As some of you may recall, the Washington state legislature had passed a 7% tax on capital gains on the sale of certain assets. This was to start January 1, 2022. Before it could take effect a trial court in Douglas County ruled that this was an invalid income tax in the state of Washington. In January of this year the Washington state Supreme Court heard arguments to sort this out. Last Friday they ruled that this tax is a valid excise tax. Let’s dig deeper.
The arguments were these: in striking down the tax, the Superior Court said that any tax based on net income reportable on your federal return is a tax on income, not a tax on the privilege of selling property. The state Supreme Court was unpersuaded and, in a 7–2 decision, ruled in favor of the State’s argument that the tax is imposed, “on the sale or exchange of capital assets, not on capital assets or the gains themselves”. Many of us are scratching our heads. The two dissenting justices are too, saying that this is an income tax.
Since the capital gains tax was ruled a valid excise tax and not an income tax it is retroactive to January 1, 2022, and any taxes on gains realized in 2022 are owed and need to be paid by April 18th, 2023 (subject to the same extension rules that apply to federal income taxes). The state estimates that about 7,000 Washingtonians will be subject to the tax in the first year, and the tax is expected to raise approximately $500 million per year, currently earmarked for childcare and education, but that is not set in stone.
The tax is imposed on individuals who have long-term capital gains exceeding $250,000, and the rate is 7% on the amount over $250,000 – the rate is zero on the first $250,000. This tax also applies to gains from pass-through entities. Gains from sales of real estate and assets in retirement accounts are exempt. Of course, some may recall that the Real Estate Excise Tax was increased quite a bit several years ago so sales of real estate should be exempted.
This tax, like we’ve seen with the State estate tax, may compel some taxpayers to redomicile to more tax friendly states. At the very least it will probably entice taxpayers to create sale strategies to spread the taxes out over many years, or possibly use charitable strategies to avoid the tax.
There are some exceptions and nuances to this law, and therefore we encourage clients to seek guidance from their tax advisors.
As Vice President and Senior Wealth Advisor, Greg provides financial analysis to high net worth individuals. He is the author of several articles for various publications and nonprofit organizations on estate and financial planning subjects.