A Washington Court Decision May Impact the Taxation of Investment Income

Washington state imposes a gross receipts tax — known as the business and occupation (B&O) tax — on gross income from business activities conducted in the state. Historically, taxpayers believed investment income was excluded (i.e., deducted) from the B&O gross income tax base — an interpretation recently reviewed by the courts.

• The B&O tax is a separate tax from the recently enacted capital gains tax that is imposed on long-term capital gains (including investment capital gains) recognized by individuals.

New court decision affecting Washington B&O tax

After a B&O tax refund claim (relating to deducting investment income) was denied and then appealed, the Washington Supreme Court looked at the state’s B&O taxing statutes, legislative history, and previous judicial decisions to determine whether this understanding was correct. The case is known as Antio, LLC v. Washington State Department of Revenue.

The court held that income generated from investments — such as interest, dividends, and capital gains — may be subject to Washington’s B&O tax in certain situations. In Antio, it held that the exclusion didn’t apply and the Washington Department of Revenue properly denied the refund claim.

Washington B&O tax court decision impact

The court decision could broadly affect any person recognizing Washington-sourced investment income. This potentially includes:

• Individuals, trusts, and estates
• Corporations, partnerships, and limited liability companies
• Investment partnerships
• Nonprofit organizations
• Foundations and charitable trusts
• Family trusts and offices
• Family limited partnerships
• Private investment funds
• Mutual funds
• Private equity funds and entities
• Venture capital funds
• Retirement plans
• Collective investment vehicles

Because the court indicated there was no change in law affecting their determination, the decision could be applied retroactively to tax years before 2025 (perhaps as far back as 2017 or 2018).

How the Washington court is applying the B&O tax decision

According to the ruling, investment income can be taxable if the investment activity generating the income is the main business activity of the taxpayer and the income is substantial. For the tax to apply, the taxpayer must be engaged in an investment business activity and the income generated from that activity must be nonincidental.

Income generated from activity must be nonincidental

The court held that only investment income earned through investments that are incidental to the main purpose of a taxpayer’s business is not taxable, otherwise the investment income could be subject to tax.

Drawing from the Antio decision, the state recently indicated it would presume an investment activity is not a taxpayer’s main activity if it generates less than 5% of the taxpayer’s annual gross receipts (constituting an incidental safe harbor). If the income from the activity falls outside this 5% safe harbor test, the taxpayer must show an investment activity is not a main business activity.

Taxpayer must be engaged in an investment business activity

Under B&O tax law, a person must be engaged in a business activity to be subject to the B&O tax on investment income. For example, individuals investing their own personal assets — solely for their own account — should generally not be considered to be engaging in an investment business activity subjecting their investment income to taxation, no matter the amount of investment income generated.

However, it may not be so clear with entities with investment income exceeding the 5% safe harbor threshold. For example, entities such as corporations, partnerships, limited liability companies, funds, trusts, and other collective investment vehicles may be determined to be engaging in investment business activities depending on the extent of their activities.

Washington state guidance on the B&O tax decision

The state is formulating guidance on what activities constitute engaging in business with respect to investment activity and what criteria the state will use to make that determination. For example, the state may look at:

• What it means to be investing “for your own account”
• Whether the investment activity is “passive” or “active” (e.g., by looking at the frequency of investment decisions, management of investments, and trading activity)
• Whether the investment activities are for one's financial betterment rather than for business operations
• What is the nature and types of investments held
• Whether the entity is investing on behalf of the public, at large
• Whether certain entities are by statute exempt (or otherwise tax exempt for federal income tax purposes such as retirement accounts or federally tax-exempt funds or organizations)

In addition to providing guidance on who is subject to the tax, the state will also need to address whether taxable investment income generated by these entities and persons must be sourced — in whole or in part — to Washington and subject to taxation. If so, the state must also determine how the taxpayer determines what portion is to be sourced to Washington and taxed.

What’s next with Washington B&O tax

There are still many unanswered questions. As of the date of this posting, the state hasn’t issued helpful instructions regarding the implications of the Antio decision. Review what the state issued on the decision.

Taxpayers will need to know:

• How the 5% safe harbor receipts test is determined (and, if they fail the test, what factors are used to prove a person’s investment activity is not a main business activity)
• Under what circumstances an entity’s or person’s investment income may be subject to taxation
• If taxable, what is considered investment income and how is that income determined and sourced to Washington
• For what years will taxpayers be liable for the tax (including whether interest and penalties will be assessed) and at what tax rate

How CLA can help with B&O taxes in Washington

CLA is monitoring the developments in this area, such as tax legislation that may be enacted in reaction to Antio, as well as state guidance, taxpayers’ notifications, and collection initiatives. Our state and local tax professionals can help you understand how this may affect you.

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