In 2021, the Washington state legislature approved a new 7% capital gains tax on long-term assets. A lawsuit was soon filed, and the tax has now been deemed constitutional and valid after the Washington State Supreme Court ruled to reverse a lower court’s decision. Washington is one of only a handful of states that has no individual or corporate income tax, and it also limits its property tax to 1%, so it heavily relies on sales taxes to fund its public obligations.
The Controversial Decision
In Quinn versus the State of Washington, the plaintiffs argued that the new 7% capital gains tax violated uniformity and levy limitations on property taxes restricted by the state’s Constitution. In the 7-2 decision, the Washington Supreme Court held that the lower Douglas County Superior Court did not address all the constitutional challenges brought by the plaintiffs and upon review, they reversed the decision that had characterized the new capital gains tax as a property tax.
In its defense, the State of Washington defined the capital gains tax as an excise tax, rather than a property or income tax. The Supreme Court ruling described their position, stating that “The capital gains tax is appropriately characterized as an excise because it is levied on the sale or exchange of capital assets, not on capital assets or gains themselves.” The distinction is important not only for the legality of assessing the tax in Washington, but also for it being contrary to all other states and the Internal Revenue Service (IRS) who interpret capital gains as income.
Balancing the Tax Burden
When the capital gains tax bill was approved in 2021, one of its main goals was to generate funds while concurrently addressing the disparity of the state tax burden on economically disadvantaged individuals compared with those of significant means. The Quinn vs Washington ruling notes their burden as being nearly six times that of wealthier residents.
Washington’s capital gains tax is on long-term gains—assets held over one year— and is structured to provide significant exemptions, deductions, and credits to relieve the tax liability for those with more modest levels of income. The Associated Press reported that the new capital gains tax is expected to be paid by 7,000 people and bring in a half-billion dollars per year. Opponents of the tax are concerned that the new tax will discourage investment in Washington state.
Washington’s Capital Gains Excise Tax
The new capital gains excise tax in Washington retains its original effective date of January 1, 2022, and is applied only to individuals. The tax is not assessed on businesses other than pass-through or disregarded entities. The capital gains tax has a standard $250,000 deduction for individuals, domestic partners, and married couples.
- Real estate, certain retirement accounts, livestock, timber, and commercial fishing privileges are exempt from the Washington capital gains tax.
- The sale of all—or substantially all—of a qualified family-owned small business may be deductible.
- Charitable donations in excess of $250,000 per year are deductible up to $100,000 per year per individual. The charitable donation deduction on capital gains is only available for charities directed or managed in Washington state.
- Credits may be taken for business and occupation tax on the same sale or exchange and for any legally imposed income or excise tax paid to another taxing jurisdiction.
- If an original installment sale took place before January 1, 2022, no capital gains tax is owed on any of the payments received.
- Electronic filing and electronic payments are expected, and penalties may be assessed if other methods are used.
Future Implications
Many states are reviewing their tax assessments and exploring ways to ease the tax burden on individuals with the least means. The solution Washington found may be seen as a precedent by other states who could adopt similar legislation. The Washington Supreme Court ruling that the excise tax on capital gains is constitutional and valid reopens the door for further scrutiny and is likely to face additional court battles in the near future.
REDW’s dedicated State and Local Tax (SALT) team will assess your individual situation and partner with you to minimize your tax liability and maintain compliance with integrity.
