Washington State: Penalties on unfiled annual reconciliation of apportionable income

The Washington Department of Revenue continues to impose penalties as high as 29% on taxpayers that did not file an Annual Reconciliation of Apportionable Income Form (ARAI). All businesses that reported apportionable income on timely filed Washington Combined Excise Tax Returns (CETR) in 2022 are encouraged to file the ARAI by October 31, 2023, even when the reconciliation results in a “no change” return. “No change” ARAI filings can be made via short form submission with no detailed receipts reconciliation required.

In addition, those taxpayers that reported revenues under only the retailing, wholesaling or manufacturing classifications need to consider filing the ARAI if there is any potential for a reclassification of receipts into an apportionable income category (e.g., services and other).

The Washington business and occupation (B&O) tax is a gross receipts tax measured by the value of products, gross proceeds, or gross income of a business. The B&O tax employs various tax classifications—most commonly retailing, wholesaling, manufacturing, royalties and service and other activities. The “service and other” classification captures any activity not explicitly taxed under another B&O tax classification. Income from certain business activities, such as service and other and royalties is deemed apportionable income. This means that the taxpayer must apply an apportionment factor to calculate the deduction for income derived outside Washington to arrive at income subject to Washington B&O tax. Most taxpayers are required to file and remit B&O tax on a monthly basis, while other taxpayers file and remit B&O tax on a quarterly or annual basis.

Taxpayers reporting apportionable income are permitted to calculate the receipts factor for the current tax year based on the most recent calendar year for which information is available for all 12 months. Alternatively, taxpayers may calculate the receipts factor based on current year information. In either case, RCW 82.04.462(4) requires a taxpayer to file an annual reconciliation by October 31 of the following tax year correcting the reporting for the current year. If the annual reconciliation is not filed with additional tax paid by October 31, penalties apply on any additional tax due. Penalties are assessed at a rate of 9% if the reconciliation is not filed and tax has not been paid by the due date; 19% after 30 days, and 29% after 60 days.

The Department takes the position that the 29% penalty for failing to file an annual reconciliation applies to any additional tax assessed on apportionable income even if the taxpayer did not report any apportionable income on its timely filed original returns. It is not uncommon for taxpayers that do not otherwise report apportionable income on their returns to be assessed tax on apportionable income on audit. This can occur for a variety of reasons. For example, the Department may reclassify a taxpayer’s receipts from retailing to service and other receipts, which are taxed at a higher B&O rate than retailing receipts. Another common scenario is that a taxpayer may have receipts—such as intercompany receipts—that it failed to include on its timely filed returns. As a result, there is risk that taxpayers could be assessed tax on apportionable income on audit and be subject to the 29% penalty, even if they are currently filing only under non-apportionable income B&O tax classifications (e.g., retailing, wholesaling or manufacturing).

Taxpayers reporting apportionable income on their returns must file an annual reconciliation regardless of whether the taxpayer calculated its receipts factor based on prior year or current year information and regardless of whether the reconciliation results in a change to the amount of tax due. In addition, all other B&O taxpayers that do not report apportionable income on their returns need to consider filing the annual reconciliation if there is any potential for a reclassification of receipts into an apportionable income category (e.g., service and other).

Simply filing the reconciliation by the October 31 due date, with or without any adjustments to amounts originally reported, likely will protect a company from the 29% penalty if the Department later assesses additional tax on apportionable income. The Department has confirmed that taxpayers filing the ARAI online who do not have adjustments to report may select “no change” and proceed with submitting the form without providing the detailed receipts information otherwise required. This short form submission will be viewed as timely filing for purposes of penalty protection if additional tax is later determined to be due.

For more information, contact a KPMG State and Local Tax professional:

Michele Baisler | mbaisler@kpmg.com

Alex Low | alexanderlow@kpmg.com