The Washington State Legislature has passed Engrossed Substitute Senate Bill (ESSB) 5814, which introduces significant changes to the state’s sales tax laws. These changes, which will take effect on October 1, 2025, are aimed at modernizing the tax code. It is important for all business owners to understand how these new rules may impact their operations.
This article provides a summary of the key changes based on interim guidance from the Washington Department of Revenue.
Digital Automated Services (DAS) and the Definition of a “Retail Sale”
ESSB 5814 broadens the scope of services subject to retail sales tax and the retailing Business and Occupation (B&O) tax. Here are the key takeaways:
- Data Processing is Now a Retail Service: Services such as data processing will now be considered a retail service and will be subject to retail sales tax.
- Expanded Taxation of Digital Services: Previously, certain digital services were exempt from sales tax. This law removes those exemptions. Now, services such as digital advertising, data processing, live-streamed presentations, and services that involve significant human effort are all considered taxable retail sales.
- New Exclusion for Telehealth: A new DAS exclusion has been created for telehealth and telemedicine services.
- Affiliate Sales Exclusion: Certain sales between members of an affiliated group are now excluded from the definition of a retail sale.
- Clarification on Professional Services: The legislature has clarified that professional services will not become taxable simply because they are delivered electronically. The Department of Revenue has provided a framework to distinguish between professional services subject to the service and other B&O tax and taxable DAS.
- Sourcing DAS Sales: The new law outlines a clear hierarchy for determining the location of a DAS sale for tax purposes.
New Tax Treatment for Custom Software
The new law also changes how custom software is taxed. Here’s what you need to know:
- Custom Software as a Retail Sale: The sale of “custom software” and the “customization of prewritten software” will now be considered a retail sale. This means these sales will be subject to both retailing B&O tax and retail sales tax.
- Previous Tax Classification: Previously, these sales were taxed under the service and other activities B&O tax classification.
- Key Definitions:
- Custom Software: Software created for a single person.
- Customization of Prewritten Computer Software: An alteration or modification of prewritten software for a specific person.
- Sourcing Custom Software Sales: The sale of custom software is generally taxed based on the location where the purchaser receives the service.
- Multiple Points of Use (MPU) Exemption: Businesses that license custom or customized software for use in multiple states may be eligible for the MPU exemption. This allows the purchaser to apportion and pay use tax directly to the Department of Revenue instead of paying retail sales tax at the time of purchase. However, the MPU exemption is not available for bundled transactions.
What This Means for Your Business
The changes introduced by ESSB 5814 are complex and could have a significant impact on your business’s tax obligations. It is crucial to review your sales of services and software to determine how these new rules will affect you.
Please note that the information above is based on interim guidance from the Department of Revenue. The Department will be issuing final guidance in the future.
We encourage you to contact us to discuss your specific situation and ensure you are prepared for these changes when they take effect on October 1, 2025.
