Today, Governor Inslee rolled out his budget “concepts” and a tax package billed as “closing loopholes”.  You can read the full document here: http://www.ofm.wa.gov/budget13inslee/full_budgetpriorities.pdf

In addition to extending the B&O surcharge of 0.3% for service companies, which includes software and IT, one of the more ill-advised tax ideas was included in this package. That is the sales tax on custom software.

This bad idea first appeared three years when the legislature was desperate for new money as the recession was in full swing and state revenues dropped severly.  Now that the state’s unemployment rate has dropped a full percentage point the last year and tax revenues are increasing, there is more money to support the state operating budget.

Yet at the same time, the demands on the state budget, particularly for K-12 education, are higher than ever.  However, floating poorly designed tax increases targeted at small tech businesses doesn’t make sense.

For as long as software has been taxed, it has always fallen into two categories:  prepackaged or “canned” and custom.  Prepackaged software has always been taxed as “manufacturing” and sold to end users as “retail”.  This means that software companies that made products for multiple users were taxed at the manufacturing rate (generally .484%) and the sale of software to end users has always been a retail sale subject to sales tax.

Custom software has always been taxed as a professional service, similar to accounting, consulting, engineering or law.  This is because these types of service providers do work for one client at a time.  The customers of an accountant usually have different situations that require a different solution.  The same with custom software.  Service companies in Washington pay a higher B&O rate, 1.8%, than all other types of businesses, which raises a substantial amount of money for the state.

Under Gov. Inslee’s proposal, custom software developers will now have to collect sales tax from their customers.  This puts them at a distinct disadvantage compared to out of state software develpers who will not have to collect that tax.  Why aren’t other professional services being asked to do the same?  This proposal targets one professional service; one that pays substantial amounts of B&O tax already; an industry that is characterized by small, entrepreneurial companies.  This ill-advised tax hardly supports innovation and entrepreneurship that the governor himself has stated he wants to grow.

WTIA will be working to halt this proposal but with the legislature’s overwhelming desire for more money, it may be difficult.  Keep an eye our for a call to action on our website.  Please contact Lew McMurran at lmcmurran@washingtontechnology.org if you have questions about this tax.

 

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