We’ve already covered on this blog how payroll taxes work in Washington State. But there are two other types of Washington State taxes that just about every small business should know about: sales/use tax, and B&O. What’s more, multistate businesses that conduct business both in and outside of Washington need to know how Washington’s nexus rules work, and how to allocate (or apportion) their business’ income among various states.
This blog post is the first in a two-part series. This post explains how Washington State sales tax works for multi-state businesses. Another blog post next week will explain how Washington’s B&O tax works for multi-state businesses.
Introduction to the Concept of “Nexus”
Steve discussed the concept of nexus in more detail in this older blog post. But the short version is, states can impose rules on businesses and collect taxes from those businesses if the business has enough of a connection to the state. This connection is referred to as “nexus,” and frustratingly, the case law on nexus is different for different types of taxes.
If your business has any amount of activity in Washington State (such as customers in Washington State, inventory located in Washington State, an office in Washington State, or people working in Washington State on your behalf), then you want to get up to speed on the nexus rules for both Washington sales tax and Washington B&O tax. And if your business is primarily based in Washington, but also does business in other states, you’ll want to know how Washington’s tax laws deal with that out-of-state activity.
How Washington’s Sales Tax Works in a Nutshell
You’re probably familiar to some degree with how sales tax works because you’ve seen it on sales receipts as an ordinary consumer.
A consumer who makes a taxable purchase in Washington pays the tax, and the business that makes the taxable sale collects the tax on the state’s behalf. Then, periodically, the business remits the tax to the Washington Department of Revenue.
The sales tax a consumer pays has both a state-level component, which is always 6.5%, and a local component, which can be as high as 3.6%, depending on what the voters in the locality have chosen. For example, the City of Seattle sales tax rate is currently 3.6%. Thus, when you purchase goods in Seattle, you pay a total sales tax rate of 10.1% (6.5 + 3.6). On the other hand, the City of Snohomish only has a local rate of 2.6%, so when you purchase goods in Snohomish, you pay a total sales tax rate of 9.1% (6.5 + 2.6). The Washington Department of Revenue has a comprehensive list of both current and historical local sales tax rates available here.
Bookkeeping for Sales Tax
When a business collects on a sale to a customer, it collects both the sale price for itself, and the sales tax for the government. However, the business only has to count the sales price portion as income in its books. The sales tax portion is instead described as an increase to a current liability account (often this account is called something like “Sales Tax Payable”). Then, when the business remits the sales tax to the state, in the books that payment decreases the liability account for sales tax.
Even though a business may owe sales tax for many local governments, the business remits the entirety of the sales tax it’s collected for Washington State jurisdictions to the Washington Department of Revenue. It reports this sales tax payment on a Washington Excise Tax Return. On this return, the business needs to do a careful job at noting which localities get which portion of the sales tax payment that’s being made with the return. Businesses file this combined return using the Washington Department of Revenue’s MyDOR portal. (It’s the same account your business uses to track its Washington business license.)
Therefore, a business needs to do the following in order to get sales tax right in Washington State:
- Identify when a sale is subject to sales tax in Washington
- Identify which local jurisdiction gets to tax the sale in Washington, if the sale is taxable
- Have an accounting system that can effectively track sales tax liabilities (not just the amount of the liability, but also which jurisdiction the tax is for)
I discuss these three issues later in this article.
One Quick Aside: Understanding Use Tax
I want to take the time to mention use tax in this article because it is an important loophole-closing provision in Washington State’s sales tax regime, and understanding it is essential for understanding the tax obligations both of your customers, and of your own business.
We all know the “trick” for getting out of paying Washington sales tax, right? Take a day trip to Portland, OR, where there is no sales tax, and take care of your major purchases there. Clever, no?
Well, you probably won’t be surprised to hear that, like any other state that collects sales tax, Washington knows this trick. And it’s closed this loophole with a response that’s pretty standard for states that charge sales tax: use tax.
Here’s how it works. Washington State says, “sure, Seattle resident, you can go buy your nice new TV in Portland. And no, the Portland business that sold it to you doesn’t need to collect Washington sales tax on the sale. But when you bring that TV back to use in your Seattle apartment, you need to pay use tax on the TV. What’s use tax? It’s 10.1% of what you paid for the TV in Portland, same as the amount of sales tax you would have paid if you had purchased the TV in Seattle.” (Consumers pay use tax using the Washington Department of Revenue’s MyDOR portal.)
This issue of use tax replacing sales tax explains why Justice Kennedy spoke about Wayfair rather scathingly in the Supreme Court’s recent South Dakota v. Wayfair decision:
Wayfair offers to sell a vast selection of furnishings. Its advertising seeks to create an image of beautiful, peaceful homes, but it also says that “‘[o]ne of the best things about buying through Wayfair is that we do not have to charge sales tax.’”… What Wayfair ignores in its subtle offer to assist in tax evasion is that creating a dream home assumes solvent state and local governments.
