Former Washington AG joins latest lawsuit against state’s newly-approved capital gains tax

A second lawsuit against Washington’s newly-approved capital gains tax was filed this week, this time joined by former state Attorney General Rob McKenna.

Court battle over capital gains tax could rewrite state’s tax code

This marks the second lawsuit against the tax, which levies a 7% tax on capital gains above $250,000 to bring in an estimated $415 million in 2023, its first year. The text of the bill describes it as an excise tax on the sale of stocks, bonds, and other assets above $250,000, excepting real estate and family-owned small businesses.

McKenna’s lawsuit — filed in Douglas County Superior Court, alongside several other plaintiffs, including the Washington Farm Bureau — challenges the assertion that it’s an excise tax, an argument the former AG has brought up frequently in the past.

“Every taxing authority in the country, including the IRS and all other state revenue departments, agrees that capital gains are income,” the lawsuit reads. “Most states tax capital gains as ordinary income subject to the state’s income tax rates. Neither the federal government nor any other state levies an excise tax on capital gains.”

A graduated income tax has been illegal in Washington since a landmark 1936 case, in which the state Supreme Court ruled that the state constitution required all property to be taxed at the same rate. The court said income counted as property, striking down a graduated income tax rate approved by voters.

In the decades since, voters have rejected an income tax at the ballot box on multiple occasions, while other proposals have been overturned by subsequent court rulings.

This new lawsuit claims that the state’s capital gains tax is “masquerading under a variety of political labels to suit the times,” and that Washingtonians have “repeatedly, consistently and overwhelmingly voted to defeat” any such proposals in the past.

Washington Rep: Capital gains tax is just ‘parity in the tax code’

On the other side of this debate, proponents have argued that Washington sorely needs to reform a tax code viewed by many as among the most inequitable in the nation. As for whether the recently-passed capital gains tax is actually an income tax, University of Washington law professor Hugh Spitzer believes that it may not be so cut and dry.

In a March editorial for The Seattle Times, Spitzer argued that the bill clearly presents itself as an excise tax on the “voluntary activity” of selling an asset, “rather than a tax on the asset itself.” Because of that, he believes there’s a high likelihood the state Supreme Court will interpret it the same way, and that anyone seeking to challenge it on the grounds that it’s actually an income tax “should be careful about what they wish for.”

The first lawsuit against the capital gains tax was filed in late April by the Freedom Foundation, also in Douglas County.

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