Law Firms Face Additional Complexity in Sourcing Billable Hours

Understanding how to properly source billable hours for tax purposes is crucial for law firms, particularly due to the varying rules across different states. The Washington Court of Appeals has clarified that litigation receipts should be sourced to the venue of the case, while consultation services should be sourced to the client’s location. This nuanced distinction adds another layer of complexity for law firms, which must also contend with conflicting state sourcing rules and the potential for multiple state claims on the same billable hours.

On November 3, 2025, the Washington Court of Appeals issued its opinion in Betts Patterson & Mines, PS. v. State of Washington, Department of Revenue (No. 86756-3-I). Betts Patterson & Mines (“Betts”) is a law firm engaged in insurance defense litigation and coverage advice with offices in Washington and Oregon. Historically, Betts sourced all its receipts to Washington State under the state’s prior cost-of-performance sourcing rules. In 2010, Washington legislatively adopted market sourcing rules for service receipts. Pursuant to the legislative changes, service receipts are to be sourced to the “location where the customer received the benefit” of the service.

In 2014, Betts filed a refund claim for the 2010 through 2014 tax years, claiming its receipts should be sourced to the location of the insurance companies’ legal department (i.e., the location of the client engaging Betts). The Washington Department of Revenue disagreed with Betts’ sourcing methodology and determined that litigation receipts should be sourced to the venue of the matter. The Court largely affirmed the Department’s determination, holding litigation receipts should be sourced to the venue, while consultation services (not tied to a venue) would be sourced to the customer’s location.

This creates additional complexities for law firms, as the applicable sourcing rule may depend on the type of matter. Furthermore, a matter may evolve from consultation to litigation or vice versa. Determining when a matter shifts from one type of service to another is not always clear cut.

While Washington has created additional complexity for how law firms define the market for sourcing their services, every state imposes its own rules. Some states retain cost-of-performance sourcing for service receipts, so work will be sourced to where the work is physically performed. Other states will define the market for all service receipts to where the customer is located. The conflict between state sourcing rules creates the potential for the same service receipt to be sourced to multiple jurisdictions.

For example, the fictional law firm of Dewey, Cheatum, and Howe LLP is engaged in insurance defense litigation. Dewey’s sole office is in New York and its attorneys work from the office, except when required to appear in Court. A Connecticut-based insurance company engages Dewey to litigate a matter in Seattle. 99% of Dewey’s billable hours on this matter are performed at Dewey’s New York office and 1% of the billable hours occur on the Courthouse steps, where the matter is settled. Connecticut presumes that service receipts are sourced to the billing location of the customer. New York uses cost-of-performance sourcing for partnerships and LLCs. In this instance:

However, if we change the type of matter to insurance coverage consultation related to a Washington claim, none of those billable hours would be sourced to Washington (although the receipt would still be sourced to both New York and Connecticut under those states’ respective rules).

In conclusion, law firms will need to analyze multiple factors to determine how to source their receipts, including (but not limited to) venue, client location, matter type, and physical work location.