Washington Court Of Appeals Limits B&O Tax Deduction For Investment Income

• Published date: 09 August 2023
• Subject Matter: Antitrust/Competition Law, Litigation, Mediation & Arbitration, Tax, Trials & Appeals & Compensation, Capital Gains Tax
• Law Firm: Perkins Coie LLP
• Author: Mr Bob Mahon and Gregg Barton

The Washington Court of Appeals has held that investment funds are subject to Washington state business and occupation (B&O) tax on their investment income. Although Washington law allows taxpayers to deduct "amounts derived from investments" from their gross income,¹ the court concluded that the deduction was limited to investments "incidental to the main purpose of a business." Because the funds' investments in debt instruments were not "incidental" to the funds' businesses, the funds' investment income was subject to B&O tax. Antio, LLC v. Department of Revenue, 527 P.3d 164 (Wash. Ct. App. 2023). The court of appeals denied the taxpayers' petition for reconsideration on June 27, 2023, and the taxpayers filed a petition for discretionary review with the Washington Supreme Court on July 27, 2023.

Who Is Affected?

This decision will likely have significant B&O tax impact on investment vehicles with operations (and potentially investments, investors, or beneficial owners)² in Washington, including:

• Private equity funds.
• Venture capital funds.
• Mutual funds.
• Other collective investment vehicles.
• Family trusts and offices.
• Businesses that conduct treasury or investment functions in special purpose entities (including federally disregarded entities) outside the entities that conduct the businesses' primary business operations.

The decision may also affect many individual investors with investment income in excess of Washington's small business credit.³

While some investors (particularly individual investors that do not invest through a business entity) may have an argument that they are not engaged in "business," Washington broadly defines "business" to include "all activities engaged in with the object of gain, benefit, or advantage to the taxpayer or to another person or class, directly or indirectly."⁴ Washington courts have noted that Washington's B&O tax is imposed "upon virtually all business activities" and "leave[s] practically no business and commerce free of... tax."⁵

What Is the Impact?

Persons with investment income that is not incidental to other business activity may be subject to a 1.5% or 1.75% Washington B&O tax on their gross income from investments.⁶ This B&O tax liability may be partially offset by a small business credit and a credit for B&O tax attributable to transactions that are subject to the Washington capital gains tax.⁷

History of Washington's Investment Income Deduction

Washington has had a deduction for amounts derived from...