Over the weekend, the Washington State Legislature passed a bill that would enact a tax on gains from the sale or exchange of certain capital assets. The bill, which was signed into law by Governor Jay Inslee on April 27, 2021, imposes a 7% tax on the gain from the sale of stocks, bonds, and other capital assets in excess of $250,000 for individuals and married couples (regardless of whether they file joint or separate returns) to fund K-12 education, early learning, and child care beginning in tax year 2022. The tax is presented as an excise tax in part to avoid the long-standing precedent that Washington’s constitution prohibits a graduated income tax; however, it is expected that this new tax will be challenged in court in part as a prohibited income tax. Additionally, the legislation specifically includes language that the intent is to provide revenue for education, which is constitutionally mandated and may be exempt from a potential voter referendum to reject the tax.
In addition to the $250,000 capital gain threshold, numerous other exemptions and deductions may reduce a taxpayer’s capital gains tax liability. There are significant issues related to how these will apply that are expected to be addressed by the Washington Department of Revenue (“DOR”) in its rule-making capacity. The bill exempts the sale or exchange of certain assets from the tax above, including:
- All real estate transferred by deed, real estate contract, judgement, or other lawful instruments that transfer title to real property and is filed as a public record with the counties where the real property is located;
- An interest in a privately held entity only to the extent that any long-term capital gain or loss from such sale or exchange is directly attributable to the real estate owned directly by such entity;
- Assets held under a retirement savings account under section 401(k) of the Internal Revenue Code (“Code”), a tax-sheltered annuity or custodial accounted described under section 403(b) of the Code, a deferred compensation plan under section 457(b) of the Code, an individual retirement account or annuity under section 408 of the Code, a Roth individual retirement account under section 408A of the Code, an employee defined contribution program, an employee defined benefit plan, or a similar retirement savings vehicle;
- Assets pursuant to, or under imminent threat of, condemnation proceedings by the United States, the state of Washington or any of its political subdivisions, or a municipal corporation;
- Cattle, horses, or breeding livestock if, for the tax year of the sale or exchange, more than 50% of the taxpayer’s gross income for the tax year, including from the sale or exchange of capital assets, is from farming or ranching;
- Property depreciable under section 167(a)(1) of the Code, or property that qualifies for expensing under section 179 of the Code;
- Timber, timberland, or the receipt of Washington capital gains as dividends and distributions from real estate investment trusts derived from gains from the sale or exchange of timber and timberland;
- Commercial fishing privileges; and
- Goodwill received from the sale of an auto dealership licensed under Chapter 46.70 of the Revised Code of Washington whose activities are subject to Chapter 46.96 of the Revised Code of Washington.
In addition to the $250,000 threshold exemption noted above, in computing a taxpayer’s Washington capital gains amount, a taxpayer may also deduct the amount of adjusted capital gain derived from the sale, or the transfer, of the assets of substantially all (i.e., 90%) of a taxpayer’s interest in a qualified family-owned small business, to the extent that such adjusted capital gain would otherwise be included in the taxpayer’s Washington capital gains. For such purposes, a “qualified family-owned small business” means a business in which: (1) the taxpayer held a qualifying interest for at least 5 years immediately preceding the sale or transfer; (2) the taxpayer, or members of the taxpayer’s family, materially participated in operating the business for at least 5 of the last 10 years (unless such sale or transfer was to a qualified heir); and (3) the business had a worldwide gross revenue of $10,000,000 or less in the 12-month period immediately preceding the sale or transfer at issue.
Finally, a taxpayer may deduct another $100,000 from the taxpayer’s Washington capital gains amount if the taxpayer made at least $250,000 in contributions to a charity directed or managed in Washington during the same tax year.
B. Filing Requirements, Required Payments, Penalties, and Criminal Actions.
- Filing Requirements.
Taxpayers who will owe capital gains tax under this new bill must file a return with the DOR on or before the date the taxpayer’s federal income tax return is due for each tax year. Such returns must be filed electronically using the DOR’s online tax filing service or other method of electronic reporting as the DOR may authorize. The DOR, however, may waive the electronic filing requirement for good cause as provided in RCW 82.32.080.
- Required Payments.
A taxpayer required to file a return under the new bill must, without assessment, notice, or demand, remit any tax due to the DOR on or before the date fixed for the filing of the return, regardless of any filing extension. Such payment must be made via electronic funds transfers as defined in RCW 82.32.085 or by the other forms of electronic payment required by the DOR. The DOR, however, may waive the electronic payment requirement for good cause as provided in Chapter 82.32 of the Revised Code of Washington.
- Interest and Penalties.
Failure to pay the tax due under the new bill will subject the taxpayer to interest and penalties as provided in Chapter 82.32 of the Revised Code of Washington. In addition, failure to file a return under the new bill will subject the taxpayer to a penalty of 5% of the tax due for each month or portion of a month that the return remains unfiled (not to exceed 25%). The DOR may waive or cancel the latter penalty, however, if: (1) the DOR is persuaded that the taxpayer’s failure to file the return was due to circumstances beyond the taxpayer’s control; or (2) the taxpayer has not been delinquent in filing any return due under such section of the new bill during the preceding five calendar years.
- Criminal Actions.
Any taxpayer who knowingly attempts to evade payment of this new tax is guilty of a Class C felony as provided in Chapter 9A.20 of the Revised Code of Washington. Moreover, any taxpayer who knowingly fails to pay such tax, make returns, or supply information, as required under the new title, will be guilty of a gross misdemeanor as provided in Chapter 9A.20 of the Revised Code of Washington.
To avoid the double taxation of the same sale or exchange under the Washington Business and Occupation (“B&O”) tax regime, a credit is allowed against taxes due under the B&O tax regime if such sale or exchange is also subject to the new capital gains tax. The amount of the credit is equal to the amount of tax imposed under the B&O tax regime on such sale or exchange.
As we noted at the outset of this article, we anticipate there will be legal challenges to Washington’s new capital gains tax. Accordingly, we will continue to track any such legal challenges and whether those challenges affect the information provided above, as well as future guidance on how the capital gains tax will be administered.