In an effort to fill a $2.6 billion budget shortfall, the Washington State Legislature proposes taxing businesses that have no physical presence in Washington and perform all of their business activities in other states. As originally proposed in House Bill 3157, and now included as one of many wide-ranging changes in House Bill 3176, Washington would tax out-of-state businesses on any revenues they derive from Washington customers.
The Commerce Clause of the United States Constitution (Art. I, § 8, cl. 3) forbids state taxes on interstate commerce unless the taxpayer has "substantial nexus" with the state. Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977). These two House Bills would claim "economic nexus" against any out-of-state business that has more than $500,000 in gross receipts or at least 25% of its total revenues from Washington residents. Thus, Washington would impose its business taxes (i) on architects, engineers, or lawyers working solely in another state, even though all of their professional services were performed outside Washington; (ii) on distributors selling products to Washington customers, even though the distributor never entered Washington to solicit sales; and (iii) on financial institutions that earn revenues from credit card accounts held by Washington residents. Furthermore, once "economic nexus" is created under the new nexus criteria, these House Bills would claim that nexus continues for the next four calendar years, even though the volume of business with Washington residents drops below the initial nexus thresholds.
If a business has substantial nexus with Washington, the Commerce Clause also requires that the state "fairly apportion" the taxpayer's revenues according to where the revenue-generating services were performed. In Gwin, White & Prince, Inc. v. Henneford, 305 U.S. 434 (1939), the United States Supreme Court specifically ruled that Washington could not tax 100% of the revenues derived from Washington customers if the service provider performed a significant portion of those services in other states. Instead, Washington was required to apportion those revenues for tax purposes according to where the services were actually performed. Ignoring that constitutional mandate, these House Bills require that 100% of revenues from Washington sources be subject to Washington business taxes without apportionment based on where the underlying sales or services occurred.
For both of these reasons, the proposed legislation would likely face a constitutional challenge. Of more immediate concern to the Washington Legislature, this bill could lead to a net loss of tax revenues from professional services firms. Even if the Commerce Clause would allow Washington to tax the revenues earned by out-of-state professionals serving Washington customers, it presumably would be difficult for Washington to enforce those taxes on professional services firms scattered throughout the other states. As a result, little additional tax revenue is likely to come to Washington from those sources. But under §§ 104-105 of the proposed statute, Washington-based professional services firms would have an equal right to exclude from the measure of their Washington taxes the fees they earn from out-of-state clients. Washington-based professionals will likely take advantage of this exclusion more frequently than out-of-state professionals will pay Washington business taxes on the fees they earn from Washington clients.