Navigating Washington’s business and occupation tax tangle

Washington State’s current business and occupation (B&O) tax laws operate under a unique structure that can confuse even the most astute insurance agent or company. Harbored within this structure is the question of tax responsibility — who reports and who pays? Because B&O taxing laws differentiate based on employee status, getting acquainted with two important tests will help clarify the distinctions between company employees and independent contractors.

Unlike many states, Washington does not have a corporate or personal income tax. Instead, it imposes the B&O tax, calculated on the gross income from business activities. With respect to the insurance industry, every person engaging in business in Washington as an insurance agent, broker or solicitor is subject to B&O tax under the “insurance agent” B&O tax classification. In other words, the agent is treated as an independent contractor.

Receipts taxed under the “insurance agent” B&O tax classification include all gross income received as a result of the insurance agent’s licensed activities as an insurance agent. Other income may be subject to a different B&O tax classification and tax rate, depending on the nature of the activity. No deductions are allowed for commissions, fees, or salaries paid to other agents, brokers or solicitors, or any other cost of doing business.

Clearly, independent contractors can have a fairly heavy B&O tax obligation. On the other hand, if an agent is a company employee, he or she does not report B&O taxes on salary. The company, as the employer, must generally issue the employee a Form W-2 and file a Form W-4 on behalf of the employee. Because the responsibilities are different for the agent and company, it is important for both parties to understand whether the agent is an employee or an independent contractor.

Washington Administrative Code 458-20-164 (Rule 164) sets forth two tests for determining whether an agent is a company employee or an independent agent. One test applies to all insurance agents. The second test only applies to agents who sell life insurance or annuity contracts on a full-time basis.

All insurance agents
Section 3 of Rule 164 provides that insurance agents, brokers and solicitors are presumed to be in business for themselves and must report under the “insurance agent” B&O tax classification. Whether an agent is able to overcome that presumption and demonstrate that he or she is a company employee has been the subject of several Washington cases. Those cases have generally revolved around two criteria that must be met for the agent to qualify as an employee.

First, the insurance agent can have no direct interest in the profits or losses of the insurance business, including liability for maintaining a place of business and overhead.

Second, the insurance agent’s performance and details of work are managed by the insurance company, or the insurance agent is treated as an employee for federal income tax purposes as substantiated by Form W-4.

Meaningful factors in determining whether the above criteria are met include whether the agents rented their own office space, paid overhead costs, hired their own employees, or assumed personal liability for expenses and losses incurred in the operation of the office. Other factors include what restrictions the insurance company imposed on the activities and authority of the agents, and if the contract between the insurance company and the agent permitted the insurance company to restrict the agent’s activities.

For example, the company might impose restrictions such as production quotas, office location, meeting attendance, completion of company sales and industry-related courses, dealing only with a company-selected broker, detailed record keeping, dress codes, territorial restrictions, limitations on the types of policies offered to prospective clients, or restrictions on the types of clients solicited.

Life insurance agents
Section 4 of Rule 164 outlines the test for full-time life insurance agents. If the agent in question is a full-time life insurance salesperson, the person is considered an employee and not required to pay B&O tax on the money earned as such. However, to be an employee, certain criteria must be met. The agent must prove to be an employee for federal income tax purposes, usually by the receipt of Form W-2 indicating that the agent is a statutory employee of the company. Or, the person must meet all of the following four requirements that demonstrate that he or she is a full-time life insurance salesperson.

First, the agent’s principal business activity must be devoted to the solicitation of life insurance and/or annuity contracts, primarily for one insurance company. The agent’s principal business activity is the activity from which the agent generally receives the most income. All business activities are considered in determining the agent’s principal business activity.

Second, the contract between the agent and the primary life insurance company must provide that substantially all of the solicitation services are to be performed personally by the agent.

Third, the agent must not have a substantial investment in the facilities used in connection with the sale of life insurance or annuity contracts. Facilities include items such as office space, office equipment and secretarial services but do not include items typically furnished by employees, such as clothing or transportation.

Finally, the sale of life insurance by the agent must occur in the course of a continuing relationship with the primary life insurance company.

If the agent meets all of the above, he or she will likely be treated as a company employee and thus not be required to report B&O tax on the income received from the primary life insurance company. However, if the agents sell contracts on behalf of other companies, they may still be obligated to report B&O tax on that income.

Independent insurance agents and larger companies both benefit from understanding each other’s tax responsibilities. With Rule 164 in mind, both insurance agents in the state of Washington and insurance companies with agents operating in Washington should be better equipped to determine whether the agents are independent contractors or company employees for purposes of reporting B&O tax.

Navigating the labyrinth of Washington’s B&O tax rules is challenging, and specific concerns should be addressed by legal counsel. At a minimum, proactively clarifying the issues will reduce the risk of finding yourself unprepared for an audit.

Stephanie Anderson is an associate in the tax, trusts and estates practice at law firm Preston Gates & Ellis LLP. Phone: 206-370-6615. E-mail: stephaniea@prestongates. com.

Topics Carriers Agencies Profit Loss Washington Contractors