What’s a Tax Loophole?

Spoof book cover - tax evasion for dummies

When you and I sell our homes, we pay real estate excise tax.  So how come some businesses don’t pay it on multi-million-dollar transactions?  If we hire contractors to remodel our homes, those contractors must charge sales tax on their labor.  But some developers have figured out a way to avoid paying that tax on mega construction jobs.

Unfair?  You bet it is, and that is why I have sponsored a bill to close these and several other loopholes and challenge questionable shell corporations set up for no other apparent reason than to avoid paying the same taxes you and I routinely pay.

My proposal, part of all the revenue proposals, would recover an estimated $25 million a year in taxes that clever companies  avoid paying through  manipulation of the state tax code.

Minimizing tax liability may be a traditional American practice, but I am troubled by cases where the intent of the law is clearly being circumvented.  We need to preserve the integrity of our tax system by addressing these schemes.

Defeat the REET

An increasing number of businesses have figured out how to avoid paying real estate excise tax (REET) on controlling interest transfers of real estate.  Businesses frequently buy businesses that own real estate, and the law says the seller must pay tax on the value of the real estate when a “controlling interest” of the business is transferred within a 12-month period.  Enter the “stepped-transaction” scheme in which a company sells 49 percent of a company initially, but gives the buyer legal options to buy the rest at a later date, after the 12-month clock runs out.  The whole business eventually gets transferred, but no tax is paid.

Here’s an even more egregious example: A company sets up a Limited Liability Company (LLC), transfers real estate to that LLC, has the LLC sell the real estate to the third party, and then dissolves the LLC without paying REET.  The joke is on the Department of Revenue, because the law says the seller is responsible for paying the tax, but the seller (the LLC) no longer exists.

Yet another ploy is the contention made by some publicly-traded companies that the Department needs to go after shareholders, not the corporations themselves, for unpaid REET, making collection all but impossible.

Creative Contracting

The contractor-partner has emerged as another clever approach to escape sales tax that the state intended to be due on construction labor.  Rather than simply be paid to build a high-rise, contractors increasingly are entering into partnerships with developers.  The contractor is still doing contracting, but gets paid in non-taxable distributions rather than taxable contractor dollars.  The partnership is dissolved after the building is complete, and state and local governments get stung again.  This approach has been used in projects approaching $500 million in construction costs, which equates to $20 million of taxpayer money at risk.

Shame on Sham Transactions

Businesses often complain about the Business and Occupation tax, but most companies still pay their fair share.  However, some companies are taking matters into their own hands by creating out-of-state shell corporations to avoid most of it.

Millions of dollars in earnings are being moved to out-of-state affiliates and then returned to the original Washington business through nontaxable means such as dividends.  These out-of-state affiliates aren’t really engaged in business, and are structured solely to reduce a business’s Washington tax liability.  This is how the scheme works.   A Washington company creates a Nevada affiliate to supposedly provide services to its Washington customers.  The Nevada affiliate, which often consists of one employee and a post office box, contracts with the Washington company to provide those services on its behalf.   In one case, the Nevada affiliate charged the Washington customers $20 million for services performed by the 200 employees at the Washington company, but the Nevada affiliate paid the Washington company only $6,000 for that work.  The Washington company had only $6,000 in gross income subject to the B&O tax, with the rest of the $20 million flowing to the Washington company as tax-exempt dividends.

Corporate Shell Games

A more personal version of the out-of-state shell game involves purchases of vehicles and equipment that otherwise would be subject to sales and use tax.  An individual wanting to buy an expensive motorhome, for example, creates a Montana corporation that supposedly owns the vehicle even though it is parked in the owner’s Washington driveway. 

Economic Nexus Needed

Out-of-state banks, service providers, and franchisers make millions of dollars in profits on services to Washington customers, yet none pays a dime in taxes because they have no physical presence here.  We need to update our old physical nexus requirement to an economic one: simply put, if you do business here, you should pay the same taxes as your in-state competitors.  Most of the additional revenue generated by establishing an economic nexus standard would be paid by banks and credit card companies, but we’d also level the playing field for our in-state engineers, architects and other service providers, who now operate at a disadvantage to their out-of-state competition.  Proposed changes in apportioning income for businesses that operate in multiple states actually would reduce state taxes for many in-state businesses.

About the Author

Ross
I am the Director of the Department of Early Learning for Washington State. I formerly represented the 48th Legislative District in the State House of Representatives, chairing the Appropriations committee and spent many a year at Microsoft.

1 Comment on "What’s a Tax Loophole?"

  1. HB3176 directs the Department of Revenue to crack down on ‘abusive tax transactions’ like those in Nevada — except for a loophole that may provide Microsoft amnesty on its twelve year practice. The bill’s lead sponsor is Ross Hunter of Medina…

Comments are closed.