Could Washington audit an active-nonreporting construction business and estimate tax when the business produced no adequate records?

Plain-English summary

The Washington Department of Revenue upheld an audit and estimated assessment against a residential construction business that was listed as active nonreporting but refused to provide requested records.

While auditing an affiliated business, the Department found a large transfer into the contractor's bank account, a loan document, and a bank-statement page showing substantial checks to construction-related payees. It also found four building permits and a real-estate listing identifying a home built by the contractor. That information gave the Department reason to examine the contractor's 2018–2021 activities.

Active-nonreporting status relieved a qualifying small business from routine returns; it did not make the business immune from audit. A business must notify the Department once it no longer meets the status requirements, including the income thresholds or absence of sales-tax duties. After the contractor repeatedly declined to provide federal returns, bank statements, reseller permits, or project records, RCW 82.32.100 allowed the Department to estimate liability.

Using the limited available evidence, audit classified the work as prime-contracting retail construction, estimated one project per year from four permits over four years, and used the known purchase-and-sale information from one property to estimate annual gross income. The determination found that method reasonable—and favorable to the taxpayer given the visible transaction volume—and upheld the tax, penalties, and interest.

What this means for you

Small businesses on nonreporting status

Monitor eligibility continuously. If income increases or the business must collect sales tax, notify the Department and resume filing from the first disqualifying period.

Contractors

Keep project contracts, invoices, permits, bank records, reseller permits, job-cost records, and evidence of property ownership. Those records determine whether work is taxable prime contracting or another activity.

Tax professionals handling audits

Refusing records rarely prevents an assessment; it shifts the process from actual figures to a reasonable estimate based on permits, listings, bank activity, and other third-party evidence. Supplying reliable records is the best route to challenge the amount.

Common questions

Q: Does active-nonreporting status prohibit a Department audit?

A: No. RCW 82.32.070 authorizes examination of every taxpayer's records, and active-nonreporting businesses remain active Washington businesses.

Q: When must a business leave active-nonreporting status?

A: It must notify the Department when it no longer satisfies the rule's conditions, including applicable income limits or the requirement that it not owe or collect retail sales tax or other covered taxes.

Q: Why could the Department estimate tax?

A: The taxpayer supplied virtually none of the requested records. RCW 82.32.100 permits the Department to obtain available facts and use the method it deems best to estimate tax when required returns or records are withheld.

Q: What supported the one-project-per-year estimate?

A: Four permits appeared over the four-year audit period, and one known property transaction supplied a basis for estimated gross income. The determination also noted substantial checks visible on a single bank-statement page.

Citations and references

• RCW 82.32.050, .070, and .100 (assessment authority, records, and estimates)
• RCW 82.32.045(5); WAC 458-20-101(3) (active-nonreporting status)
• RCW 82.04.050(2)(b), .250(1), and RCW 82.08.020 (prime-contracting sales and taxes)
• WAC 458-20-230 and -254 (assessment periods and recordkeeping)
• Mayer v. Sto Industries, Inc., 156 Wn.2d 677, 132 P.3d 115 (2006) (abuse-of-discretion standard)
• Det. No. 15-0350, 35 WTD 291 (2015) (reasonable estimated assessments)

Source

• Landing page: Washington Tax Decisions ZIP files
• Original PDF: 45WTD062.pdf
• Source archive: Volume 45 ZIP (member wtdvol45/45WTD062.pdf)

Original ruling text

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Cite as Det. No. 24-0003, 45 WTD 062 (2026)
BEFORE THE ADMINISTRATIVE REVIEW AND HEARINGS DIVISION
DEPARTMENT OF REVENUE
STATE OF WASHINGTON
In the Matter of the Petition for Correction of )
Assessment of
)
)
...
)
)
)

DETERMINATION
No. 24-0003
Registration No. . . .

