Washington State Capital Gains Tax Upheld by State Supreme Court as Constitutional

In an unfortunate blow to Taxpayers, the Washington State Supreme Court ruled 7-2 on Friday, March 24, 2023, to uphold the constitutionality of the state’s capital gains tax. The ruling comes as a sharp reversal of a lower court decision striking down the tax as unconstitutional, which we reported on here.

The Washington Supreme Court declined to reconsider existing precedent that bars a progressive income tax, and instead ruled that the tax is constitutional because it is an excise tax, as opposed to a property tax. Superior court Judge Huber had previously rejected the state’s position that the tax was an excise tax. But Justice Debra Stephens, writing for the majority, explained “The capital gains tax is an excise tax because taxpayers do not owe the capital gains tax merely by virtue of owning capital assets or capital gains, like a property tax.” She continued, the tax relates to “the power to sell or transfer capital assets — like an excise.” The reasoning used by the court rejects arguments put forth by the respondent that the tax was an imposition of a property tax on income in violation of the uniformity and levy limitations on property taxes imposed by article VII, sections 1 and 2 of the Washington Constitution.

The two dissenting Justices, Sheryl Gordon McCloud and Charles Johnson, did not hide their feelings on the decision. In a dissenting opinion they noted, “The structure of the capital gains tax shows that it is a tax on income resulting from certain transactions — not a tax on a transaction. Capital gains are income. In Washington, income is property. A Washington capital gains tax is therefore a property tax.” The dissent concluded by stating that “A tax is determined by its incidents, not by its legislative label.”

The ruling represents a major win for state lawmakers who passed the measure in 2021 as a means to raise additional state revenue. The tax applies a 7% tax on the sale of financial assets, including stock and bonds, and is only applicable to profits over $250,000. The state estimates that the tax could generate as much as $500 million per year in revenue.

For taxpayers, who historically have chosen to move to Washington because of its absence of a state income tax, the imposition of a 7% tax on capital gains is consequential. For those taxpayers with significant income from capital gains, the new tax could represent a significant increase in their annual tax liability.

The Governor of Washington, Jay Inslee, lauded the court’s ruling. He stated, “For 134 years, Washington State has been waiting for the day when a fairer tax system came about, one where working people were not carrying an inequitable share of the burden… Washington’s capital gains tax helps right an upside-down tax structure where low-income Washingtonians ultimately expend a much larger share of their income in taxes than our wealthiest residents.”

As noted above, the court stopped short of completely overriding existing precedent that made progressive income taxes unconstitutional in Washington. But the majority opinion made comments suggesting they did not favor that opinion, explaining that the court was deadlocked on the decision until the then-governor “appointed a new justice who appeared to favor the tax, but, as the story is told, one justice changed his position while the case was pending, resulting in a five to four vote to void the tax.” Justice Stephens’s comments suggest that perhaps the current court would reconsider overriding that existing court precedent in the future.

For now, Washington State Taxpayers with significant income from capital gains will have an important decision to make regarding their tax residency. Washington is not the only state that has implemented new taxes with the goal of increasing tax revenue generated from wealthy taxpayers. See our recent post here. And from our experience, taxes like this often have the unintended impact of pushing wealthy taxpayers out of the state. So Washington officials need to be prepared for the possibility of a mass exodus by the state’s wealthiest individuals, something New York legislators are increasingly familiar with.

We can only wait and see if Washington’s taxpayers will be compelled to relocate. But we will continue to keep our finger on the pulse for new taxes around the country, especially those with questionable constitutionality!

Disclaimer:

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