The Washington Supreme Court recently issued an important decision upholding the state’s new capital gains tax. Two dissenting justices agreed with the trial court’s conclusion that the tax is unconstitutional based on 90 years of jurisprudence that rejected many prior efforts to adopt a full-fledged income tax.

The seven-justice majority declined the opportunity to overturn the Supreme Court's prior income tax cases. Instead, it upheld the capital gains tax on narrow grounds by agreeing with the Legislature’s characterization of the new tax as a valid excise tax rather than a tax on income. The excise tax characterization resolved the principal objection under the state constitution. The court also rejected a second argument under a different provision of the state constitution and a third argument under the federal constitution.

Washington is now the only state in the nation that taxes capital gains without a full income tax on a "sale." This adds to the state’s unique, and uniquely complicated, array of excise taxes.

The 2021 Legislature narrowly adopted the new 7% tax on the sale or exchange of certain long-term capital assets on or after January 1, 2022. The legislative intent was to fund education - the same is true of the Washington estate tax - lessening the tax burden of the poorest Washington residents.

What it means

• The tax had an effective date of January 1, 2022.
• The tax applies only to individuals, not businesses or nongrantor trusts, but taxable individuals may include beneficial owners of capital assets held by pass-through or disregarded entities.
• The tax allows certain exemptions, deductions and credits. Among these are exemptions for real estate and retirement accounts along with deductions for certain family-owned businesses and charitable donations.
• There is also a general deduction of $250,000. For example, if a Washington resident had a gain in 2022 of $260,000 on the sale of stocks, they would owe 7% on $10,000 ($700).
• To calculate the total amount owed, the taxpayer must identify their “Washington capital gains” using federal income tax reporting as a starting point. Then, adjustments are made for statutory exemptions, deductions and allocations to arrive at the taxable amount.
• Residency and domicile are important components of the new tax and will be particularly important for future planning purposes.
• The first payments are due from taxpayers on April 18, 2023. The return deadline may be extended by a federal income tax extension if confirmation of the federal extension is filed with the state before the original due date. However, the tax payment deadline may not be extended.
• Individuals subject to the new tax should act promptly to make online arrangements for timely electronic payment of the tax. Failure to make timely payment of the tax may trigger substantial penalties and interest.
• The Department of Revenue anticipates approximately 7,000 individuals will pay the tax for 2022 and projects the tax will generate nearly $2.5 billion over the next six years.

Taxpayers who want to avoid the Washington capital gains tax - and perhaps the Washington estate tax - may wish to consider moving to another state. Fox Rothschild attorneys have substantial experience in doing such planning.

Washington Gov. Jay Inslee argues that the tax “helps right an upside-down tax structure” that has low-income residents paying more of their income in taxes than the wealthiest residents do. Critics see the imposition of the tax as a slippery slope to a Washington state income tax. But absent a successful appeal to the United States Supreme Court on the issue under the federal constitution, the tax appears to be constitutional and here to stay.

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