the B&O tax:

“In computing tax there may be deducted from the measure of tax amounts derived by persons, other than those engaging in banking, loan, security, or other financial businesses, from investments or the use of money as such, and also amounts derived as dividends by a parent from its subsidiary corporations.”

In O’Leary v. Department of Revenue, the Washington Supreme Court interpreted “investments” to mean the “incidental investments of surplus funds.” Additionally, the court found that “[w]hether an investment is ‘incidental’ to the main purpose of a business is an appropriate means of distinguishing those investments whose income should be exempted from the B&O tax.”

Applicable in 2002, the legislature changed the statute to provide a deduction for “amounts derived from investments” and included language identifying which activities qualified for the deduction and which did not. However, following this legislative change, it was a long-standing policy of the Washington Department of Revenue to allow the deduction for any investment income from most businesses except businesses involved in banking, lending, and sales of securities.

Antio limits definition of investment income

In Antio, taxpayers are related limited liability company investment companies that received all their income from buying and selling distressed debt instruments. Taxpayers claimed that all their income qualified as investment income and therefore is deductible for B&O tax purposes.

The Washington Supreme Court held that the 2002 legislative change did not affect the meaning of the term “investment” as defined in O’Leary. Accordingly, the term “investment” in the current statute is construed narrowly to apply only to incidental investments.

The court held that because taxpayers’ investment income involved income earned through their primary business activities – and not income derived from incidental investments – the income was not investment income eligible for deduction from the B&O tax.

Crowe observation

The Antio decision invites further scrutiny of taxpayers’ investment functions regarding what activities fall within a taxpayer’s main business and what activities are considered incidental. Such a subjective inquiry could bring with it considerable uncertainty in the B&O tax treatment of investment income. B&O taxpayers that have taken the investment income deduction should review their activity and investment income to identify any potential tax exposure risks in light of Antio.

Looking ahead

It remains unclear how the Washington Department of Revenue might investigate taxpayers’ business activity and their investment income deductions. Taxpayers should monitor the Department of Revenue’s activity for an indication of how the Antio decision will be implemented. Legislative action might be warranted to clarify the application of the investment income deduction.