Washington's Receipts Throwout Can Raise a Nonresident's Share of Pass-Through Income

Say you live in Nevada. You own a consulting firm organized as an LLC taxed as an S corporation. Some clients are in Washington.

Washington's new income tax reaches part of your share of the firm's income. How much depends on one fraction: the receipts factor.

The receipts factor contains a "throwout" rule. It removes certain receipts from the denominator, increasing the percentage of income apportioned to Washington.

We've covered the basics elsewhere: the PTE election, leaving Washington, and moving midyear. This post is about the throwout.

All statutory quotes are from the ESSB 6346 session law.

Step one: nonresidents are taxed on Washington-source business income

Section 401(2)(d) treats as Washington-source income "an individual's distributive share of income from a pass-through entity operating within this state as provided in section 402 of this act, to the extent determined under section 405 of this act."

Section 402(1) says the same thing a different way: "pass-through entities that operate in the state."

The act doesn't define "operating within this state" or "operate in the state."

Step two: a single receipts factor

Section 405(3) apportions business income "by multiplying the income by the receipts factor."

The factor is "a fraction the numerator of which is the total receipts of the taxpayer in this state during the tax period and the denominator of which is the total receipts of the taxpayer everywhere during the tax period."

No property factor. No payroll factor. Just receipts.

Step three: services are sourced to where they're delivered

For a service, the market is in Washington "if and to the extent the service is delivered to a location in this state." § 405(3)(b)(i)(C).

Two notes.

• The act doesn't define "delivered to a location."
• Section 405 doesn't cross-reference RCW 82.04.462, the B&O tax's service-sourcing rule. Maybe DOR borrows from it by rule. The statute doesn't say so.

If you can't determine where a receipt goes, it "must be reasonably approximated." § 405(3)(c).

Step four: the throwout

Here is § 405(3)(d) in full:

"If the taxpayer is not taxable in a state to which a receipt is assigned under this subsection (3), or if the state of assignment cannot be determined under (b) of this subsection (3) or reasonably approximated under (c) of this subsection (3), the receipt must be excluded from the denominator of the receipts factor."

So two kinds of receipts drop out of the denominator:

1. Receipts assigned to a state where "the taxpayer is not taxable."
2. Receipts that can't be assigned or reasonably approximated.

They come out of the denominator only. The numerator (Washington receipts) doesn't change. A smaller denominator means a bigger Washington percentage.

A worked example

Illustrative numbers only.

A Nevada resident is the sole owner of a consulting LLC that has elected S corporation status. Apportionable income passed through to the owner: $600,000. The owner has no other income. Receipts: $1,000,000.

Without the throwout: $300,000 / $1,000,000 = 30%. Washington-source income: $180,000.

With the throwout: the $100,000 that can't be assigned or approximated comes out of the denominator. § 405(3)(d) says so expressly.

$300,000 / $900,000 = 33⅓%. Washington-source income: $200,000.

Same receipts. Same services delivered to Washington. $20,000 more Washington-source income.

The bigger the unassignable bucket, the bigger the effect. That's why documenting where services are delivered matters.

Sourced income is not tax owed

The $200,000 is apportioned income. It isn't a tax bill.

Section 314 allows "a standard deduction of $1,000,000 per individual, or in the case of spouses or state registered domestic partners, their combined standard deduction is $1,000,000, regardless of whether they file joint or separate returns." It also says: "The standard deduction must be adjusted for nonresidents as provided in section 315 of this act."

Section 315 says the deduction "for individual taxpayers who are not residents of this state for the entire taxable year must be reduced by multiplying the amount of the deduction by a fraction. The numerator of the fraction is the individual's Washington base income. The denominator of the fraction is the individual's federal adjusted gross income from all sources. The fraction may never be greater than one."

Apply it to the example. Assume Washington base income is $200,000 and federal AGI is $600,000:

• Deduction: $1,000,000 × ($200,000 / $600,000) = $333,333.
• Washington taxable income: $200,000 − $333,333 = zero.

So at this size, the throwout changes sourced income but not the tax.

Scale everything up 10x ($6 million of income, $2 million Washington-source). The deduction is still $333,333. Taxable income is about $1.67 million. Now the throwout matters: without it, Washington-source income would be $1.8 million and taxable income about $1.5 million.

The nonresident deduction shrinks in proportion to your Washington share. The throwout raises that share. Both point the same way.

(Simplified. Washington base income is computed with modifications we're ignoring here. The deduction is indexed starting in 2029 under § 316.)

The harder question: who must be "not taxable," and where?

The throwout has a second trigger. A receipt also comes out of the denominator if "the taxpayer is not taxable in a state to which a receipt is assigned."

Section 405(10)(f): "'Taxpayer' means a pass-through entity or individual conducting business activity in the state of Washington."

The statute doesn't say whose taxability counts for a pass-through: the entity's or the owner's.

The act also doesn't define "taxable" for this purpose. Traditional UDITPA-style statutes say a taxpayer is taxable in another state if it's subject to a net income tax there, or if that state has jurisdiction to impose one, whether or not it does. ESSB 6346 doesn't include that definition.

That matters for Nevada, which has no personal income tax. If "not taxable" means "not actually subject to an income tax there," the owner's Nevada receipts could be thrown out too. In the example that would push the Washington factor well above 33⅓%. If it means "the state could tax you if it chose to," Nevada receipts likely stay in.

We don't know which reading DOR or a court will adopt. We'd treat the Nevada question as open, not as a planning assumption either way.

The escape hatch is narrow

Section 405(4)(a) lets a taxpayer petition for (or DOR require) an alternative method if the standard rules "do not fairly represent the extent of the taxpayer's business activity in this state."

The burden is high. The party seeking the alternative "must prove by clear and convincing evidence" both that the standard rules don't fairly represent the business activity and "that the alternative to such provisions is reasonable." § 405(4)(c)(i).

That's not a planning tool. It's a dispute.

A drafting glitch

Section 405(3)(b)(i)(D)(II)(2) says contingent receipts from selling intangibles "must be treated as receipts from the rental, lease, or licensing of such intangible property under subsection (4)(a)(i) of this section."

Subsection (4)(a)(i) is "Separate accounting." The rental/lease/license rule is in (3)(b)(i)(D)(I). This appears to be an incorrect cross-reference. It does not affect the service-business example above.

What to do

• Map where your services are actually delivered. Write down why.
• Document your sourcing method and any reasonable approximation. Receipts whose destination still cannot be determined or reasonably approximated are excluded from the denominator.
• Know where you, and your entity, file and pay income tax.
• Run the § 315 deduction math. Sourced income isn't the tax.
• Model your Washington share under more than one reading.
• Watch for DOR rules or guidance on "taxable," "delivered to a location," and "operating within this state."
• If the result is badly out of line with your Washington activity, think about § 405(4) early. The evidence standard is high.

Open questions

• Is "not taxable" tested at the entity level or the owner level?
• Does "taxable" mean actually taxed, or subject to a state's jurisdiction to tax?
• What does "delivered to a location" mean for remote services?
• Will DOR adopt B&O-style service sourcing (RCW 82.04.462) by rule?
• When does a pass-through "operate" in Washington?

We'll update this post when DOR says something.

This post is general information, not legal or tax advice.