Earlier this year, Washington’s legislature passed Senate Bill 5096, which was signed by Governor Jay Inslee on May 4, 2021, and has since been codified under RCW 82.87. Starting on January 1, 2022, the new law imposes a 7% capital gains tax on annual federal long-term capital gains in excess of $250,000. The new tax applies only to capital gain which are allocable to Washington and may apply to both Washington residents and non-residents. Proceeds from the new capital gain tax will be used to support K-12 education, early learning, and childcare by funding Washington’s legacy education trust account and common school construction account.
How Are Capital Gains Allocated to Washington?
Capital gain resulting from the sale of intangible property (e.g., liquidation of an investment account), is subject to taxation if the taxpayer is a Washington resident, regardless of where the account is located.
Capital gain resulting from the sale of tangible property (e.g., gold, jewelry, artwork) is subject to tax if it is located in Washington at the time of sale, or if (i) it was located in Washington at any time during the year of sale or the entire preceding year, (ii) the taxpayer is a Washington resident at the time of sale, and (iii) the taxpayer is not subject to income/excise tax on gain in another jurisdiction (i.e., another state or foreign country).
What Exemptions, Deductions, and Credits are Available?
- Standard Deduction. The primary tax-reduction tool available to each taxpayer is the $250,000 standard deduction. This means you will only need to pay the new capital gain tax on the amount of gain in excess of the standard deduction. An important note: Unlike other common tax deductions, the standard deduction is not doubled for married couples filing a joint return; the standard deduction amount applies on a “per return” basis.
- Retirement Accounts. Assets held in most common retirement accounts are exempt, including Traditional and Roth IRAs, as well as 401(k), 403(b) and 457(b) accounts.
- Real Estate. Capital gain resulting from the sale of real estate is entirely exempt from the Washington capital gain tax. Unlike the federal capital gain tax, the real property does not need to be your primary residence. Additionally, capital gain resulting from the sale of business entities is exempt to the extent the capital gain is attributable to real estate owned by the business entity. This exemption may provide investors with an important planning tool to reduce the amount of their tax liability.
- Qualified Family-Owned Small Business. Amounts derived from the sale of a qualifying family-owned small business may be fully deductible. Among other technical requirements, the following conditions must be met to qualify for the deduction: (i) all or substantially all of the business assets must be sold; (ii) the taxpayer—together with the taxpayer’s family members—must meet the percentage ownership requirements for at least 5 years prior to the sale; (iii) The taxpayer, or a family member, must have materially participated in the business for 5 of the last 10 years; (iv) the business must have $10,000,000.00 or less in gross revenue for the 1-year period immediately prior to sale.
- Charitable Donations. A charitable donation deduction of up to $100,000 is available for qualifying donations. Because of the standard deduction, the charitable deduction is only effective if you make qualifying donations of amounts totaling between $250,000 and $350,000. Additionally, the donations must be made to charities that are primarily directed or managed within Washington.
- Miscellaneous. Additional exemptions are available for certain depreciable property used in trade or business; timber and timberland sales; certain cattle, horse, or breeding livestock sales; commercial fishing privileges; and goodwill received from the sale of auto dealerships. Credits for taxes paid to other taxing jurisdictions are also available.
When is the Tax Due?
The Washington capital gain tax return is due on the same date as the taxpayer’s federal income tax return, plus any extensions granted by the Washington Department of Revenue. Failure to file a required return can result in a 5% penalty assessed on the amount due for each month that the return is not filed, up to a total amount of 25% of the tax due.
There is unresolved litigation regarding the legality of Washington’s new capital gain tax under the Washington State Constitution. The core question being litigated is whether the capital gain tax is a property tax, which subject to strict limitation under the Washington’s Constitution, or whether it is an excise tax, which is free from such constitutional restrictions.
The Washington State Constitution requires that taxes must be uniformly applied on the same class of property and that taxes on property cannot exceed an annual rate of 1% of the fair value of the property. Washington courts have consistently held that “income” is “property.” Therefore, opponents of the tax argue that the tax violates the Washington’s Constitution since it exceeds the 1% cap on property taxes and is not uniformly applied to all Washingtonians.
However, in an attempt to circumvent this constitutional barrier, the legislature characterized the tax as an excise tax on the exchange of capital assets and therefore not subject to the constitutional limitations applicable to taxation of income. Unlike income taxes, excise taxes are imposed on specific uses of property or the transfer of ownership interest in property.
As of September 10, 2021 the Washington Superior Court for Douglas County has rejected Washington’s efforts to dismiss the case of a challenger and the case is set to proceed toward full litigation. It is likely that the constitutionality of the tax will ultimately be decided by the Washington Supreme Court.
The ongoing challenges create an uncertain future for individuals with potential future taxable events. If you have questions and would like to speak with an estate planning attorney, please consider contacting one of our firm’s knowledgeable and experienced Estate Planning Attorneys for more information.