OVERVIEW

The amount of taxes due this year for many Washington state taxpayers just increased following a 7-2 decision from the Washington Supreme Court in which it reversed a lower court’s ruling and held that the state’s new capital gains tax is valid. Quinn v. State, No. 100769-8 (Wash. Supreme Ct. Mar. 24, 2023).

The primary issue was whether the state’s capital gains tax, which was enacted in 2021, should be classified as an “income tax” or an “excise tax.” Although the Internal Revenue Service and all 41 states that tax capital gains treat such gains as income and a tax on them as an income tax, the Evergreen State has its own rules when it comes to defining basic terminology for purposes of taxation. For example, the state’s Constitution defines the word “property” so broadly that the courts have interpreted that term to include income. Thus, any proposed “income tax” is subject to the same uniformity and levy requirements placed on the state’s property taxes.

In finding that the new capital gains tax is an excise tax, the Washington Supreme Court disregarded the actual language in the statute (which states that “[t]he tax applies when the Washington capital gains are recognized by the taxpayer in accordance with this chapter”) and instead focused on the sale or exchange of capital assets, not the gains themselves. In other words, the Court held that the taxable incident of the tax is the transaction, not the income.

The dissent points to this flaw in the majority’s reasoning and explains that since the capital gains tax is on net income, the number of underlying transactions is irrelevant. An individual with multiple transactions and no gain could escape the tax, while an individual that had just one transaction with a net income over $250,000 would have to pay. Thus, the dissent fairly argues that the realization of profit is the taxable incident, not the transfer itself.

Unfortunately, dissenting opinions carry little weight when determining the validity of the tax at issue in any given case. Individuals with capital gains over $250,000 are now subject to a 7% tax in Washington state and are required to file a capital gains tax return along with a copy of their federal income tax return for the same taxable year. For capital gains made in 2022, the return is due on April 18, 2023.

The capital gains tax only applies to gains allocated to Washington state, and there are several exemptions, deductions and credits available.

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