Washington’s High Court Upholds New Capital Gains Tax

The 2021 Washington State Legislature enacted a new 7% excise tax on long-term capital gains, effective for sales or exchanges of capital assets on or after January 1, 2022. The Washington Supreme Court recently upheld the new tax as a valid excise tax under the Washington state constitution, with two justices dissenting. The court had allowed the tax to be enforced pending its decision, which solidifies the court’s position that the tax is legal and should continue to be enforced. The first payments for the tax are due on or before April 18, 2023.

The Washington capital gains tax is imposed only on individuals – that is, natural persons – who are the legal or beneficial owners of long-term capital assets. An individual is considered a beneficial owner of an asset if the asset is owned by a passthrough entity, such as a partnership, limited liability company, or S corporation, or by an entity that is disregarded for federal tax purposes of which the individual is an owner to the extent of the individual’s ownership interest in the entity.

Calculating the Tax Base

Adjusted Capital Gains

The new tax is imposed on a taxpayer’s adjusted capital gains allocated to Washington less allowable deductions and exemptions. Adjusted capital gains starts with a taxpayer’s federal net long-term capital gain for the tax year and is adjusted by (i) adding back long-term capital losses from sales or exchanges that are exempt or are not allocable to Washington, and (ii) subtracting long-term capital gains from sales or exchanges that are exempt or are not allocable to Washington.

Deductions and Exemptions

Several deductions are allowed against adjusted capital gains. For example, a standard deduction of $250,000 is provided per return or filer. As a result, an individual filing a separate return and married persons filing a joint return receive the same standard deduction. A taxpayer’s federal filing dictates whether the Washington capital gains tax filing is separate or joint. There is also a deduction for sales of qualified family-owned small businesses and charitable donations to Washington-based charities in excess of $250,000 (but the deduction is limited to $100,000). Other exemptions include those for sales of real estate and long-term capital gains and losses from capital assets held in IRAs, 401(k) plans, and other retirement plans.

Allocating Capital Gains and Losses

Long-term capital gains and losses from the sale or exchange of intangibles are allocated to Washington if the taxpayer was domiciled in Washington at the time of the sale or exchange.

Long-term capital gains and losses from the sale or exchange of tangible personal property are allocated to Washington if the property is in the state. In addition, gain or loss from the sale or exchange of tangible personal property is allocated to the state if: (i) the property was in Washington at any time during the tax year in which the sale or exchange occurred, (ii) the taxpayer was a Washington resident at the time of the sale or exchange, and (iii) the taxpayer was “not subject to the payment of an income tax or excise tax legally imposed” by another jurisdiction on the long-term capital gain or loss. “Jurisdiction” is defined to include not only U.S. states, political subdivisions, territories, and possessions but also foreign countries and political subdivisions of foreign countries.

Tax Credits Available

A tax credit is allowed against the new Washington tax for an income or excise tax legally imposed by another jurisdiction on capital gains “derived from capital assets within the other taxing jurisdiction to the extent such capital gains are included in the taxpayer’s Washington capital gains.”

Further, any Washington capital gains tax qualifies as a credit against the Washington business and occupation (B&O) tax if the B&O tax also applies to the gain from a transaction subject to capital gains tax.

Filing Returns

A Washington capital gains tax return is required only if tax is owed, and it must be filed on or before the due date of the individual’s federal income tax return, including extensions. Washington accepts federal extensions for these purposes. However, payment of the tax is required by the original due date of the individual’s federal income tax return, not including extensions. Filing returns and making payments must be done electronically via the Washington Department of Revenue’s “MyDOR” portal.

Insight

While the tax will likely impact Washington residents the most, nonresidents could also be affected if capital gains from the sales or exchanges of their tangible personal property is allocated to Washington.