The recent Antio, LLC v. Department of Revenue decision has upended how investment income is taxed in Washington. While some details are still unclear, with this decision Washington’s tax system has gotten broader, potentially impacting more non-profits and individuals.
Background
To understand this decision, one must first understand the Business and Occupation (B&O) tax. The B&O tax is a very broad-based tax that applies to all gross receipts, absent a specific exemption or deduction. It applies to all “persons” which includes not only various business entities but also nonprofits, trusts, estates, clubs, societies and individuals. Since the B&O tax is calculated and paid by each separate ‘person’ the tax can pyramid as revenues flow between persons and tax is paid with each transfer.
Given the breadth of the tax, statutory exemptions and deductions are critical as both can lead to a non-taxable result. However, these are narrowly interpreted by the courts. At issue in the Antio decision was the deduction for investment income. With the surprisingly narrow interpretation adopted by the court, and presumption of taxability by the Department of Revenue, taxpayers are left to analyze the remaining statutory exemptions to determine whether any apply.
Antio Decision
There is a deduction available for “amounts derived from investments” for those not in banking, lending or security businesses. Therefore, the majority of taxpayers have not been paying B&O tax on investment income such as interest, dividends and investment gains under the plain language of the deduction statute.
The Washington Supreme Court ruled in the Antio case that investment income is only deductible when it is from “incidental investments of surplus funds”. The Department of Revenue recently issued guidance that they generally consider investment income below 5% of total gross receipts to be incidental.
The Department’s guidance leaves more questions than answers. The guidance notes that mutual funds, private investment funds, family trusts and other collective investment vehicles may be considered engaged in business and leaves the door open on how they are taxed. It is also silent on how gains are to be measured and reported on monthly or quarterly returns. Finally for multistate entities, it’s unclear what portion of their investments are taxable by Washington.
Since this change is from a court decision, their interpretation applies retroactively. But frustratingly, it may be several years before we have formal guidance and/or court decisions clarifying the extent to which the B&O tax applies to investments by previously untaxed persons. Therefore, we are highlighting additional statutory exemptions and deductions below that form a safe harbor in a sea of presumed taxability.
Nonprofit Organizations
While nonprofits are taxable on certain business-like activities (such as running a store or making routine sales to support their charitable purpose) they do have an exemption for contributions of money or property as part of qualified fundraising activities. This exemption does not explicitly include amounts earned on these contributions, since historically these have been assumed to be covered under the investment income deduction. However post-Antio, presumably the 5% test would need to be met for these to be deductible.
Individuals
Sales of real estate are exempt from B&O tax. There is also an exemption for employee wages. However other revenues earned by individuals, such as independent contractor/1099 revenues and Board of Director fees are taxable. There is no guidance on the taxability of stock options outside the context of Director fees (included in the taxable amount) so these likely exceed the wage exemption.
Ironically, this decision is more likely to impact middle class individuals. There is a credit available against the B&O tax for investment income which is also subject to the capital gains tax in Washington. Since wealthy individuals are more likely to be paying Washington capital gains taxes, this will likely reduce the tax impact of this decision on them, whereas middle class individuals are less likely to benefit from this credit.
While federally there are protections for certain qualified retirement accounts, those only apply to income taxes, and there are no comparable exemptions from the B&O tax. Since retirement accounts are not subject to capital gains tax, there is no offsetting B&O credit available for these investments.
In conclusion, absent a legislative fix, many individuals, trusts, estates, and non-profits may find themselves relying on the above exemptions as audit focus turns to under reported investment income. As these additional tax costs start to work their way through non-profit’s endowments and individual’s retirement funds, they will reduce the funds available for serving community needs as well as retirement security.
Currently there is no legislation that addresses the Antio decision’s interpretation of investment income, so open discussion of the impacts is key to raising the necessary awareness. If you have questions on how this decision impacts your situation, reach out to your Sweeney Conrad team!