New Capital Gains Tax To Go Into Effect in Washington
Starting January 1, 2022, the State of Washington will impose a seven percent tax on money earned from the sale or exchange of long-term capital assets, otherwise known as “capital gains.” As described below, Lane Powell has filed a lawsuit seeking to invalidate this tax as unconstitutional on behalf of its clients. We cannot predict with certainty how long it will take for the courts to reach a final decision, so it is best to plan now.
What is Being Taxed?
Money earned from the sale or exchange of tangible and intangible capital assets held for more than one year, such as stocks, bonds, businesses, and other investments. Certain capital gains are exempt, including gains derived from real estate, certain retirement plans, livestock used in farming or ranching, timber, depreciable property used in a trade or business, goodwill in sales of auto dealerships, etc.
Long-term capital gains derived from tangible capital assets (e.g., physical property) will be taxed by Washington if either (1) the property was located in this state at the time of sale or exchange; or (2) the property was located in Washington at some time during the taxable year, the taxpayer was a resident of Washington at the time of the sale or exchange, and the taxpayer is not otherwise subject to the payment of an income or excise tax on the long-term capital gains or losses by another state.
Long-term capital gains derived from intangible personal property (e.g., stocks, bonds, goodwill) will be taxed by Washington if the taxpayer was domiciled in Washington at the time the sale or exchange occurred.
Who Will Have to Pay?
The capital gains tax will be paid by individuals, including Washington residents and others who sell tangible assets that are located in the state. Individuals who own certain pass-through entities, such as LLCs, S corporations, partnerships, and grantor trusts, will also be taxed on any sales or transfers made by the pass-through entity.
How is the Tax Calculated?
Washington is using the net long-term gains reported on an individual’s federal income taxes as the starting point for calculating what amounts will be taxed at seven percent. The amount is then adjusted for certain losses, exempt property, and sales/transfers of capital assets that are not allocated to Washington. Certain deductions are allowed: (1) a standard deduction of $250,000 per individual, or a total of $250,000 for spouses or domestic partners; (2) a deduction for capital gains derived from the sale or transfer of certain family-owned small businesses; and (3) a $100,000 deduction for charitable donations over $250,000 made to Washington-based nonprofit organizations. A credit is allowed for any income or excise tax paid to another jurisdiction on the capital gains so long as it does not exceed the total amount of Washington capital gains tax due.
Taxpayers owing the capital gains tax will need to file a tax return with the Washington Department of Revenue by the date their federal income tax return is due. Along with the Washington tax return, taxpayers must provide the Department their federal income tax returns, all federal schedules, and supporting documentation. Thus the first filings will be due in 2023.
Is This Really Happening?
We have filed a lawsuit challenging the legality of the capital gains tax in Douglas County Superior Court on behalf of our clients. The lawsuit argues that the capital gains tax violates the Commerce Clause of the U.S. Constitution. The lawsuit also argues that the capital gains tax is a tax on income, which is prohibited by the Washington State Constitution. The trial court recently rejected the state’s efforts to have the case dismissed as premature because no tax is due yet or paid. The case will now proceed to the merits of the invalidity of the tax, with a trial court decision expected in early 2022. Regardless of who prevails before the trial court, we expect the losing side will appeal.
If you would like to know more about the Washington capital gains tax, how it might affect your business or personal planning, or how you can help support the challenge, please contact one of our tax partners: Scott Edwards, edwards@lanepowell.com, 206-223-7010, or Callie Castillo, castilloc@lanepowell.com, 206-223-7145.