March 29, 2023
Washington Supreme Court holds capital gains tax is a valid excise tax, not an unconstitutional income tax — affected taxpayers may need to take immediate action
On March 24, 2023, the Washington State Supreme Court (WSC) reversed a superior court order and held that the legislatively imposed capital gains tax (CGT or tax) is a valid excise tax, not an unconstitutional income tax.1
The CGT applies at a rate of 7% on long-term capital gains of more than $250,000 in a calendar year. Gains from real estate, retirement accounts and qualified family-owned small businesses, among other things, are excluded from the tax base. The CGT went into effect January 1, 2022, with payments for tax year 2022 due by April 18, 2023.
Washington State's Constitution requires all taxes on property to apply uniformly.2 In applying this uniformity requirement, the WSC previously held in Culliton3 that net income is property, so the taxes must apply uniformly. Further, the aggregate of all taxes levied on property cannot exceed an annual rate of 1%.4
The CGT was enacted in May 2021 (see Wash. Laws 2021, ch. 196 (SB 5096)). Following enactment, taxpayers filed lawsuits challenging the constitutionality of the tax on the basis that the CGT was an income tax applied non-uniformly and at a rate above 1%.
In March 2022, the Washington Superior Court for Douglas County ruled that the CGT was unconstitutional as it violated the uniformity and limitation requirements under Art. VII, Sections 1 and 2 of the Washington State Constitution.5 In its decision, the superior court held that the CGT was properly characterized as an income tax, rather than an excise tax, because a capital gain is income and, therefore, property under the Washington Constitution. The superior court also found that capital gains were taxed at a non-uniform rate. The State appealed the decision to the WSC, which heard arguments in the case on January 26, 2023.
In its holding, the WSC stated:
The capital gains tax is a valid excise tax under Washington law. Because it is not a property tax, it is not subject to the uniformity and levy requirements of article VII, sections 1 and 2 of the Washington Constitution. In light of this holding, we decline to interpret article VII or to reconsider our decision in Culliton. We further hold the tax is consistent with our state constitution's privileges and immunities clause and the federal dormant commerce clause.
The WSC held that the CGT was an excise tax because it taxes transactions involving capital assets but "not the assets themselves or the income they generate." Accordingly, the CGT is not an income tax and is not subject to the restrictions imposed by the Washington State Constitution.
It is unknown at this time if the plaintiffs will appeal this decision to the US Supreme Court. There is some initial discussion about possibly putting the issue before the voters in an initiative measure.
While the starting point for determining the CGT liability is federal net long-term capital gain, the Washington Department of Revenue (WA DOR) has not yet issued clear guidance on whether it follows the federal income tax treatment on all items.
The tax was effective as of January 1, 2022; for the 2022 year, the tax is due on or before April 18, 2022. Returns must be electronically filed via SecureAccess Washington.6 Individual taxpayers should note that registrations for access are not immediately processed, so it is imperative to get started on the registration process immediately if they have Washington-sourced taxable capital gains. The standard deduction of up to $250,000 of Washington capital gains applies per individual, but is limited to $250,000 for married couples, regardless of whether they file joint or separate returns.7
Taxpayers that fail to timely file their returns or pay the tax due could be subject to interest as well as late filing penalties, which are 5% per month, up to a maximum of 25%, and late payment penalties, which range from 9% to 29%.8 Criminal penalties could also apply. With significant penalties and interest in place, it is imperative that taxpayers act immediately to determine if they have a filing obligation.
Taxpayers that need more time to file their return, can file a request for an extension of time to file. The extension, however, does not extend the time to pay the tax due.
Additional information on the CGT is available on the WA DOR's website.
EY will monitor this development and issue additional information as warranted.
Published by NTD’s Tax Technical Knowledge Services group; Jennifer A Brittenham, legal editor
1 Quinn et al v. Washington State, No. 100796-8 (Wash. S.Ct. March 24, 2023).
2 Wash.. Const. Art. VII, Section 1.
3 Culliton v. Chase, 174 Wash. 363, 289 P.2d 81 (1933).
4Wash. Const. Art. VII, Section 2.
5Quinn/Clayton v. Washington, Nos. 21-2-0075-09 and 21-2-00087-09, (Wash. Superior Ct., Douglas Cnty., March 1, 2022).
7 SB 5096 Sec. 7.
8 WAC 458-20-300.