WA: Taxpayer’s Receipts Subject to Throwout

In a recent tax determination, the issue was whether an Internet-based company that matched music teachers and students within and without Washington was required to throw out certain receipts in apportioning its income for B&O purposes.  The Department of Revenue audited the taxpayer’s B&O returns and determined the taxpayer had not apportioned its income properly. The auditor then did so by attributing receipts to each jurisdiction where a music lesson occurred. Then the auditor threw out any receipts attributed to states in which the taxpayer did not meet Washington State’s factor presence nexus standard (more than $250,000 of receipts, $50,000 of property or payroll, or at least 25 percent of its property and payroll in the state). The end result was that all of the taxpayer’s out-of-state apportionable income was treated as throwout income.  Under Washington State law, so-called throwout income is excluded from both the numerator and denominator of the receipts factor if at least some activity is performed in Washington and the income is attributed to a state where the taxpayer is “not taxable.”  A taxpayer is considered taxable in a state in which it would be deemed to have substantial nexus under Washington’s factor presence nexus standards. The taxpayer protested the resulting assessments arguing that it was taxable in the other states in which the music lessons occurred, despite the fact that it did not file corporate income tax returns in those states. The taxpayer further argued that none of its income generating activities were performed in Washington.  The hearing officer, noting that the taxpayer was domiciled in Washington and incorporated in Delaware, ruled that the auditor incorrectly treated the income attributed to Delaware as throwout income. However, the hearing officer concluded that the taxpayer was not taxable in any other states.   Specifically, the taxpayer did not meet Washington’s thresholds of sales in these states and had not offered any evidence that its activities in the other states (either independently or through a representative) were sufficient to create nexus under the Commerce Clause. The hearing officer also rejected the taxpayer’s argument that it had no income-generating activities in Washington, observing that the taxpayer’s corporate officers responded to customer communications in Washington.  The taxpayer’s request for a waiver of penalties, including penalties related to failing to file an annual reconciliation report, was also rejected. Please contact Michele Baisler at 206-913-4117 with questions on Washington Determination No. 18-0021.