[1]
WAC 458-20-230; RCW 82.32.050; RCW 82.32.070 – DEFICIENT TAX OR PENALTY PAYMENTS – RECORDS TO BE PRESERVED - If the Department obtains information from which it appears a person has not paid the amount of tax properly due, it is authorized to assess the additional amount of tax found to be due. This authority is generally held up to four years after the close of the tax year but may exist for up to seven years under certain circumstances.
[2]
WAC 458-20-254; RCW 82.32.070; RCW 82.32.100 – RECORDS TO BE PRESERVED – FAILURE TO FILE RETURNS OR PROVIDE RECORDS – It is a taxpayer’s responsibility to keep accurate and complete business records, file accurate returns, and pay taxes in a timely manner. Should a taxpayer fail to provide suitable records, the Department has the authority to estimate tax liability. Headnotes are provided as a convenience for the reader and are not in any way a part of the decision or in any way to be used in construing or interpreting this Determination. Adam R. Teal, T.R.O. – A business engaged in the custom construction and remodeling of residential real estate asks the Department to correct its assessment of taxes and penalties because, it argues, . . . the Department did not have the authority to audit it. The business also argues that the Department incorrectly estimated taxes after the business failed to produce adequate records to calculate an actual assessment. We deny the petition. 1 ISSUES

1. Whether, under RCW 82.32.050, RCW 82.32.070, and WAC 458-20-230, the Department
   has the authority to examine the records of a business in active non-reporting status and issue an assessment of taxes, within four years after the close of the calendar year in which the taxes were incurred?
2. Whether, under RCW 82.32.070, RCW 82.32.100, and WAC 458-20-254, the Department
   properly estimated its assessment of taxes, based upon the estimated construction of one 1

Identifying details regarding the taxpayer and the assessment have been redacted pursuant to RCW 82.32.410.

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residence per year, after the business failed to provide any of the business records requested for calculation of an actual tax assessment. FINDINGS OF FACT
. . . (Taxpayer) is a Washington business operated by sole proprietor [Owner] engaged in the custom construction and remodeling of residential real estate. Taxpayer’s owner . . . is also a governing member of an affiliated business, . . . (Affiliate). While reviewing the business activities of Affiliate, the Department’s Audit Division (Audit) identified a $ . . . transfer from Affiliate to another bank account on January 25, 2021. Audit identified the recipient account as Taxpayer’s. Audit looked into Taxpayer’s filing history and determined that Taxpayer was in “active nonreporting” status and had not reported any income during the periods of the Affiliate audit (January 1, 2018, through December 31, 2021). Audit asked Affiliate about the nature of the transfer, and any records related to it. In response, Affiliate provided a document dated December 28, 2020, which states that Taxpayer made a $ . . . loan to Affiliate “for 30 days at zero interest.” Affiliate also provided Audit a written statement from Owner dated July 15, 2022, that explains his relationship to both entities, stating in part, “I am authorized by operating agreement to perform transactions between accounts. I loaned my own business my own money.” Included with the written statement was a single page of checks written from Taxpayer’s account dated December 31, 2020. The page, listed as “Page 4 of 4”, showed seven checks written by Taxpayer from December 1, 2020, through December 28, 2020, totaling over $ . . . . Amongst the recipients were a paint supply store, a plumbing contractor, and Washington State’s Department of Labor and Industries. After receiving this information, Audit researched Taxpayer’s business. It discovered that Taxpayer had three building permits issued to it, in and around the Affiliate audit period. Those permits disclosed the [following] information about the construction projects: (1) December 2017

• “Residential – single family residence – new” at [Address 1]; (2) August 2018 - “Residential – .
  . .” at [Address 2]; and (3) October 2020 - “Residential – single family resident – remodel” at
  [Address3]. Audit also discovered that Taxpayer had a fourth permit issued in February 2022 for “Residential – single family residence – new” at [Address 4], and a real estate listing from 2020 for a residential home at [Address 5] that describes the property as a “Wheelchair accessible quality home by [Taxpayer].” Property deed records for the [Address 5] home showed that Owner purchased the property on August 21, 2019, for $ . . . , and sold it for $ . . . on November 30, 2020. On August 2, 2022, Audit issued a letter to Taxpayer to notify it that Audit would be conducting a review of its business activities from the period of January 1, 2018, through the current period (the Audit Period), to ensure proper excise tax reporting. Audit requested Taxpayer provide: Federal income tax returns, bank statements, any relevant reseller permits for wholesale sales, and a report listing Washington projects or contracts. On August 7, 2022, Taxpayer responded by stating it, “fully [understood] how the DOR has the authority to conduct audits and what documents they can look at”, but questioned Audit’s authority to audit affiliated businesses.

