Washington Supreme Court upholds capital gains tax

In detail

Effective January 1, 2022, Washington imposes a 7% tax generally applicable to the recognized long-term capital gains reported on an individual’s federal income tax return. However, some adjustments to the federal determination of taxable capital gains may apply, in addition to certain Washington-specific carve-outs (such as real estate) and deductions (such as a standard deduction of $250,000).

If the capital asset is tangible personal property, the tax applies if (1) the property is located in Washington at the time of the sale or exchange or (2) the property was located in Washington at any time during the current or immediately preceding taxable year, the taxpayer was a Washington resident at the time of the sale or exchange, and the sale was not subject to income or excise tax on the adjusted capital gain by another taxing jurisdiction. If the capital asset is intangible personal property, then the tax applies if the taxpayer is domiciled in Washington at the time of sale or exchange. For more on the enacted law, see PwC’s Insight.

Washington Supreme Court finds the tax is valid

On the contrary, the Washington Supreme Court found, “Because the capital gains tax is an excise tax under Washington law, it is not subject to the uniformity and levy requirements of article VII.”

The court reasoned that the capital gains tax is an excise tax because taxpayers do not owe the tax “merely by virtue of owning capital assets or capital gains, like a property tax,” but instead due to their “exercise of rights ‘in and to property’—namely, the power to sell or transfer capital assets—like an excise” (quoting Mahler v. Tremper, 243 P.2d 627 (1952)). Therefore, the court concluded that the capital gains tax “taxes transactions involving capital assets—not the assets themselves or the income they generate.”

The Supreme Court noted that on the same day it had decided Culliton v. Chase, 25 P.2d 81 (1933), finding that a graduated income tax violated the state constitution, it also issued State ex rel. Stiner v. Yelle, 25 P.2d 91 (1933), which upheld Washington’s first business and occupation tax. The court in Stiner distinguished between a property tax on income and an excise tax on a particular activity or privilege that is measured by income.

Likewise, in Quinn, the court said that the capital gains tax “specifically targets an activity long recognized as subject to excise taxation—the sale or exchange of property.” The court stated that the capital gains tax is comparable to real estate and rental excise taxes upheld in a line of Washington Supreme Court decisions. While the plaintiffs “argue the taxable incident [of the capital gains tax] is not the transaction but the realization of capital gains,” the court concluded that “the tax is not levied on capital gains; rather, it is measured by capital gains.”

The Supreme Court further rejected challenges based on the Washington Constitution’s privileges and immunities clause and the US Constitution’s dormant commerce clause. In analyzing whether the tax withstood commerce clause scrutiny, the court emphasized the statute’s allowance of a credit for taxes paid in other states. The court noted that its commerce clause analysis is limited to the plaintiffs’ facial challenge to the capital gains tax, and that “our holding today does not foreclose future as-applied challenges under the dormant commerce clause should factual circumstances arise in which the tax cannot be constitutionally applied.”