Summary: The rules and guidance for sourcing service revenue for income and gross receipts tax purposes can vary based on the state and the particular service, as illustrated by a recent Washington court decision addressing how the state’s rules should be applied to a law firm that provides insurance litigation and advisory services.
The Washington Court of Appeals’ recent decision in Betts Patterson & Mines, PS v. Washington Dept. of Revenue[1] provides key take-aways for taxpayers applying the apportionment rules for the state’s gross receipts tax – i.e., the Business & Occupation (B&O) tax. Notably, the court’s ruling provides guidance on:
- How a taxpayer that provides services should determine where their customer receives the benefit of the taxpayer’s service; and
- When it may become “commercially unreasonable” for a taxpayer to apply the general “benefit received” sourcing rule whereby other permitted sourcing methods, such as customer billing address, may be utilized.
A Closer Look at the Case: Service Sourcing for Legal Practices
The taxpayer, a law firm with offices in Washington and Oregon, offers insurance coverage advice and defense litigation services to insurance companies. The dispute in the case centered on how the taxpayer was required to apportion (or source) its gross income for B&O tax purposes with respect to the taxpayer’s revenue from its insurance litigation services. The applicable B&O tax sourcing rule for service providers requires a taxpayer to attribute its gross income to the state “where the customer received the benefit of the taxpayer’s service.”[2] For a customer that is a business, the benefit of service is generally treated as received “where the customer’s related business activities occur.”[3]
The law firm argued that the benefit of its insurance litigation services was received at the insurance companies’ legal department billing addresses, often outside of Washington. The basis of the taxpayer’s position was that the litigation results are communicated to these departments and that such communication was when the customer realized the benefit of the taxpayer’s litigation services. However, the Department of Revenue (Department) countered that the benefit of litigation services is received where the litigation occurs. In other words, if the litigation is filed with a Washington court, then the benefit of the litigation services is received in Washington.
Key Takeaways from the Court’s B&O Reasoning
Somewhat expectedly, the Court agreed with the Department, referencing previous decisions and emphasizing that the location where the customer receives the “helpful or useful effect” of the services is crucial. With respect to the litigation services, the court determined that the helpful and useful effect of those services was received by the law firm’s clients when the attorneys litigate a case in Washington on behalf of an insurance company, and that the benefit is realized at the disposition of the case. The benefit is not realized when the result of the litigation is communicated to the insurance company’s legal department.
Although it was not the focus of the case, the court did draw a contrast between the sourcing of taxpayer’s gross income from litigation services versus its gross income from providing advice to clients regarding insurance coverage. The court provided that the helpful and useful effect of those services is received at the location of a client’s legal department. Even if the advice concerns Washington-based policyholders, the sourcing of the legal advice would still be based on the location of the legal department.
Decoding Commercial Reasonableness and Alternative Sourcing Methods
The court also addressed the taxpayer’s claim that it was not commercially reasonable to track the jurisdiction of litigation for tax purposes. Washington’s relevant B&O regulation provides a cascading method for attributing receipts whereby if the taxpayer can reasonably determine where the benefit is received, the receipts must be attributed accordingly.[4] However, if it is not commercially reasonable to make that determination, a taxpayer may use an alternative method, such as attributing receipts to the customer billing address. The taxpayer submitted a declaration from its managing shareholder reflecting that it would be extremely time-consuming and resource intensive for the taxpayer to track the sourcing of its revenue based on where a litigation was filed. The court found the declaration insufficient and lacking specific details about the time and expense required to track litigation locations.
It’s important to note that the court emphasized that a client’s billing address was unrelated to where the litigation services are performed. The decision underscores that taxpayers must diligently analyze its specific services and attribute the receipts based on where the benefit of those services was received. For taxpayers applying the cascading sourcing rules, the court’s decision reflects that there is a reasonably high burden on the part of the taxpayer in a “commercially unreasonable” claim in order to avoid determining where the benefit of it services are received. The court’s reluctance to allow a taxpayer to use billing address as a default method highlights the need for a clear connection between the service and the location of its benefit.
Final Thoughts: Applying a “Benefit Received” Sourcing Rule
Many states now use a “benefit received” sourcing rule for both income and gross receipts taxes (like Washington’s B&O) or a rule that is very similar. These rules can vary to some extent, but the commonality is that they require taxpayers to determine the states to which their revenue is attributed based on the markets that they serve. The application of these rules can also vary depending on the nature of the services provided by the taxpayer. Therefore, it’s important for services providers with customers located in multiple states to assess whether the use of billing address is an unreasonable approach, especially when there is information available to them that is more representative of the location where customers receive the value of the service provided.
[1] Betts Patterson & Mines, PS v. Washington Department of Revenue, Wash. Ct. App., No. 86756-3-I, 11/3/2025
[2] RCW 82.04.462(b)(i); WAC 45820-19402(301)(a).
[3] WAC 45820-19402(303)(c).
[4] See WAC 45820-19402(301).
