October 11, 2026

Introduction

Washington’s expansion of sales tax to custom software has made the classification of development contracts more consequential. Businesses now need to distinguish software purchased for their own use, development of a software master copy, and payments for intellectual-property rights. Similar programming work can produce different tax results depending on what the customer is purchasing.

Background

Before October 1, 2025, custom software and customization of prewritten software generally fell under service and other activities B&O tax. ESSB 5814 changed that treatment: these transactions generally became subject to retailing B&O tax and retail sales tax. DOR’s 2025 guidance expressly acknowledges that the existing administrative rule does not yet reflect those changes. Custom-software IGS, “Background and relevant law” and tax-treatment section.

Recent Master Copy Guidance (October 7, 2026)

The Department has recently provided guidance on the taxation of programming services with respect to “master copies of software.” The DOR’s recent guidance reiterates that RCW 82.04.215(2) expressly “excludes retained rights in software and master copies of software” from the defined term computer software.

Thus, the guidance states that a “master copy” is not classified as either prewritten or custom software. A master copy is the copy from which a developer, publisher, or other qualifying party produces copies for sale or license. So, essentially, a master copy is a set of coded instructions intended for making copies for sale or license.

Owning source code does not, by itself, establish that a business owns a qualifying master copy. The statutory definition turns on how the copy is used.

Classification and Reporting

DOR’s October 7, 2026 master-copy guidance provides a reporting framework: qualifying development generally receives service B&O treatment, while compensation for the use of intangibles receives royalties B&O treatment. Its examples illustrate the distinction:

• Example 1: Patch improves Supernova’s master copy, and Supernova owns the finished work. DOR calls the development “the sale of a professional service.” Master-copy IGS, Example 1.
• Example 2: Techtonic separately pays $100,000 for master-copy development and $50,000 for prewritten software. The developer retains no rights in the new code. Development receives service B&O treatment; the separate software purchase receives retailing B&O and sales-tax treatment when sourced to Washington. Master-copy IGS, Example 2.
• Example 3: FoMo Bugs licenses proprietary code into Upside Download’s master copy. The code is not prewritten software, and payment compensates copyright use. DOR identifies “gross income from royalties.” Master-copy IGS, Example 3.

Questions to Consider

Businesses reviewing development contracts to determine the proper tax classification may consider the following questions:

• Is the customer purchasing custom programming for its own internal use or for work on a qualifying master copy?
• Does the payment buy development services, rights to use intellectual property, or separate prewritten software products?
• Do the contract, deliverables, and actual use support that characterization?
• Does a work-for-hire provision address all code, or does the developer reserve existing components?

Contact

For more information or assistance, please contact John Katsandres, Ashley Smith, or Caleb Allen at KOM Consulting. Our team can help you better understand the impact of this guidance on your business operations and tax reporting obligations.