Planning for Washington’s New Capital Gains Tax

by Andrew Shaw, Intern | May 10, 2021

In late April 2021, Washington state lawmakers approved a new capital gains tax that takes effect on January 1, 2022. The bill imposes a 7% tax on long-term capital gains exceeding $250,000, such as on profits on the sale of stocks, bonds, and businesses. Supporters of the capital gains tax see it as a solution to the state tax code’s current reliance on sales taxes, which disproportionately affect low-income groups. Opponents of the tax argue that it will hurt business investment. The bill was signed into law on May 4, 2021, and is facing some legal challenges.

Business leaders need to stay updated on changing tax legislation to understand how many of their employees may be affected.

Exemptions and Deductions

The bill exempts certain categories of assets from the new tax. These categories include

• real estate
• retirement accounts
• assets subject to condemnation proceedings
• livestock related to farming and ranching
• certain business assets subject to depreciation or expensing
• timber and timberlands
• commercial fishing privileges
• goodwill from the sale of auto dealerships.

Furthermore, the tax does not apply to ordinary income, short-term capital gains, qualified dividends, tax-exempt interest, and other income categories.

Additionally, the bill provides several deductions for individuals and certain businesses. A standard deduction of $250,000 is available for individuals and married couples, and a charitable deduction of no more than $100,000 per taxpayer per year is available for contributions to Washington charities exceeding $250,000. There is also a deduction for gains from the sale of qualified family small businesses with annual gross revenue of $10 million or less. Finally, there will be a credit for business and occupation taxes paid on capital gains and similar taxes paid to other states.

Penalties

All individuals who legally reside in Washington are subject to the capital gains tax. Individuals who fail to comply will face fines and interest, and it is a Class C felony to knowingly attempt to evade the tax. Knowingly failing to pay the tax, file returns, keep records, or supply authorities with requested information related to the tax is considered a gross misdemeanor.

Constitutional Challenges

The bill passed by the state legislature includes language that prevents opponents from repealing the tax through a voter referendum, so changes to the tax must occur through the more difficult voter initiative process or a lawsuit. Opponents of the bill assert that it violates the state constitution, which says that all taxes on property must be uniformly applied and cannot exceed an annual rate of 1%. In the past, the Washington Supreme Court has ruled that graduated income taxes are unconstitutional on the basis that they violate this requirement.

However, in other cases, the court has also upheld similar taxes as constitutional, such as the business and occupation tax or excise taxes on voluntary activities or events. Given that the bill is narrowly worded to only apply to voluntary activities such as the sale of stocks, supporters argue that the Washington Supreme Court will take the latter view and uphold its constitutionality. Nonetheless, it will remain difficult to determine the tax’s constitutionality until the court issues a decision at a later time.

Planning for the Capital Gains Tax

Although the future of the capital gains tax is uncertain, taxpayers may want to start planning for the new tax now. Taxpayers looking to avoid the tax can consider several different options, such as changing their residency status, moving capital gains events to 2021, or transferring assets to a trust or another entity.

At Equinox, our team is experienced in helping business owners and individuals navigate a changing tax landscape. Speak with our corporate counsel attorneys to discuss your tax compliance and estate planning needs. Contact us at 425-250-0205 or contact@equinoxbusinesslaw.com.

Legal Disclaimer: This article contains general information. Do not view this article as legal advice. Talk with counsel familiar with your unique business needs before taking or refraining from any action.