On April 25, 2021, the Washington State Legislature passed Senate Bill 5096 (SB 5096). The bill was immediately sent to Governor's Inslee's desk for signature. It brings a new tax regime to the state of Washington.
Before we go into the details surrounding the new tax, I have to mention that it was challenged even before the governor had the opportunity to sign it into law. A group of potentially affected taxpayers filed a lawsuit in Douglas County, Washington, to strike down the new law as being unconstitutional. So, it is possible that SB 5096 will never breathe life.
Knowing that the new tax regime is under attack, it is still important to have a good understanding of it in the event it survives the battle.
Purpose: The purpose of the tax is to fund K-12 education in Washington.
Revenue: It is expected that the new law will raise $415 million or more in annual tax revenue.
Tax: The tax is 7 percent on the long-term capital gains derived from the voluntary sale or exchange of stocks, bonds and other capital assets in excess of $250,000 per year (subject to an inflationary adjustment). For this purpose, the new law defines "capital assets" by adopting the definition contained in Section 1221 of the Internal Revenue Code of 1986, as amended. Long-term capital gains means the sale or exchange of a long-term capital asset (a capital asset held more than one year).
Commencement Date: The new tax is to be effective on January 1, 2022.
Exceptions: The new law contains numerous exceptions. The tax does not apply to:
Obviously, several industries had good lobbyists. Real estate, farming, ranching, fishing and automobile dealerships will receive favorable treatment under the new law. Unfortunately, other industries are not so privileged.
Not so fast, buried in Section 8 of SB 5096 is an important carve-out. The "adjusted capital gain derived in the taxable year from the sale of substantially all of the fair market value of the assets of, or the transfer of substantially all of the taxpayer's interest in, a qualified family-owned small business" are not subject to the new tax. There are several components to this carve-out:
The new law provides a deduction of up to $100,000 from the taxpayer’s capital gains if the taxpayer made $250,000 or more in contributions to a charity directed or managed in Washington during the same tax year as the sale or exchange giving rise to the tax.
To avoid double taxation of a 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 tax. In such cases, the credit is the amount of B&O tax on the sale or exchange.
The new law comes with some compliance teeth. In addition to civil penalties and interest for noncompliance, it is a Class C felony to knowingly attempt to evade the tax. Also, it is a gross misdemeanor for knowingly failing to pay the tax, file returns or keep records or supply the taxing authority with information requested relative to the tax.
It is expected that Governor Inslee will sign the new tax regime into law. Whether it will survive the pending lawsuit is anyone's guess at this point in time.
One thing is for certain, Washington state lawmakers are eying opportunities to increase tax revenues to fund budgetary needs. For taxpayers considering moving to Washington to reduce their state and local tax burden arising from the sale or exchange of capital assets, they need to proceed with caution. Unless a planned taxable event will occur before 2022 (the anticipated effective date of the new law), these taxpayers may be moving into harm's way. Washington, the tax haven for Oregonians (and others) anticipating a significant capital gains event, may be no longer.
We will keep you advised as the controversy surrounding the new Washington capital gains tax regime evolves.