OLYMPIA, June 25.—In the waning days of this year’s legislative session, business interests have been pushing a bill it is safe to say most members of the statehouse never heard of during their nearly six-month idyll in the state’s capital city. Yet millions of dollars are at stake in this intricate issue involving the taxation of corporate payroll services, and it has triggered a frantic last-ditch lobbying effort by the state’s business community that aims to place the matter front and center during the Legislature’s endgame.
Ask the throngs of business lobbyists in the Rotunda today what they are working on, and it would seem that nearly half of them are working on the so-called “paymaster” bill, the latest version of which has been filed as HB 2076. It’s not a new issue – it was raised as long ago as February when early versions of the measure were filed in the House and Senate. But the matter really hasn’t been on the Legislature’s radar screen as it engages in high-level debate over tax increases, state-government reforms and the big increases in K-12 funding that are required by the Supreme Court’s McCleary decision. “Everyone supports it,” says Amber Carter of the Association of Washington Business, who is leading the business-community lobbying effort. “No one is against it. But it has been a political battle trying to call attention to it in the midst of McCleary and budget-balancing and workers’ comp and all the other end-of-session activities.”
Big money is involved – and it has to do with a point of law so fine and so technical that it takes a bit of explaining. But the bottom line is that corporations with disparate entities and centralized payroll services may soon find themselves on the hook for millions of dollars in taxes they never before had to pay. It can only be seen as an unintended bit of double taxation that will hit many of the largest businesses operating in the state of Washington, and which would likely cause many of them to engage in costly reorganizations to avoid the tax. “The state will never see a dime,” predicted Tim Boyd of Boise, Inc. at a February Senate hearing.
New Interpretation Drives Decision
Unless the Legislature passes the bill, the Department of Revenue is planning to issue an “excise tax advisory” at the end of session that changes the way internal payroll-processing operations are taxed. Many corporations organize themselves as a group of affiliated entities, rather than as a single business, and to save on overhead costs, they use a single centralized payroll department. Until now, those payroll operations have been treated as an internal business function. And so all the millions of dollars those businesses pay out in the form of paychecks are “passed through” – they are not subject to an additional tier of taxation.
But under the new advisory the Department of Revenue will say that when a corporation is structured that way, the payroll department ought to be taxed on its gross revenue. That makes the entire payroll amount subject to the state’s unique tax on gross receipts, the business and occupations tax. No other state taxes payroll operations that way – though it should be noted that no other state has a tax code like Washington’s, either, and therefore such a tax could not be imposed by accident, as appears to have happened in this case. Most states impose an income tax instead.
What is driving the new interpretation is a 2002 state Supreme Court decision, William Rogers v. Tacoma, which clarified taxation procedures for companies that perform internal business functions for other businesses. Back in 2010, an omnibus tax bill required the Department of Revenue to review and clarify its taxation procedures. The department concluded that the 2002 decision required it to tax gross revenue received by centralized payroll operations, when a corporation is organized as a group of “affiliated entities.” The irony is that there is an exemption in Washington law for outside firms like ADP that provide payroll services — money provided for payroll checks is supposed to be passed through without additional taxation. But there is no such exemption for corporations with affiliated entities that operate their own payroll departments.
What it means is that every dollar that goes to a worker would be hit with the B&O tax – even though the employer presumably paid that tax once already, when it made sales or billed clients for services. And the situation gets even stranger when one considers that the amounts remitted to the federal government for income taxes and for social security taxes would be taxed again. Same would be true for amounts remitted to the state for unemployment insurance and workers’ compensation taxes.
Would Force Business Reorganizations
Thus the issue comes before the Legislature. Corporations with an affiliated entity structure would have to pay $43 million in taxes under the new interpretation, according to a fiscal note on the early House and Senate bills. And there are plenty of them that would be hit, among them Starbucks, Amazon, Darigold, T-Mobile, Boise Cascade. AWB is circulating a “one-pager” that posts their logos prominently. “You’ve got some good Washington-bred companies here,” Carter says. “Iconic companies. And I think it shows the mix of impacts.” There are even a number of business associations and trade unions that would be affected, she said.
Most likely companies would be forced to reorganize to avoid the tax, and little if any money would be collected by the state. But it would mean big legal bills and a corporate-governance headache.
AWB’s one-pager puts it like this: “Without this bill, DOR will adopt a policy that will force employers to pay an unfair tax or change their payroll systems without any financial benefit to the state. This will only result in higher costs and regulatory burdens for employers with affiliated entities and detract from Washington’s competitiveness.”
At a February hearing before the House Finance Committee on the earlier version of the bill, Boyd of Boise, Inc. said his company would immediately reorganize if DOR issues its tax advisory – not that it would do so happily. Currently the company has five affiliated companies doing business in the state of Washington, with 760 employees. “Here’s the reality,” he said. “Boise, Inc. will restructure rather than pay that tax. It will be expensive, but not nearly as expensive as paying the tax on that passed-through payroll. We already have our tax attorneys identifying options, and as I said, we will do so. So Washington isn’t going to see that revenue from my client. And Washington is going to get a bit of a black eye as a difficult place to do business, as a result of not affirming what has been policy in this state for some time.”
Not a Loophole, Business Says
One of the ironies inherent in the legislation is that at least in a technical sense it might be considered a tax break – one of the big bugaboos for the Legislature this year. Without a change to the law, taxes will be imposed, even if there might not be much chance of collecting them. And the case helps put the current debate over “loopholes” in context – in many cases, tax exemptions are designed to correct cases of double taxation that otherwise would occur as a result of court decisions, definitions in the Washington tax code, and changes in tax-policy interpretations. So too with this. Carter hopes to avoid the suggestion that the measure would create a tax loophole.
“It is hardly that,” she said. “The purpose of tax exemptions are to capture competitiveness issues and prevent double taxation. Well, we know that no other state taxes payroll transfers among affiliated entities, so obviously this is a competitive issue for having an exclusion for taxation in our B&O system. From a double-taxation perspective, your payroll transfer includes health care, worker compensation payments, FICA – anything that is on your pay stub. So these exclusions exist for a reason. It is hardly a loophole.”
It might be noted that the House bills have been sponsored by one of the Legislature’s fiercest critics of tax exemptions, state Rep. Chris Reykdal, D-Olympia. At that February hearing, he said, “I can’t even believe we are in this situation.”
Meanwhile, the Department of Revenue maintains that its planned excise tax advisory simply clarifies existing law. And there is a subtlety involved here — essentially, its position is that the law was established years ago by the court ruling, and businesses should have been paying the taxes all along. Revenue spokeswoman Kim Schmanke says the agency has been working with AWB to draft legislation this session, but it takes no position on the bill.
“Tax liability under the excise tax advisory remains the same as it is today,” Schmanke said. “The ETA simply describes how Revenue interprets and applies current law. It explains how a business can qualify for the paymaster exclusion. If a business chooses to restructure to qualify for that exclusion, the state would actually see a reduced tax liability. A business that has been incorrectly taking the deduction will realize (under the ETA) its true liability. That may be what the AWB is considering ‘increased’ liability, but in no way represents any change in policy or application by Revenue. A business will be taxed in exactly the same way under the ETA as it is today.”
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