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Having not received any documents from Taxpayer, Audit contacted Taxpayer on September 7, 2022. Audit stated that it had not received any of the requested [records]. Audit explained that if it did not receive the requested records, it would be unable to calculate Taxpayer’s income and would need to estimate it. That same day, Taxpayer emailed a response to Audit. Taxpayer stated that it would be appealing the audit, because Taxpayer believed that an audit could not be performed on it since it had not filed any returns with the Department. On October 3, 2022, Audit emailed Taxpayer preliminary findings based on an estimate of Taxpayer’s income. Audit explained that it estimated the income because Taxpayer had not provided any of the requested information or records. Audit notified Taxpayer that the [audit] would be submitted for finalization unless Taxpayer provided the requested documentation by October 17, 2022. Later, on October 3, 2022, Taxpayer responded that it is in “non-filing status and IS NOT required to file a return” and argued that Audit’s “assumptions are inflated and erroneous based on guessing.” Taxpayer did not provide Audit with any additional information or records. On December 1, 2022, the Department issued Taxpayer its Audit Report with a $ . . . assessment, composed of $ . . . in taxes, $ . . . in penalties, and $ . . . in interest. Year

Estimated
Gross
Income

Retail Sales
Tax

2018
2019
2020
2021
Total

$...
$...
$...
$...
$...

$...
$...
$...
$...
$...

Retailing Delinquent Substantial
B&O Tax
Penalty
Under(29%)
payment
Penalty
(5%)
$...
$...
$...
$...
$...
$...
$...
$...
$...
$...
$...
$...
$...
$...
$...

Interest

Total

$...
$...
$...
$...
$ . . .2

$...
$...
$...
$...
$...

Since Audit did not receive any information or records, it estimated Taxpayer’s income based upon the limited information it did have: building permits and the real estate listing. First, Audit determined Taxpayer’s reporting classification. Based on the permits and real estate listing, Taxpayer appeared to perform construction services on properties owned by someone other than Taxpayer, as documentation showed only one instance in which Taxpayer had purchased, held title, or received financing, to purchase to any of the properties at issue. Thus, Taxpayer’s business activities generally met the definition of a prime contractor performing custom The numbers in this chart are reflective of the preliminary findings first issued to Taxpayer on October 3, 2022. Because interest continued to accrue after the preliminary findings, the amounts listed on the December 1, 2022, assessment were slightly higher. 2

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construction services, instead of a speculative builder, and Taxpayer’s reporting classification would be retail. Then, Audit estimated Taxpayer’s retail income from prime/custom construction services. To begin, Audit noted that during the four-year Audit Period, Taxpayer was issued four building permits and appeared to perform substantial work on another property (later listed for sale). The permits did not disclose the value of the construction services that Taxpayer provided, though three appeared to be for brand new residences/ADUs/garages . . . . The property listed for sale was purchased for $ . . . and sold fifteen months later for $ . . . . With the limited facts and information available, Audit estimated [Taxpayer’s] income based on if it had constructed and sold one home each year of the Audit Period. Then, Audit estimated the gross income from the construction of each such home at $ . . . per year. Audit assessed the according amounts of retail sales tax and retailing B&O tax for each period, as outlined in the chart above. Audit assessed a 29 percent delinquent payment penalty for each period that Taxpayer failed to properly report and pay its taxes. Audit also assessed a five percent substantial underpayment penalty for each period, because Taxpayer failed to pay 80 percent of its tax obligation for each such period. Finally, Audit assessed interest. On December 16, 2023, Taxpayer filed a timely petition with the Department’s Administrative Review and Hearings Division (ARHD). Taxpayer argues that the Department does not have the authority to audit businesses that are affiliated with other businesses that have been audited. Taxpayer also argues that because it was placed on active nonreporting status during the periods at issue, that it neither is required to file a tax return nor participate in audits. Finally, Taxpayer disputes the amounts assessed against it, stating that the amounts are not based on fact. Taxpayer asserts that if it had records, it would have provided them to Audit. On May 16, 2023, we conducted an informal hearing with Owner . . . . Owner reiterated his argument that the audit was invalid because Audit has not proven that he made any retail sales. As such, he argues that the audit is based on presumptions and not facts. Taxpayer stated that while the permit for [Address 2] was issued, he did not work on that property. When asked about the
[Address 3] property, he stated that he didn’t remember what that permit was for. He denied doing any work on the [Address 4] property. The [Address 1] property is where he currently lives. He argues that the [Address 5] property was built for him and his wife to live in but was forced to sell it due to medical reasons. ANALYSIS

