How income from royalties is taxed in the State of Washington.

Washington imposes the Business & Occupation (B&O) tax on the privilege or act of engaging in business activities in the state. The B&O tax is determined by applying the applicable tax rate against the gross income of the business. “Gross income of the business” includes royalty income. Royalty income is taxed at the “domicile,” or location, of the owner of the property. Businesses located in Washington receiving royalty income pay B&O tax on that income. However, businesses located outside Washington receiving royalty income do not owe B&O tax on that income and therefore do not pay tax on that income. For example, if a Washington owner of royalty generating property effectively transfers the property to a related company (e.g., parent and subsidiary corporations) located outside Washington, then the related company’s location will determine if the income is subject to Washington’s B&O tax. If the related company is legally domiciled outside Washington, then no B&O tax is due on the royalty income. Unlike many states that impose an income tax, Washington typically does not tax related companies as if they were a single entity; Washington law recognizes the separation between related companies. Recognizing legally distinct entities results in increased revenue to the State even when the companies are related because when related companies transact business with each other, Washington B&O tax is due on these transactions.

Why the Step-Transaction Doctrine is Inapplicable.
The step-transaction doctrine is a method used to determine taxability by disregarding one or more intervening transactions and viewing the entire transaction as a single taxable event. Based on the Washington Supreme Court case of Estep v. King County, 66 Wn.2d 76, (1965) the Department of Revenue cannot impose taxes based on the step-transaction theory.