Following the Washington Supreme Court’s October 2024 decision in Antio, the Department of Revenue (DOR) has updated its tax topics publication, “Investments,” acknowledging the decision’s effect on the state’s investment tax rules.
In Antio, the state’s high court agreed with the DOR’s position, concluding that Antio, a group of related limited liability companies whose sole income was derived from owning or trading investments, was not entitled to a business and occupation (B&O) tax refund based on the deduction for amounts derived from investments.
Critically, the court disagreed with Antio’s argument that the statute, and the DOR’s interpretation thereof, implied a much broader definition that any investment income was deductible with exceptions only for specific types of businesses (for example, stockbrokers, security houses, and financial institutions). In doing so, the court relied on O’Leary, a 1986 decision, to determine that the investment deduction is limited to the incidental investment of surplus funds. The court concluded that the legislature’s 2002 revisions to the statute did not abrogate the 1986 definition because they did not change the term “investments.”
As a result, the investment income deduction as previously understood by many practitioners is now limited to the incidental investment of surplus funds. In other words, the deduction is not available for investment income earned by a company whose primary business activity is owning or trading investments.
In its publication on the taxability of investments, the DOR noted that the Washington Supreme Court held in Antio that the investment deduction is limited to income earned through investments that are incidental to the main purpose of the taxpayer’s business. That means a taxpayer cannot deduct investment income if the investment activity generating the income is the taxpayer’s main business activity. The DOR established a safe harbor, saying it will presume that an investment activity is not a taxpayer’s main activity if the activity generates less than 5% of the taxpayer’s annual gross receipts.
The DOR clarified that taxpayers have the burden of proving an investment activity is not their main business activity if the income therefrom exceeds the safe harbor. Thus, a taxpayer with investment activity income that falls outside the safe harbor must establish that the income was generated from an incidental investment of the taxpayer’s surplus funds. In determining whether investment activity is incidental, a taxpayer's facts and circumstances at and before the time of filing will be relevant.
According to the DOR, persons not engaged in business are not subject to B&O tax on investing income. The department is considering what activities constitute engaging in business in Washington and, in that context, how the state treats mutual funds, private investment funds, family trusts, and other collective investment vehicles for tax purposes. The previous version of the publication indicated that those types of entities were allowed the deduction for investment income, but the update does not include that language.
The DOR has specified that it plans to issue guidance after further reviewing Antio and stakeholder feedback. It advises taxpayers with questions about the taxability of their investments to request a ruling.
BDO Insights
- Businesses that have been taking the investment income deduction should review their B&O tax filing methodologies (including sourcing methodologies) to determine potential exposure and identify planning opportunities.
- Antio has important implications for companies engaged in investment activities that make up more than 5% of — that is, are not incidental to — their business because income derived from investments is subject to the B&O tax rate of 1.5% for services and other activities (the rate increases to 1.75% if the taxpayer has more than $1 million in income from services and other activities in the prior tax year).
- The DOR update leaves many questions unanswered, including how the department will address this issue for tax periods during which the statute of limitations is still open, how investment income should be sourced in Washington, and what the DOR considers a reasonable set of facts for proving an investment activity that exceeds the safe harbor is not the taxpayer’s main business activity.
- Washington’s capital gain excise tax provides a credit for B&O tax paid to avoid taxing the same sale or exchange under both tax regimes. Therefore, individuals may be able to credit their distributive share of B&O tax against their capital gain excise tax liability.
Please visit BDO’s State & Local Tax Services page for more information on how BDO can help.