Washington Supreme Court Upholds Capital Gains Tax

Mar 27, 2023   Print PDF

By Steven D. Matyas | Related Practice: Estate Planning & Administration

On Friday, the Washington Supreme Court ruled in Quinn v. State of Washington, that the state’s new capital gains tax is constitutional, allowing the law to go into effect nearly two years after its passage.

In 2021, the state enacted a 7% tax on long-term capital gains realized by Washington residents on or after January 1, 2022, with the first tax payments due in April 2023. The tax applies only to individuals, not to business entities. However, the tax does apply to long-term capital gains earned by pass-through or disregarded entities such as S-Corporations, limited liability companies, partnerships, and grantor trusts.

Gains from the sale of intangible property (e.g., stocks, bonds, business interests) wherever located are subject to the tax if the seller is domiciled in Washington, and gains from the sale of tangible personal property located in Washington are subject to the tax regardless of the seller’s domicile. There is a standard deduction of $250,000, so only gains in excess of that amount are subject to the tax each year. In addition, there are a number of exemptions from the tax, notably gains resulting from the sale of real estate (including gains passed through an entity if the gain is directly attributable to the real estate sold by the entity), gains realized within retirement accounts, gains from the sale of timber or timberland, gains from commercial fishing privileges, and gains from cattle, horses or breeding livestock provided more than half of the taxpayer’s gross income is derived from farming or ranching.

The tax was initially found to be an unconstitutional property tax by a Douglas County Superior Court judge in March of 2022, immediately halting any collection of the tax. However, in late 2022, the Supreme Court allowed the state to begin collecting the tax while the Court considered the case.

The key question before the Court was whether the tax is an income tax, which must be imposed uniformly and may not exceed 1% per Washington’s constitution, or an excise tax, which is not subject to the same limitations. In upholding the tax, the Court stated “the capital gains tax is appropriately characterized as an excise because it is levied on the sale or exchange of capital assets, not on capital assets or gains themselves,” and found the tax to be “consistent with a long line of precedent recognizing excise taxes as those levied on the exercise of rights associated with property ownership, such as the power to sell or exchange property, in contrast to property taxes levied on property itself.”

It is estimated that nearly 7,000 households in Washington will be affected by the tax, roughly two-thirds of which are located in King County, and sponsors expect the tax to generate approximately $500 million per year in revenue. We expect the Department of Revenue to issue additional regulations surrounding the tax to clarify how it interplays with federal taxes.

With the tax in effect, it is important for taxpayers to understand the application of the tax on their transactions; the considerations may differ depending on the property to be sold or exchanged and the individuals or entities involved, among other factors. Consulting with competent tax and legal advisors remains crucial to an effective estate and tax planning strategy.

To learn more, please contact a member of the Stokes Lawrence Business or Estate Planning Group at (206) 626-6000 in Seattle or (509) 853-3000 in Yakima