It makes you wonder how the former justice would feel about the headline to this ad campaign from Portland’s tourism department.
When Do I Have Sales Tax Nexus in Washington?
If one or more of these four criteria apply to your business, then your business needs to collect and remit Washington State sales tax:
- Your business has a physical presence in Washington State, however slight [WAC 458-20-193]
- Your business has $100,000 or more in annual gross sales, or 200 or more annual transactions, in Washington State [emergency ruling] (this is essentially a copy of the South Dakota law upheld in the Wayfair case, linked above)
- Your business has a referral agreement with one or more Washington State residents, and your total referrals from all Washington residents exceeds $10,000 [RCW 82.08.052] (this is essentially a copy of New York’s Amazon law).
However, it’s important to note that Washington has a use tax reporting law, in addition to its regular sales tax laws. (These use tax reporting laws are sometimes referred to as “Colorado laws” because Colorado was the first state to use the trick.)
Washington’s use tax reporting law says that if your business has $10,000 or more in annual gross sales in Washington State, then your business needs to file a report with the Washington Department of Revenue detailing who each one of your Washington customers was and how much those customers bought (RCW 82.13.020). This is so the Department of Revenue has the information it needs to collect use tax from those customers. In addition, your business would also have to notify Washington customers with a detailed explanation of their use tax obligations, and how to pay that use tax.
If a business doesn’t want to provide this information to the Department of Revenue or its customers, it can opt out by voluntarily collecting sales tax. (In other words, if a business collects sales tax even when it doesn’t have to, it gets out of the use tax reporting requirement.)
What Counts as “Physical Presence”?
The Washington Department of Revenue lists on its website some examples of what it considers physical presence. The most obvious ways to have physical presence in Washington are to own property in the state, lease property in the state, or have employees working for you in the state. Note that owning property in the state includes stuff like storing your inventory in an Amazon warehouse in Washington State.
What Counts as a “Washington Sale”?
The sourcing rules for sales and use tax are in RCW 82.32.730, if you want to get into the nitty-gritty of it. But the short version is that Washington uses destination-based sales tax for sourcing retail sales. So, if you deliver goods to customers in Washington State who will presumably use those goods in Washington, then it’s a Washington sale.
What Types of Sales Are Subject to Sales Tax?
If you know your business has sales tax nexus in Washington State, your next step is to determine whether the sale is of a type subject to sales tax.
In general, any transaction that’s considered a “retail sale” of tangible personal property under state law is subject to sales tax [RCW 82.08.020]. Washington’s sales tax laws define “retail sale” as “any sale, lease, or rental for any purpose other than for resale, sublease, or subrent” [RCW 82.08.010(11)]. The definition of “retail sale” for sales tax also includes any sale that counts as a “retail sale” for B&O tax [RCW 82.08.020(1)(e)].
Among accountants, the common definition of “tangible property” is property that exists in the physical world, as opposed to “intangible property” like patents, copyrights, and trademarks. And “personal property” is any property that isn’t real estate. These are the definitions you’ll see on sites like Investopedia.
However, state laws have gotten more creative in the recent past about how they define “tangible property” as a way of expanding their sales tax base.
For example, Washington State’s sales tax laws define “tangible personal property” to include electricity, water, gas, steam, and prewritten computer software [RCW 82.08.010(7)]. And the state takes special care to clarify that personal property includes digital goods, digital codes, and digital automated services unless the context clearly indicates otherwise [RCW 82.08.010(10) and 82.08.020(1)(b)].
Businesses subject to Washington sales tax rules must charge customers sales tax on the full sales price. Washington’s sales tax laws define “sales price” to include things like delivery and installation charges, even if those charges are separately itemized [see RCW 82.08.010(1) and 82.08.145].
Exceptions to the General Rule
Know that Washington’s sales tax laws contain numerous exemptions. Many of these exemptions are pretty random, and are surely the result of successful industry lobbying efforts. But the most common exemptions fall into four major categories:
- Wholesale sales
- Non-Washington sales
- Sales handled by what’s called a “marketplace facilitator”
- Sales of basic needs like prescriptions and groceries
Note: it may be worth taking a brief skim though RCW 82.08 to see if there’s an exemption listed that applies to your business.
Exemption for Wholesale Sales
If your business sells items wholesale, then you don’t need to collect sales tax on the sale as long as you can prove that the sale wasn’t a retail sale. But note that under state law, the burden of demonstrating that a sale is a wholesale sale rather than a retail sale falls on the seller (see RCW 82.08.050, 82.04.470, and 82.08.140). So how does a business prove that its sales are wholesale? By collecting and saving reseller permits.
Save reseller permits for at least five years after the date of sale. If you aren’t careful about saving reseller permits and you get audited by the Washington Department of Revenue, they’ll charge you sales tax on the sales to any customers who you didn’t save a permit for.
Exemption for Non-Washington Sales
If you sell and deliver a product to a customer outside of Washington State, then you don’t need to collect sales tax as long as you document it properly. Note that non-Washington sales include sales to customers in other U.S. states, Native American tribes, and foreign countries (WAC 458-20-192, 458-20-193, and 458-20-193C).
