United States: Washington Department Of Revenue Rules On Application Of Economic Nexus To B&O Tax

The Appeals Division of the Washington Department of Revenue has held that a business with more than $250,000 in total annual service-taxable receipts in Washington has substantial nexus in Washington for purposes of the state's Business & Occupation (B&O) Tax.1


The business, a web hosting company physically located outside Washington, provided services to Washington customers. The business delivered products and services over the Internet and had aggregate sales of $920,000 in Washington from 2005 to 2011. In 2012, the Department contacted the business by requesting a Washington Business Activities Questionnaire be completed. The business complied, reporting that its Washington income annually exceeded $250,000 in 2010, 2011 and 2012. The Department assessed the business for an unreported amount of B&O Tax under the service and other activities classification, along with associated penalties and interest. The business appealed the assessment.

B&O Tax "Doing Business" Standard

The B&O Tax is imposed on businesses "for the act or privilege of engaging in business" in Washington.2 In this matter, the business was not subject to any of the specific classifications contained within the B&O Tax, and so the Department was requested to address whether the business was subject to the service and other activities classification.3 In doing so, the Department pointed to the B&O Tax broadly defining the term "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 Despite this expansive definition, the Department was required to consider whether any constitutional limitations could otherwise restrict the application of the B&O Tax to a business that did not have physical presence in Washington.

Commerce Clause Analysis

The Department's administrative law judge (ALJ) who presided over the appeal began the constitutional analysis by identifying the nexus requirements arising from the U.S. Constitution's Commerce Clause and Due Process Clause. Under the Commerce Clause, four elements must be met for a state to impose tax on a business located outside the state. The tax must: (i) be applied to an activity with substantial nexus with the taxing state; (ii) be fairly apportioned; (iii) not discriminate against interstate commerce; and (iv) be fairly related to the services provided by the state.5

In this matter, the business argued that it was not subject to the B&O Tax because the business lacked substantial nexus with Washington due to a lack of physical presence in the state. The ALJ responded to that argument by citing the B&O Tax statute defining the term "substantial nexus" to include nonresident business entities that have more than $50,000 of property or payroll in Washington, more than $250,000 of receipts from Washington, or at least 25 percent of the total property, payroll or receipts of the business in Washington (i.e. factor presence nexus).6 The statute does impose a physical presence requirement for businesses taxable under classifications that are not included in the definition of apportionable activities.7 However, the service and other activities classification was included in the apportionable activities list.

Citing Lamtec Corp. v. Dep't of Revenue,8 the ALJ determined that physical presence was not necessary for a business subject to the factor presence nexus standards. As the business met the factor presence nexus standard by earning more than $250,000 in receipts in Washington, the business was subject to the services and other activities classification under the B&O Tax. With that, the ALJ summarily decided that the Commerce Clause substantial nexus standard was not violated, though the ALJ was quick to point out that even if the factor presence nexus standard were facially unconstitutional, the Department's status as an administrative body precluded a ruling on this issue.

Due Process Clause Analysis

Two elements must be met to satisfy the dictates of the Due Process Clause: (i) a definite link or "minimum connection, between a state and the person, property or transaction that the state seeks to tax" is required; and (ii) the income attributed to the state for tax purposes "must be rationally related to values connected with the taxing State."9 In thestate of Washington, for B&O Tax purposes, these two elements of the Due Process Clause are statutorily addressed.

With respect to the first element, the term "engaging within the state" is defined to mean that a person may generate income from sources within Washington regardless of whether the person has physical presence in Washington.10 Citing Quill for the proposition that a foreign corporation purposefully availing itself of the benefits of an economic market in a forum state could meet the "minimum contacts" standard even without having physical presence in the state, the ALJ ruled that an absence of physical presence did not matter under the Due Process Clause. The ALJ found that since the factor presence nexus standard was exceeded, the business purposefully availed itself of the benefits of Washington's economic market. Accordingly, the Department's ALJ determined that the business had adequate minimum contacts with Washington residents to satisfy the first element of the Due Process Clause analysis.

As for the second element, the "rational relationship" between the income and the values taxed by the state is statutorily represented through receipts factor apportionment, under which a ratio of in-state to everywhere apportionable income is applied to determine the amount subject to B&O Tax.11 The ALJ ultimately rejected the argument of the business that because its physical activities related to web-hosting were performed outside Washington, the B&O Tax was not rationally related to values connected with Washington. The ALJ determined that the business did not offer clear and cogent evidence that the taxation of income earned on the services provided to Washington customers was arbitrary, not in proportion to, or not rationally related to the business transacted with Washington customers. The ALJ reiterated that the Department did not have the power to rule on constitutional matters.


The Department's decision in this matter is hardly surprising given the breadth of the B&O Tax, and the factor presence nexus standards that were adopted in 2010. However, this determination appears to be the first instance in which the Department has published its contention that a service business without any physical presence in the state may be subject to the B&O Tax if it has enough Washington sales.12 In practice, the issue frequently arises, to the chagrin of out-of-state businesses that believe that a lack of physical presence automatically means that a state cannot constitutionally subject them to tax. Apparently, more clarity on the constitutional issues that are raised by the factor presence nexus standard contained in the B&O Tax will need to be resolved by the Washington judicial system. This decision is consistent with the Ohio Board of Tax Appeals' decisions in L.L. Bean,13 Newegg14 and Crutchfield,15 in which factor presence nexus standards applied to the Commercial Activity Tax, another tax based on gross receipts, were upheld.


1 Determination No. 14-0342, Washington Department of Revenue, Oct. 30, 2014 (released Apr. 30, 2015).

2 WASH. REV. CODE § 82.04.220.

3 WASH. REV. CODE § 82.04.290(2).

4 WASH. REV. CODE § 82.04.140.

5 Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).

6 WASH. REV. CODE § 82.04.067(1). The $50,000 and $250,000 thresholds are indexed for inflation. WASH. REV. CODE § 82.04.067(5). Effective for the 2013 tax year, these thresholds have increased to $53,000 and $267,000 respectively. See Excise Tax Advisory No. 3195.2015, Washington Department of Revenue, Feb. 3, 2015.

7 WASH. REV. CODE § 82.04.060.

8 246 P.3d 788 (Wash. 2011). In Lamtec, a taxpayer with minimal physical presence through several of its sales employees visiting Washington customers was determined to have substantial nexus for B&O Tax purposes.

9 Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

10 WASH. REV. CODE § 82.04.066.

11 WASH. REV. CODE § 82.04.062(3)(a).

12 It should be noted that the Department previously addressed the taxability of a business whose sole contact with Washington was an employee working remotely in the state that earned slightly more than $50,000 in compensation, triggering the $50,000 payroll nexus threshold. Determination No. 14-0306, Washington Department of Revenue, Feb. 26, 2015.

13 L.L. Bean, Inc. v. Levin, Ohio Board of Tax Appeals, No. 2010-2853, March 6, 2014 (settled on appeal, Nov. 20, 2014).

14 Newegg, Inc. v. Testa, Ohio Board of Tax Appeals, No. 2012-234, Feb. 26, 2015.

15 Crutchfield, Inc. v. Testa, Ohio Board of Tax Appeals, Nos. 2012-926, 2012-3068, 2013-2021, Feb.26, 2015.

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