The failure of an initiative to repeal the state capital gains tax has emboldened three Seattle council members to float a Seattle city capital gains tax modeled on the state tax. As lawyers, we do not want to take a position on the wisdom of this policy; that is for voters and elected officials. However, we do want to explain why such an effort is not likely to survive the judicial review that will surely follow.
Seattle, unlike the state, does not have plenary taxing authority. Rather, as creatures of the state, Washington’s cities only have such taxing authority as is granted to them by the state legislature. We expect there to be much discussion about whether such a tax would be an income tax or excise tax. While that distinction was central to the Washington Supreme Court’s ruling upholding the validity of a statewide capital gains tax, either characterization poses serious challenges to Seattle’s authority to enact a local capital gains tax. First, following our successful challenge to Seattle’s effort to enact a city income tax, which resulted in the Court of Appeals striking the tax on constitutional rather than statutory grounds, the Legislature passed new legislation expressly prohibiting local income taxes. So, Seattle cannot legally enact a capital gains tax that constitutes an income tax. On the other hand, if the capital gains tax is championed as an excise tax, rather than an income tax, the Legislature has restricted cities’ authority to impose a tax on business activities to require a uniform method of taxation – city B&O taxes must generally conform to the state B&O tax structure. A capital gains tax, justified as an excise tax, would almost certainly violate statutory uniformity requirements. Thus, regardless of whether it constitutes an income tax or an excise tax, a Seattle capital gains tax likely exceeds the city’s statutory taxing authority and would be ripe for legal challenge.
Of course, if we are wrong and the courts find a way to uphold a Seattle capital gains tax, its value likely will prove short-lived. Those subject to the tax will find it easy to move a few miles to escape a tax they don’t want to pay, as Seattle lacks the authority to impose such a tax beyond its city limits.
For questions, solutions, and next steps, please contact any member of our Tax Team.