1. Authority to Audit
   The Washington tax system is based largely on voluntary compliance. The Revenue Act imposes on taxpayers the responsibility to inform themselves about applicable tax laws, register with the Department, and accurately and timely pay taxes. Ch. 82.32A RCW. If the Department obtains information from which it appears a person has not paid the amount of tax properly due, RCW 82.32.050(1) authorizes the Department to assess against a taxpayer “such

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additional amount found to be due and shall add thereto interest” where “an examination of any returns or from other information obtained by the department shows that a tax or penalty had been paid less than properly due…” The Department may generally assess up to four years after the close of the tax year but may assess for up to seven years under certain circumstances. 3 RCW 82.32.050(4), WAC 458-20-230. Here, while in the course of auditing an affiliated business, the Department noticed that business had transferred $ . . . into Taxpayer’s bank account. When questioned about the transfer, Taxpayer told Audit that the money was repaying a loan that it had issued the affiliated business. When asked for supporting documentation, Taxpayer provided Audit only with a single page of a bank statement, which outlined that it paid over $ . . . in checks in one month. This additional information gave the Department reason to believe that Taxpayer had taxable income and had not paid the amount of tax properly due. Thus, on August 2, 2022, the Department notified Taxpayer that it intended to review its business activities from 2018 through 2022. Because the audit was completed within four years after the close of the tax year 2018, the Department acted within its statutory authority. RCW 82.32.050. Taxpayer argues that the Department does not have the authority to audit a taxpayer that is an affiliate of a business that is also subject to an audit. Taxpayer argues that because there is no rule or statute that specifically authorizes the Department to audit affiliated businesses, it cannot do so. We disagree. RCW 82.32.070 grants the Department the broad authority to audit “Every taxpayer,” regardless of whether they are an affiliate of another business. Taxpayer then argues that it is not subject to this broad authority because it was placed on “active nonreporting” status. RCW 82.32.045(5) and WAC 458-20-101(3) (Rule 101) allow the Department to relieve qualifying taxpayers from the requirement to file tax returns. Businesses assigned to this status are not required to file excise tax returns. Businesses retain their Unified Business Identifier (UBI number), and Department’s tax registration number, and are considered to be actively doing business in Washington. To qualify for the “active nonreporting” status, all of the following criteria must be met: (i) The person's value of products (RCW 82.04.050), gross proceeds of sales (RCW 82.04.070), or gross income of the business (RCW 82.04.080), from all business activities taxable under chapter 82.04 RCW (B&O tax), is less than $125,000; (ii) The person's gross income (RCW 82.16.010) from all business activities taxable under chapter 82.16 RCW (public utility tax) is less than $24,000 per year; and (iii) The person is not required to collect or pay to the department retail sales tax or any other tax or fee the department is authorized to collect. WAC 458-20-101(3)(a). Being placed on active nonreporting status is not a permanent designation, however. RCW 82.32A.030(2) requires taxpayers to “know their tax reporting obligations, and when they are uncertain about their obligation, seek instructions from the RCW 82.32.050(4) states that no assessment may be made by the department more than four years after the close of the tax year, “except (a) against a taxpayer who has not registered as required by this chapter, (b) upon a showing of fraud or of misrepresentation of a material fact by the taxpayer, or (c) where a taxpayer has executed a written waiver of such limitation.”

