Washington State Supreme Court Upholds Capital Gains Tax

Washington State Supreme Court Upholds Capital Gains Tax

By Gabriel Neuman, GSBA Policy Counsel and Government Relations Manager

In 2021, Washington joined the 41 other states and the District of Columbia in taxing capital gains. On March 24, 2023, the Washington State Supreme Court upheld the constitutionality of the tax—a culmination of a decade of activism from groups throughout the state. Millions of students, from pre-school to technical college, will directly benefit from the extra $500 million per year raised by the tax. It will decrease the pressure on low and middle income families by only taxing the wealthiest among us—only 0.2% of Washington taxpayers will see enough profits to be eligible.

The new capital gains tax imposes a 7% tax on the sale or exchange of certain long-term capital assets beginning January 1, 2022. The capital gains tax was passed by a narrow one-vote majority in the state senate in April 2021 and was signed into law by Governor Inslee the following month. On March 24, 2023, the Washington State Supreme Court validated the legitimacy of the tax, holding that the capital gains tax is an excise tax under Washington law, so it Is not subject to the uniformity and levy requirements under Article VII of the state Constitution. The information included in this post was taken from the Supreme Court’s majority opinion in Quinn v. State:

Legislative Findings

In enacting the tax, the legislature mad specific findings that “it is the paramount duty of the state to amply provide every child in the state with an education” and that “high quality early learning and child care is critical to a child’s success in school and life.” The legislature also found that “Washington’s tax system today is the most regressive in the nation because it asks those making the least to pay the most as a percentage of their income.” Thus, the legislative objective of the capital gains tax is twofold: “to help meet the state’s paramount duty” to amply fund public education, while “making material progress toward rebalancing the state’s tax code.”

Revenue Allocation

All revenues from the capital gains tax are dedicated to public education in Washington. The first $500 million collected each year will be deposited into the education legacy trust account, which supports K-12 education, expands access to higher education, and provides funding for early learning and childcare programs. All annual revenue beyond $500 million will be deposited into the common school construction account, which funds the construction of facilities for common schools.

Exemptions and Deductions

The capital gains tax contains numerous exemptions and deductions implemented in order to exacerbate existing tax inequities. Covered are transactions involving real estate, retirement accounts, agriculture, certain family-owned businesses, and charitable donations. The tax only applies to individuals, not businesses, and it only applies to the sale or exchange of long-term capital assets, meaning the taxpayer must have held the asset for longer than a year. The legislature also included a standard deduction of $250,000, so the tax applies only to nonexempt long-term capital gains that exceed $250,000 beginning January 1, 2022. For example, if a person made $260,000 from selling stocks in 2022, they would owe the 7% tax on $10,000 of that amount, or $700.

Allocation Process

The legislature enacted an allocation process in order to avoid taxing capital gains attributed to another state. The statute allocates to Washington only those gains from the sale or exchange of tangible personal property located in-state and intangible property owned by individuals domiciled in-state. The law also identifies circumstances when tangible personal property located out-of-state at the time of sale is allocated to Washington, for example, if the owner is a WA resident at the time of sale. To further avoid the risk of taxation by multiple states, the statute offers a tax credit “equal to the amount of any legally imposed income or excise tax paid by the taxpayer to another taxing jurisdiction on capital gains derived from capital assets within the other taxing jurisdiction.”

Calculating Amount Owed

Taxpayers must identify their “Washington capital gains” using federal tax reporting as a starting point. Then, specific adjustments are made to account for statutory exemptions, deductions, and allocations before arriving at the Washington taxable amount. The first payments are due from taxpayers on April 18, 2023. The Department of Revenue anticipates approximately 7,000 individuals will pay the tax in its first year. Over its first six years, the tax is expected to generate nearly $2.5 billion in revenue.