The Infamous B&O Tax

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Nobody likes taxes, but people really, really hate the levy Washington imposes on businesses.

Called the Business & Occupation Tax, the “B&O” is loathed with the intensity usually reserved for your college football team’s archrival. Think the Apple Cup, but with lots more money at stake.

The B&O is a tax on gross receipts. Sounds simple, right? Not at all, say business owners. First enacted as a temporary funding mechanism in 1933, it has been amended, tweaked and updated to include hundreds of exemptions, exceptions and classifications. And 39 cities in the state—including Seattle—have gotten in on the action, imposing their own versions of the B&O on top of the state tax.

“It’s crazy. It’s a nightmare to figure out,” says Steve Neighbors, chairman of Bellevue-based Terra Staffing Group, which connects job seekers with a variety of businesses.

Here’s how the state B&O works: Businesses receive a classification with a corresponding tax rate. They then apply that rate to their gross receipts and cut Washington a check. Most classifications come with a tax rate below 1 percent, which is low. But what drives many nuts is that businesses get taxed whether they make money or lose money, which critics of the levy say is especially hard on startups and small firms.

“Even in those years you’re not making a profit, the government gets paid before the owner of the business,” says Neighbors.

And classifications aren’t concrete. They vary depending on what the business does and where it does it—a feature that can drive bean counters mad. For example, if a widget factory in Wenatchee sells its product to a customer in Washington, it gets taxed at the rate for wholesalers (0.484 percent). But if it sells those widgets in Wyoming or anywhere else out of state, it's considered a manufacturer. And within the manufacturing classification, different tax rates can apply.

Neighbors says the situation is particularly maddening for his firm, which sends workers out to different types of businesses in different cities. Terra Staffing has to figure out the particular tax for the particular industry its workers toil in, and cough up accordingly. And to make matters worse, Neighbors says an exemption the staffing industry once enjoyed was recently eliminated.

“Our B&O tax tripled when that went away,” he notes.

Washington is the only state in the country that taxes businesses this way. The Washington Policy Center, an independent public-policy think tank, says the B&O is “nationally recognized as one of the worst ways to tax businesses.” An economist from the Tax Foundation, a Washington, D.C.-based research group, has called the tax “deeply flawed and damaging.”

Gubernatorial candidates Rob McKenna, Republican, and Jay Inslee, Democrat, have both talked about changing the tax structure in Washington state. And there’s bipartisan agreement in the state Legislature that Washington’s tax situation is messed up. Liberals hate the regressive retail sales tax and conservatives (and more than a few liberals, too) think there has to be a better way to get money from businesses.

So changing or eliminating the B&O should be an easy sell, no?

Here’s where things get complicated. Businesses have come to, if not like, at least tolerate with gritted teeth the B&O system they know. And policymakers are wary of tweaking Washington’s second-largest source of revenue behind the general sales tax. In the 2011 fiscal year, the state collected $3 billion from businesses, representing nearly 19 percent of Washington’s tax receipts.

Dann Mead Smith, president of the Washington Policy Center, says the B&O is hard to kill for several reasons.

“First, the most likely alternative is an income tax, which would ahave a negative impact on the state’s attractiveness as a place to do business,” Smith says.

"Second, [the B&O] has a very low rate and a broad base. Essentially, businesses do not have a huge tax rate because the base is so large. The problem is the base includes unprofitable businesses, so if you readjusted the base to exclude unprofitable businesses, those who are profitable would see their tax rates rise,” he explains. “Many in the business community are stuck between hating a tax that dings them in years when they are unprofitable and paying a really low rate when they are profitable.”

Smith also says many businesses bene-fit from the several hundred exemptions that have been written into the B&O tax. “Switching to an income tax could wipe that out,” he says, “… [and] the beneficiaries of all of these exemptions fight tooth and nail to keep them.”

Finally, many business owners don’t trust the Legislature to enact something better, so “they tepidly embrace the devil they know.”

Some defenders of the B&O tax say the system has the virtue of being much harder to avoid. It’s far easier, for example, to manipulate your income in any given year than it is your gross revenues. And Microsoft, which tends to earn a lot of income in relation to its revenues, benefits from a tax that is based on revenues and would likely fight a change. Then there is Boeing, whose taxes are sharply reduced through special exemptions. Such big players are unlikely to support any changes in the current structure.

Considering that the state’s tax receipts are cratering—lawmakers faced a $5 billion deficit last year and are in the process of patching a roughly $2 billion hole now—there’s not much legislative initiative to overhaul the system, either.

Those efforts, however, haven’t stopped people from making recommendations. In 2010, the Washington Policy Center suggested replacing the B&O with a single “margin tax” based on gross receipts, but with deductions to consider some of the costs of doing business. The tax would be figured by taking a business’s total annual gross receipts, then subtracting the cost of production or total compensation. The amount a business paid would depend on how much money it actually made.

Others would simply like to see the elimination of special exemptions. But business owners aren’t hopeful of seeing a new set of rules anytime soon. “I’m a little pessimistic,” Neighbors admits. “When you’re dealing with the Legislature, you chip away, a little at a time. But I think we need to keep banging on it.”

Rates for Washington’s Business & Occupation Tax for Master Classifications

Retailing— .471 percent

Wholesaling— .48 percent

Manufacturing— .48 percent

Services— 1.8 percent

Some categories get special breaks, some don't

Manufacturing/selling commercial aircraft and components— .2904 percent

Manufacturing/wholesaling of solar energy systems— .275 percent

Travel agents, tour operators, stevedoring, freight brokers, aircraft repair, computer-chip manufacturing— .275 percent

Processing of meet, beans, raw seafood, fruit, vegetables, reselling prescription drugs, manufacturing biodiesel— .138 percent

Gambling contests of chance (less than $50,000 a year)— 1.8 percent

Gambling contests of chance (more than $50,000 a year)— 1.93 percent

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