The 2021 Washington State Legislature enacted a new 7% excise tax on long-term capital gains, effective for sales or exchanges of capital assets on or after January 1, 2022. Although the tax is being challenged as an unconstitutional income tax under the state constitution, the Washington Supreme Court has allowed the tax to be enforced pending its decision. The first payments for the tax are due on or before April 18, 2023.
The Washington capital gains tax is imposed only on individuals – that is, natural persons – who are the legal or beneficial owners of long-term capital assets. An individual is considered a beneficial owner of an asset if the asset is owned by a passthrough entity, such as a partnership, limited liability company, or S corporation, or by an entity that is disregarded for federal tax purposes of which the individual is an owner to the extent of the individual’s ownership interest in the entity.
Calculating the Tax Base
Adjusted Capital Gains
The new tax is imposed on a taxpayer’s adjusted capital gains allocated to Washington less allowable deductions and exemptions. Adjusted capital gains start with a taxpayer’s federal net long-term capital gain for the tax year and are adjusted by (i) adding back long-term capital losses from sales or exchanges that are exempt or are not allocable to Washington, and (ii) subtracting long-term capital gains from sales or exchanges that are exempt or are not allocable to Washington.
Deductions and Exemptions
Several deductions are allowed against adjusted capital gains. For example, a standard deduction of $250,000 is provided per return or filer. As a result, an individual filing a separate return and married persons filing a joint return receive the same standard deduction. A taxpayer’s federal filing dictates whether the Washington capital gains tax filing is separate or joint. There is also a deduction for sales of qualified family-owned small businesses and charitable donations in excess of $250,000 (but the deduction is limited to $100,000). Other exemptions include those for sales of real estate and long-term capital gains and losses from capital assets held in IRAs, 401(k) plans, and other retirement plans.
Allocating Capital Gains and Losses
Long-term capital gains and losses from the sale or exchange of intangibles are allocated to Washington if the taxpayer was domiciled in Washington at the time of the sale or exchange.
Long-term capital gains and losses from the sale or exchange of tangible personal property are allocated to Washington if the property is in the state. In addition, gain or loss from the sale or exchange of tangible personal property is allocated to the state if: (i) the property was in Washington at any time during the tax year in which the sale or exchange occurred, (ii) the taxpayer was a Washington resident at the time of the sale or exchange, and (iii) the taxpayer was “not subject to the payment of an income tax or excise tax legally imposed” by another jurisdiction on the long-term capital gain or loss. “Jurisdiction” is defined to include not only U.S. states, political subdivisions, territories, and possessions but also foreign countries and political subdivisions of foreign countries.
Tax Credits Available
A tax credit is allowed against the new Washington tax for an income or excise tax legally imposed by another jurisdiction on capital gains “derived from capital assets within the other taxing jurisdiction to the extent such capital gains are included in the taxpayer’s Washington capital gains.”
Further, any Washington capital gains tax qualifies as a credit against the Washington business and occupation (B&O) tax if the B&O tax also applies to the gain from a transaction subject to capital gains tax.
A Washington capital gains tax return is required only if tax is owed, and it must be filed on or before the due date of the individual’s federal income tax return, including extensions. However, payment of the tax is required by the original due date of the individual’s federal income tax return, not including extensions. Filing returns and making payments must be done electronically via the Washington Department of Revenue’s “MyDOR” portal.
• In 2021, the Superior Court of Douglas County, Washington, ruled in Quinn v. State of Washington that the capital gains tax is unconstitutional and invalid under the Washington Constitution. That decision is on appeal before the Washington Supreme Court, which also issued an order allowing the tax to be enforced. Thus, unless the Washington Supreme Court upholds the lower court’s decision before April 18, 2023, taxpayers that owe Washington capital gains tax must make payment on or before that date (no extension allowed) and either file returns by then or apply for a six-month filing extension.
• While the tax will most likely impact Washington residents the most, it is important to understand that nonresidents could also be affected if capital gains from the sales or exchanges of their tangible personal property are allocated to Washington.
Written by Scott Smith. Copyright © 2023 BDO USA, LLP. All rights reserved. www.bdo.com