Washington State Supreme Court Issues Ruling on Capital Gains Tax

March 24, 2023 is a day that will go down in Washington State history, regardless of opinion, as the State Supreme Court issued it's long awaited ruling on the capital gains tax passed by the State Legislature in 2021 and subsequently challenged in court.

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Senate Bill 5096 (SB 5096) cleared the chamber by one vote, and established the collection of a capital gains tax in Washington State at the rate of 7%.  It defined capital gains as an excise tax and not an income tax and, when the Governor signed it into law, created the path the resulted in today's ruling.

What is a capital gains tax?

A capital gains tax is applied to the profit an investor makes after they sell said investment.  Capital gains is paid only after the investment is sold.  The most frequent example of capital gains is the buying and selling of stock.  If you buy $100 worth of stock and sell it for $400 you've 'realized' $300 in profit from the sale of that stock.  The tax is then assessed on the $300 of profit.  It is declared on your federal income tax return which is what made the State Legislature's classification an outlier.

Excise Tax vs Income Tax

The Washington State Constitution Article VII Section 1 declares property is "everything, whether tangible or intangible, subject to ownership.  That definition has been held by the court to define income as property.  The IRS, along with other U.S. States and territories, define capital gains as a tax on property.

An excise tax applies to specific goods and services, not property.  The marijuana tax is an example of an excise tax.  No sales tax is paid on the purchase of marijuana by the consumer, but a 37% excise tax is levied on the marijuana stores (which is passed on to the consumer).  The State Legislature categorized capital gains as excise.

The Washington State Supreme Court Ruling

In their 7-2 ruling today the Justices sided with the State in determining the capital gains tax was an excise tax and not an income tax.  In the ruling it determined that the tax was not levied on the property itself but on the sale or exchange of that property.  As a result, the Court determined it does not violate Article VII of the State Constitution because it is not subject to the requirements (not defined as property).

The Court refused to reexamine previous cases, like Culliton vs Chase in 1933,  that has been the long held reason why Washington State does not have a graduated income tax system.  There are some things that are exempted from the Capital Gains tax in Washington State.

What is Exempt Under the New Tax?

• all real estate
• assets held in a retirement account
• assets transferred as part of a condemnation proceeding
• livestock related to farming or ranching
• agricultural land that meets certain requirements
• certain types of property used in a trade or business such as machinery and equipment that have been immediately expensed
• capital assets acquired and used only for purposes of a trade or business of a sole
  proprietorship
• timber and timberlands
• goodwill received from the sale of a franchised auto dealership
• The first $250,000 of capital gains sales is also exempt from the tax

When Do I Need to Pay?

The first payment of tax on capital gains is due to the Department of Revenue on or before Federal tax day, April 18th.  It is possible opponents could challenge in federal court claiming a violation of the Dormant Federal Commerce Clause, but in their ruling the WSSC stated they did not feel the law violated the Federal law.

The burning question is does this ruling open the door for the Legislature to pass a graduated income tax in hoped of the State Supreme Court again ruling in their favor?