The Reversal of Washington State’s New Capital Gains Tax – Now What?

The Washington State Superior Court on March 1, 2022 overturned a new law enacted last year to tax capital assets. The capital gains tax took effect on January 1, 2022.

The Washington State’s Capital Gains Tax imposed a single tax rate of 7% would apply to all levels of such income that exceed the standard deduction of $250,000. This tax was set to apply to only individuals. However, individuals can be liable for the tax due to their ownership interest in a business entity that sells or exchanges long-term capital assets.

As expected, this legislation faced stiff legal challenges as the state constitution prohibits a graduated tax on income. Governor Inslee reportedly said, “Yes, I am confident that it is constitutional,” when the legislation was enacted. This lower court ruling will likely result in the controversial ruling to be heard by the Washington State Supreme Court, as Attorney General Bob Ferguson said his office would appeal to the state Supreme Court. The state’s Department of Revenue had initially estimated the tax would apply to about 7,000 state residents a year and would raise about $445 million starting in the fiscal year 2023. Since the state doesn’t otherwise levy an income tax, the ultimate decision will impact individuals as well as many business owners who have sought tax residency in the state, which is often used to implement state tax strategies in planning for the sale of a business.

Takeaway

As the capital gains tax return with first payments is set to be due at the same time as the taxpayer’s federal income tax return, April 18, 2023, there is still time for the Washington State Supreme Court to issue a ruling before taxpayers are impacted by the law. While it looks like the law will continue to face litigation, it’s likely the state’s highest court will ultimately decide whether the new capital gains tax is constitutional.

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If you think the overturn of this law will impact you and your taxes, contact Withum’s State and Local Tax Group for a tailored discussion on your specific scenario.