3

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department.” This includes the responsibility to know if they still qualify for active nonreporting status. If a Taxpayer no longer meets any of Rule 101’s criteria, it is their responsibility to notify the Department: Persons placed on an active nonreporting status by the department are required to timely notify the department if their business activities do not meet any of the conditions explained in (a) of this subsection. These persons will be removed from an active nonreporting status, and must file tax returns and remit appropriate taxes to the department, beginning with the first period in which they do not qualify for an active nonreporting status. WAC 458-20-101(3)(c) (emphasis added). Here, Taxpayer was placed on active nonreporting status prior to the Audit Period. Because Taxpayer was not filing tax returns with the Department, it was Taxpayer’s sole responsibility to notify the Department if it no longer qualified for that status. When Audit discovered Taxpayer had both deposited $ . . . into its bank account and written over $ . . . in checks over the course of two months, it had reason to believe that Taxpayer may be required to pay taxes to the Department. Thus, Audit initiated an examination of Taxpayer’s business activities. As discussed above, RCW 82.32.070 authorizes the examination of any taxpayer’s records, even those in active nonreporting status.

2. Assessed Amounts
   As discussed above, RCW 82.32A.030 details taxpayer rights and responsibilities and charges Taxpayers with the responsibility for keeping accurate and complete business records, filing accurate returns and paying taxes in a timely manner. RCW 82.32A.030(3)(4). RCW 82.32.070 expressly mandates taxpayers to provide adequate records to establish their correct tax liability. It reads, in part: Every taxpayer liable for any tax collected by the department must keep and preserve, for a period of five years, suitable records as may be necessary to determine the amount of any tax for which the taxpayer may be liable. Such records must include copies of all of the taxpayer's federal income tax and state tax returns and reports. All of the taxpayer's books, records, and invoices must be open for examination at any time by the department of revenue. . . . RCW 82.32.070(1). Should a taxpayer fail to provide suitable records, RCW 82.32.100 provides the Department with authority to estimate tax liability. RCW 82.32.100 reads, in pertinent part: (1) If any person fails or refuses to make any return or to make available for examination the records required by this chapter, the department shall proceed, in such manner as it may deem best, to obtain facts and information on which to base

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its estimate of the tax; and to this end the department may examine the records of any such person as provided in RCW 82.32.110. (Emphasis added.) RCW 82.32.100 affords the Department wide discretion in the methodology employed to calculate a reasonable estimate of tax. See Det. No. 15-0350, 35 WTD 291 (2015) (affirming the Department’s authority to assess taxes based on a reasonable estimate and citing Det. No. 14-0106, 33 WTD 402 (2014); Det. No. 13-0302R, 33 WTD 572 (2014); Det. No. 03-0279, 23 WTD (2004); and Det. No. 97-134R, 18 WTD 163 (1999)). An abuse of discretion occurs when a decision rests on untenable grounds or is manifestly unreasonable. Mayer v. Sto Indus., Inc., 156 Wn.2d 677, 684, 132 P.3d 115 (2006). Here, having correctly asserted its authority to examine Taxpayer’s records, Audit explicitly requested Taxpayer’s federal tax returns, banks statements, reseller permits, and other documents and information—records that Taxpayer was required to keep, preserve, and provide to the Department. RCW 82.32.070(1). Aside from the single page of a bank statement that had been provided as part of the audit of an affiliated business, Taxpayer did not provide any of the requested records or information. Audit determined that Taxpayer had not provided suitable records sufficient for calculating an actual assessment, and that Audit would have to estimate Taxpayer’s tax liability. RCW 82.32.070, RCW 82.32.100. To estimate Taxpayer’s tax liability, Audit attempted to obtain as much information as it could about Taxpayer’s business activities through a variety of available resources and discovered that building permits were issued to Taxpayer during the Audit Period and that Taxpayer’s construction work was noted in a real estate sale listing. Audit examined the building permits. It noted that aside from the [Address 5] property, Taxpayer did not appear to own the land where it performed the work, as Taxpayer had not purchased, held title, or received financing, for such land. Accordingly, Audit properly determined that Taxpayer performed construction services as a prime contractor. Prime contractors are subject to retail sales tax and retailing B&O tax, on retail sales of construction services, unless the sales are otherwise exempt from taxation. RCW 82.04.050(2)(b); RCW 82.08.020; RCW 82.04.250(1). To calculate an estimate of retail sales tax and retailing B&O tax, Audit estimated Taxpayer’s retail sales of construction services based upon the limited information available: building permits and real estate sale listing. Audit discovered that Taxpayer had been issued four building permits over the four-year Audit Period – an average of one per year. So, Audit decided to estimate the same amount of retail construction sales per year, for each year of the Audit Period. Notably, the building permits did not include the [Address 5] property, so Audit did not include it in determining the average number of sales per year. While none of the permits disclosed the value of the construction services, two of the permits appeared to be for new single family residence construction projects, and the other two were for a

