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Washington State Capital Gains Tax

Washington Governor Jay Inslee signed ESSB 5096 into law on May 4, 2021, creating a 7% tax on the sale of long-term capital assets beginning January 1, 2022. The tax only applies to long term capital gains exceeding $250K annually and there are a number of assets exempt from the law. The $250K exemption amount does not increase for married couples filing jointly. 

Planning for this tax is a little tricky because it appears likely the law will be overturned either by courts or voters, but we probably won’t know that until November of 2022. First payments of this tax wouldn’t be due until April 15, 2023. 

What assets are subject to the tax?

Washington defines capital assets the same way as federal tax law does. Thus the sale of equities, fixed income securities, partnerships, business assets, and other capital assets held for at least one year are potentially subject to the tax. Note that the tax applies to individuals only. The bill was designed to avoid taxing capital assets that are physically located outside of the state of Washington. 

What assets are exempt from the tax?

The major exemptions to the law are real estate and qualified small family owned businesses. To be a qualifying family owned small business global revenues over the past year must be under $10M. The owner of the small business must have held their ownership interest for at least 5 years before the sale of the business and must have materially participated in the operation of the business in 5 out of the last 10 years.

Here’s the full list of exemptions from the tax:

  • Real estate.
  • Interests in a privately-held entity to the extent that the capital gain or loss from such sale or exchange is directly attributable to the real estate owned directly by such entity.
  • Assets held in certain retirement accounts.
  • Assets subject to condemnation, or sold or exchanged under imminent threat of condemnation.
  • Certain livestock related to farming or ranching.
  • Assets used in a trade or business to the extent those assets are depreciable under Title 26 U.S.C. Sec. 167(a)(1) of the internal revenue code or qualify for expensing under Title 26 U.S.C. Sec. 179 of the internal revenue code.
  • Timber, timberlands, and dividends and distributions from real estate investment trusts derived from gains from the sale or exchange of timber or timberlands.
  • Commercial fishing privileges.
  • Goodwill received from the sale of a franchised auto dealership.

There is also a deduction for charitable donations in excess of $250,000 per taxpayer. The charitable donations deduction cannot exceed $100,000 per year per taxpayer

Why is the tax unlikely to actually be implemented?

Washington State’s Constitution states that “All taxes shall be uniform upon the same class of property.” ‘Property’ includes everything subject to ownership and Washington State’s Supreme Court ruled in 1932 that income is considered property and therefore a graduated income tax violates the State’s Constitution. 

Multiple lawsuits have been filed challenging the new tax alleging that this new tax violates the uniformity clause of the State Constitution (amongst other things). Seattle attempted to institute an income tax on high earners in 2018 only to lose in court as it was deemed unconstitutional based on the uniformity clause. Thus if history and recent precedent is any guide it looks likely that the tax will face an uphill battle in court. 

There is also the possibility of a voter referendum on the tax. There have been ten votes on a state income tax since 1934, with all of them failing. Generally around ⅔ of votes have been against an income tax, with the most recent initiative in 2010 having 64% of voters saying no to an income tax. 

Scott Caufield, CFA, CPA