In addition, non-residents of certain states are exempt from Washington sales tax if the property they purchase will be used outside of Washington (RCW 82.08.0273), even if you don’t deliver the sale out of state. These are called “qualified nonresident sales,” and you can read more about them on the Washington Department of Revenue’s website.
Sales Handled by a Marketplace Facilitator
Note that if you have what the law calls a “marketplace facilitator” collecting and remitting sales tax for you, then you don’t need to worry about collecting and remitting sales tax yourself on those sales (see RCW 82.08.0531(4) and 82.13.020). A marketplace facilitator would be a company like Amazon.com or the Apple App Store.
Exemptions for Basic Needs
The most common exemptions are for things like food and prescriptions; things that are clearly necessities, and thus have been exempted from sales tax to make the tax less regressive. The Washington legislature will sometimes change the rules on borderline cases: things that you’d probably find in a grocery bag, but aren’t really necessities, such as bottled water or candy.
The Washington Department of Revenue has a page that explains a bit about various exemptions and tax breaks here.
How Do I Determine the Correct Local Sales Tax Rate to Use on a Receipt?
Once you’ve determined that a sale is subject to sales tax in Washington State, your next question to answer is, what local rate do I need to add on top of the 6.5% state tax rate for this sale?
Remember that Washington State uses destination-based sales tax. That means the answer to this question usually depends not on where your business is located, but where your customer is located. Say you operate a furniture store in Duvall. A customer makes a purchase in your Duvall store location, but needs you to deliver the furniture to their residence in Bellevue. What’s the correct local rate?
You (and your customer) might hope that you only need to charge Duvall’s 2.1% local rate. But because the destination of the furniture is Bellevue, you actually need to charge Bellevue’s 3.5% local rate. And, accordingly, your furniture business needs to have an accounting system that can track customer destinations and is capable of applying the correct sales tax rate for every possible destination (i.e., every local jurisdiction your business is willing to deliver to).
How Do I Even Begin to Comply with This?
If you’re a traditional brick-and-mortar retailer with only one or two shops, then complying with sales tax is easy. This is because as long as you don’t deliver products to your customers, and only transfer goods you sell in your store, you only ever charge the sales tax rate for the physical location your store is in. Your customers, if they take the items purchased to a jurisdiction with a higher sales tax rate, may need to pay use tax on the difference. But dealing with the complexity of that falls onto the consumer, not you.
On the other hand, if your business does deliver products to consumers (say, because you’re an online retailer), complying with Washington’s sales tax laws is a real headache. The sales tax rate you charge is based on where you deliver the product and where the customer will use it, and Washington has hundreds of sales tax jurisdictions. There’s no way around it: you need to spend money on sales tax software that your brick-and-mortar competitors don’t need to spend. In this situation, your major options for dealing with sales tax include AvaTax, TaxJar, and QuickBooks Online’s new Automated Sales Tax.
QuickBooks Desktop Sales Tax Tracking
If your business is a traditional brick-and-mortar shop that only makes sales and transfers goods to customers at a handful of store locations, then your sales tax solution can probably be cheap and simple. Desktop versions of QuickBooks have had sales tax tracking for a long time, though the system requires some manual effort from the bookkeeper.
To use this solution, you’ll need to enter sales tax rates yourself, update them yourself each time the rate changes, and identify for yourself which rate applies to each sale. However, if you only have a few rates to keep track of because you don’t deliver products to your customers, those drawbacks aren’t too bad. Note, also, that the Washington Department of Revenue has files with sales tax rates in them which you can import into desktop versions of QuickBooks.
Automated Sales Tax Solutions
E-commerce businesses and other shops that deliver goods to customers probably need a sales tax solution that’s more automated than the sales tax tracking available in QuickBooks desktop. We know of three automated sales tax options that are designed to work for these types of small businesses:
The common thread among all of these programs is that they try to automate several aspects of tracking sales tax that would otherwise leave the typical small business owner overwhelmed.
For example, one common feature among such programs is keeping track of which jurisdictions use destination-based sales tax (e.g. Washington), which use origin-based sales tax (e.g. Illinois), and which use their own odd system (e.g. California). Then, the program will use information like the customer’s shipping address to automatically look up the correct sales tax rate for the relevant jurisdiction (out of a database containing the approximately 10,000 different sales tax jurisdictions across the U.S.)
Often these programs will also try to help small business owners identify when they have physical presence in a state—and thus sales tax nexus (even under pre-Wayfair rules)—because the business stores inventory in that state. (This is a common scenario for business who participate in Amazon’s FBA program; such a business might have nexus in 40 or so states under the physical presence standard.)
These programs will also typically offer help with preparing sales tax returns, so the business can file all of their sales tax reports through one software program using one user login, rather than needing to create and keep track of dozens of different logins for all of the jurisdictions the business has nexus in.