Washington Supreme Court Okays Collection Of New Capital Gains Tax

The Washington Supreme Court on November 30 issued a one-page order that stayed a lower-court ruling declaring the state’s capital gains tax unconstitutional. As a result of the order, the state’s revenue agency can move forward with collection of the tax. However, the stay does not resolve the questions regarding the tax’s constitutionality, and the Supreme Court is scheduled to hear arguments on that issue on January 26.

If the court ultimately determines that the tax is unconstitutional, any revenues collected would be refunded with interest, according to a statement from Department of Revenue Communications Manager Mikhail Carpenter. The first returns are due April 18, 2023, for gains recognized during 2022.

Judicial History
The Supreme Court’s ruling is the latest entry in the tax’s long procedural and judicial history. The law creating the tax –SB 5096 — was originally enacted in May 2021, when Governor Jay Inslee signed it into law. It imposes a 7% excise tax on the sale or exchange of capital assets above $250,000 by Washington state residents. Real estate gains, retirement accounts, and some sole-proprietor businesses are exempt from the tax.

Opponents of the new tax sued, and in March 2022 a lower court declared the tax unconstitutional, ruling that the capital gains tax was not a tax on property, but appeared to be closer to an income tax, which is unconstitutional in Washington state.

The tax also violated the state Constitution’s uniformity requirement “by imposing a 7% tax on an individual’s long-term capital gains exceeding $250,000 but imposing zero tax on capital gains below that $250,000 threshold,” Douglas County Superior Court Judge Brian Huber wrote.

The state immediately appealed Judge Huber’s decision to the Washington Supreme Court, and in early November, state Attorney General Bob Ferguson filed a motion to stay Judge Huber’s ruling.

At Issue
Opponents of the tax argue that it is illegal under the Washington state constitution, which strictly limits income taxes. Proponents counter that the tax is not an income tax at all, but an excise tax, which are legal in the state.

Thus, the central issue for the Supreme Court is whether the capital gains tax is an income tax or an excise or sales tax.

Insights
The tax is imposed on the long-term capital gains reported on the taxpayer’s federal income tax return. Taxpayers may want to consider whether tax-loss harvesting or realizing long-term losses from equity positions they no longer wish to hold is appropriate to reduce their 2022 long-term capital gains.

The Supreme Court’s ruling’s biggest impact is that it allows the state of Washington to move forward with implementation of the mechanism to file returns and collect the tax. The state has indicated that there will be an online system for taxpayers to report and pay the tax.

The state Supreme Court is scheduled to hear oral arguments on the case on January 26, so it is possible that a ruling on the tax’s constitutionality will be issued before the tax is due.