Investments

Gains realized from trading in stocks, bonds, or other evidences of indebtedness, interest income, dividends, and other investment related income are included in the term “gross income of the business” without any deduction for losses (RCW 82.04.080).

Deduction for amounts derived from incidental investments

A B&O tax deduction is provided for amounts derived from incidental investments (RCW 82.04.4281).

The Washington Supreme Court recently held in Antio that this deduction is limited to income that is earned through investments that are incidental to the main purpose of the taxpayer’s business. This means that a taxpayer cannot deduct investment income if the investment activity generating the income is the main business activity of the taxpayer. The department will presume that an investment activity is not the main activity of a taxpayer if it generated less than 5% of the taxpayer’s annual gross receipts. This constitutes a safe harbor.  

Taxpayers have the burden of proving an investment activity is not the main business activity if the income from the activity exceeds the safe harbor. Therefore, a taxpayer with investment activity income that falls outside of the safe harbor must establish that the income was generated from an incidental investment of the taxpayer’s surplus funds.  In this regard, in determining whether investment activity is incidental, a taxpayer's facts and circumstances at and prior to the time of filing will be relevant.  

Also, this deduction does not generally apply to amounts received from loans, the extension of credit, revolving credit arrangements, installment sales, and similar interest income.

The department encourages taxpayers with questions about their specific situation to contact the department for further guidance. 

Endowments

Investment income from a bona fide endowment fund is fully deductible under a separate statute, RCW 82.04.4282. Both beneficiaries and holders of endowment funds may deduct investment income if they can show that the endowment fund is the source of the deducted income.

Persons not engaging in business

Persons who are not engaging in business are not subject to B&O tax on their income earned from investing. This category includes individuals who are not engaged in business and who invest their own personal assets.

The department is also considering providing additional guidance on what activities constitute engaging in business in Washington, and in this context how mutual funds, private investment funds, trusts (including family trusts), and other collective investment vehicles respectively are treated for tax purposes. The department is currently reviewing stakeholder requests for guidance on this issue, and is evaluating what, if any, guidance is appropriate.

Apportionment of investment income for businesses other than financial institutions

While the guidance below reflects the department’s position for sourcing investment receipts, we recognize this method of sourcing will benefit from additional study and potential legislative action to ensure that it fully aligns, in future periods, with state policy goals. Accordingly, Revenue created an Investment Income Apportionment Workgroup to develop, evaluate, and review potential options for future legislation. This effort will include participation of interested parties representing Washington business interests. As part of this effort, Revenue plans to issue a report with options for the Legislature to consider.

Businesses that receive investment income, other than financial institutions defined in WAC 458-20-19404(3)(i), must follow a series of cascading steps to determine how to attribute apportionable income. These steps are used to assign income to the numerator of the receipts factor.

These cascading steps are described in RCW 82.04.462(3)(b) and WAC 458-20-19402(301). More information about apportionment and the receipts factor is also available on the department’s Apportionment webpage.

Attribution to commercial domicile

While taxpayers must follow the cascading steps, the department’s current understanding is that investment income should be attributed to the taxpayer’s commercial domicile, under the cascading step described in RCW 82.04.462(3)(b)(vii) and WAC 458-20-19402(301)(g).

The department is not aware of any situations in which the earlier cascading steps would apply for the following reasons:

• The investment income is not received in exchange for providing a service, so steps (301)(a) through (c) do not apply.
• The investment income is not associated with an identifiable customer, so steps (301)(d) through (f) do not apply.

Example

Portfolio Investments, LLC (“Taxpayer”) is a company engaged in business with its commercial domicile in Washington. Taxpayer is not a “financial institution” as defined in WAC 458-20-19404(3)(i). Most of Taxpayer’s annual gross income comes from gains realized from buying and selling stocks on a public stock exchange. Taxpayer maintains a large, diversified portfolio of stocks involving a high volume of sales activity.

Gains realized from the sale of stocks are generally apportionable income subject to B&O tax under the Service and Other Activities classification. For apportionment purposes, Taxpayer cannot apply the cascading steps in WAC 458-20-19402, steps (301)(a)-(c), because the income is not earned from providing a service to a customer. Taxpayer also cannot apply steps (301)(d)-(f) because it cannot reasonably identify a customer associated with its stock sales. As a result, the gains realized from stock sales are properly attributed to Taxpayer’s commercial domicile in Washington under WAC 458-20-19402(301)(g).   

Other apportionment methods

While the department expects that investment income will generally be attributed under step (301)(g), taxpayers asserting that an earlier cascading step applies must maintain sufficient books and records to support their attribution method and provide those records to the department upon request. See WAC 458-20-19402(302)(c)(ii).

Deduction not available for banking business, lending business, or security business

The deduction for amounts derived from incidental investments is not available to a banking business, lending business, or security business.

For this purpose, a security business is defined as a business, other than an issuer, in the business of effecting transactions in securities as a broker, dealer, or broker-dealer, as defined in the Securities Act of Washington (Chapter 21.20 RCW) or the federal Securities Act of 1933.

Generally, these laws require a broker, dealer, or broker-dealer to register with the Washington Department of Financial Institutions and/or the Securities and Exchange Commission.

A person who buys and sells securities for his or her own account, either individually or in a fiduciary capacity rather than as part of a regular business, is generally considered a trader rather than a dealer, broker, or broker-dealer, and not considered a security business. According to the SEC’s Guide to Broker Dealer Registration, the following characteristics are indicative of a dealer rather than a trader:

• Advertising or otherwise letting others know that the person is in the business of buying and selling securities.
• Doing business with the public (either retail or institutional).
• Making a market in or quoting prices for the purchase and sale of one or more securities.
• Participating in a selling group or otherwise underwriting securities.
• Providing services to investors, such as handling money and securities, extending credit, or giving investment advice.
• Writing derivatives contracts that are securities.

The frequency of trading activity alone is not determinative if the other characteristics of the investing activity indicate the trading is not part of a regular business. A trader not meeting the characteristics of a broker, dealer, or broker-dealer is not a security business.

Gross income of stockbrokers, security houses, banks, and other financial institutions

How gross income is calculated depends on the type of institution.

Stockbrokers and security houses: computed following WAC 458-20-162. Stockbrokers and security houses are not allowed a deduction for income derived from investments. Gross income includes amounts from interest, commissions, trading, dividends, and other sources. Gross income from trading is the amount received from the sale of stocks, bonds, and other securities over and above the cost or purchase price of such stocks, bonds and other securities.

Banks and other financial institutions: computed following WAC 458-20-146. Since banking and lending businesses are also not allowed the deduction for income derived from investments, gross income includes gains realized from trading in stocks, bonds, or other evidences of indebtedness, interest, discount, rents, royalties, fees, commissions, dividends, and other similar emoluments.

Compensation for rendition of services not derived from investments

Gross income from rendering services, such as investment advisory services, is generally subject to service and other activities B&O tax. This income is not deductible under RCW 82.04.4281, since it is derived from services rather than from investments.

More information

Investment income