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new garage/ADU and single-family residence remodel. The only available information that Audit could find regarding Taxpayer’s construction activities was the [Address 5]. property, which was purchased for $ . . . and then sold fifteen months later for $ . . . Audit used this limited information to estimate the gross income from that project to be $ . . . . With four permits being issued over the four-year Audit Period, Audit estimated Taxpayer’s income based on if it had constructed and sold one home each year and each such construction resulted in $ . . . in gross income from retail construction services. Then, Audit assessed the according amounts of retail sales tax, retailing B&O tax, delinquent penalties, substantial underpayment penalties, and interest, for each year over the Audit Period. Taxpayer disputes the estimated assessment and asserts it is inaccurate because it is based on presumptions and not facts. Taxpayer also asserts that there are no business records for the Department to review. As explained above, RCW 82.32.100 affords the Department wide discretion in the methodology employed to calculate a reasonable estimate of tax. See Det. No. 15-0350, 35 WTD 291 (2015) (affirming the Department’s authority to assess taxes based on a reasonable estimate and citing Det. No. 14-0106, 33 WTD 402 (2014); Det. No. 13-0302R, 33 WTD 572 (2014); Det. No. 030279, 23 WTD (2004); and Det. No. 97-134R, 18 WTD 163 (1999)). An abuse of discretion occurs when a decision rests on untenable grounds or is manifestly unreasonable. Mayer v. Sto Indus., Inc., 156 Wn.2d 677, 684, 132 P.3d 115 (2006). An estimated assessment is an assessment of last resort. The Department always attempts to calculate an actual assessment based on the facts in taxpayer’s books and records. Though, if a taxpayer fails to provide books and records, the Department will estimate an assessment based upon the limited facts available. Here, after Taxpayer declined to provide any business information or records, Audit used the very limited information available to calculate an estimate of Taxpayer’s income. Using the only available purchase and sale prices from one of Taxpayer’s projects, Audit estimated Taxpayer’s gross income per project to be $ . . . . We find this estimate to be reasonable, and in Taxpayer’s favor, because the calculated gain from the project is $ . . . ($ . . . sale price less $ . . . purchase price). Noting that there were four building permits issued over the four-year Audit Period, Audit assessed
[tax based on] the estimated per-project income of $ . . . for each year. Though more records and information would have been helpful in calculating an estimate, based on the very limited information available, we find this estimate to be reasonable. Especially considering that Taxpayer’s bank statement for one month was four pages long and one page had $ . . . of written checks. Though perhaps the volume of transactions that month was an outlier, when $ . . . is multiplied by 12, it produces $ . . . . This would indicate that Taxpayer had income of at least $ . .
. per year to cover those expenses. Further, the volume of transactions in the bank statement seems to indicate that Taxpayer was performing more than one construction job at a time – in other words, more than one job per year. Again, we find Audit’s estimate to be reasonable and in Taxpayer’s favor.

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Taxpayer also asserts that it does not have any records to provide Audit. That assertion was proven untrue when Taxpayer provided the single page of its bank statement from December 2020. That one page proved both that Taxpayer had records available, and that those records would likely indicate some business activity. Instead of providing any additional bank statements, Taxpayer continued to assert that it did not have to help Audit’s investigation. Thus, Audit proceeded to estimate Taxpayer’s tax based on the limited facts it had. Had Taxpayer provided any additional information, it may have had grounds to question the tax assessed against it. However, Taxpayer opted to not even provide so much as the additional three pages of the December 2020 bank statement. With no records provided, Audit proceeded in the manner it deemed best, estimating Taxpayer’s income and resulting tax based on the sale of one home per year. Accordingly, we deny the petition as to this issue. DECISION AND DISPOSITION Taxpayer's petition is denied. Dated this 4th day of January 2024.