Seattle Payroll Expense Tax Upheld by State Appellate Court

This week, the Washington Court of Appeals affirmed a lower court's decision to dismiss a challenge to the recently enacted payroll expense tax in Seattle, WA. Seattle Metro. Chamber of Commerce v. City of Seattle, No. 82830-4-I, 2022 WL 2206828 (Wash. Ct. App. June 21, 2022).

The tax, which went into effect on January 1, 2021, applies to entities "engaging in business within Seattle" and is measured using the business's "payroll expense" (defined as "compensation paid in Seattle to employees," including wages, commissions, salaries, stock, grants, gifts, bonuses and stipends). The tax only applies to businesses with a payroll expense of more than $7 million in the prior calendar year, and compensation is considered "paid in Seattle" if the employee works more than 50% of the time in the city. Additionally, if the employee does not work in any city more than 50% of the time, the employee's compensation is treated as though it was "paid in Seattle" only "if the employee resides in Seattle."

Although the tax is based on employee compensation, the Washington Court of Appeals held that incidence of the tax is on the employer, not the employee. This was a critical distinction because, under Washington law, municipalities generally are prohibited from levying taxes directly on wages (e.g., an income tax). By finding that the tax incidence fell on the employers, the Court was able to define the tax as an excise tax on the employer's privilege of doing business in the city.

As expected, the tax is already bringing in significant revenue for Seattle. In its first year on the books, the tax brought in more than $230 million. Yet, despite this new revenue (as well as revenue from several other recently enacted taxes), Seattle is still projecting a financing gap of more than $100 million for 2022. Taxpayers are concerned that the city will explore even more revenue options to help close the gap.

The McDermott tax team is constantly monitoring tax developments on a state-by-state basis and will provide updates on the PNW specifically as they are made known.