New “Innovation Tax” Puts Tech Industry and Professional Service Firms at Risk

3/10/10

The challenge currently before our Governor and Legislature to balance the Washington state budget in the face of declining tax revenues is not an easy one. No one envies the task of either cutting needed state programs or raising new taxes—yet this year we are faced with the prospect of both.

In the past 24 hours, the state House of Representatives has passed a bill that will create a new tax on a whole range of innovative software companies that are at the center of our technology industry. Without any input from industry, the House passed a version of Senate Bill 6143 that includes a new tax on custom software development—a fundamental shift in tax policy that could lead to job losses, business closures and new taxes on other professional services.

There are over 2,500 custom software businesses in our state and most of these are small companies—and many are independent and freelance consultants. These companies and their employees already pay over $150 million in state and local taxes and are held up as the kind of innovation businesses we want to encourage in Washington.

Yet this new tax scheme does just the opposite of encourage. Among the many problems:

* A slippery slope. Custom software has traditionally been considered a “professional service,” similar to attorneys, engineers, management consultants and other similar professions. This tax is a major departure from that classification system and puts us on a slippery slope to tax other professional services.

* New burden on small business. Unlike sellers of digital goods, custom software providers are not set up to take payments from customers by credit card, do not have e-commerce systems, and converting to a sales tax collection system will be burdensome and costly—resulting in frustration and likely business closures.

* Putting economic development at risk. Large customers of custom software companies will surely seek to lower programming costs by going to offshore providers, which could lead to job loss among local custom software providers. Custom software providers may decide to locate themselves in a neighboring state or province, thereby avoiding the burden of being a tax collector for the state, and instead put the burden on the customer to pay use tax, where compliance is traditionally less than for sales tax.

* The language is ill-defined. The technology sector is ever-changing. Is a Web design firm considered a “custom software” provider? Does any service done for a particular customer that uses software to produce that service fall under this provision? Confusion will rein and both the Department of Revenue and taxpayers will have endless discussions and arguments over tax liability.

Again…the challenge before the Governor and our Legislators is not an easy one, but this new tax is not the answer. If you agree with us, then please contact your State Senator and tell them to reject the house version of Senate Bill 6143. To follow our fight, please visit our Government Affairs blog.

Ken Myer is currently an Interim Executive In Residence at the UW Center For Commercialization. He also serves on the board of FIRST. Follow @

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  • Mark Osborne

    Over the next 10 years, Boeing will move virtually all of its operations away from Washington to avoid strikes every three or four years. Microsoft will see its cash cows – Windows and Office – migrate to the cloud; it will be a much smaller company than it is today. And now the legislature is driving custom software developers to other states.

    Welcome to Washington – the new rust belt.

  • Ron L

    I am in the industry and very concerned. The article talks about what it may or may not do, can you quote the area of the law that supports the claims?