Washington state’s capital gains tax unconstitutional, rules Douglas County Court

A Douglas County Superior Court has ruled Washington state’s capital gains tax unconstitutional.

Legal battle over capital gains tax kicks off in Douglas County court

The decision will likely be appealed to the Washington Supreme Court.

“There’s a great deal at stake in this case, including funding for early learning, child care programs, and school construction,” wrote Washington Attorney General Bob Ferguson in a news release.

“Consequently, we will continue defending this law enacted by the peoples’ representatives in the Legislature. All the parties recognize this case will ultimately be decided by the State Supreme Court. We respectfully disagree with this ruling, and we will appeal.”

Gov. Jay Inslee echoed that sentiment as well, expressing how he was “disappointed” by the ruling, and that he “believes the matter will likely be settled by the state Supreme Court.”

The challenge was levied against SB 5096 — signed into law last year and effective in January 2022. The legislation created a 7% excise tax on the sale or exchange of capital assets above $250,000.

Defining it as an excise tax — as opposed to an income tax — was the crux of the legal challenge, largely contingent on the argument that capital assets should be considered income. Subsequently, a specific tax on income brackets above the $250,000 threshold is unconstitutional.

The state’s position, largely, was that the capital gains tax applies on the sale or transfer of property and is, therefore, an excise tax. The county Superior Court countered with the position that the new tax is levied on receipt and ownership of capital assets.

The court sided with the challengers, supporting their definition of capital gains as income.

With the definition of the capital gains tax as an income tax in hand, the court concluded that the tax violates those aspects of the Washington State Constitution that guarantee uniformity.

“It violates the uniformity requirement by imposing a 7% tax on an individual’s long-term capital gains exceeding $250,000 but imposing zero tax on capital gains below that $250,000 threshold,” the ruling reads.

In support of its definition of the capital gains tax as an income tax, Douglas County Superior Court offered the following judgment.

It relies upon federal IRS income tax returns that Washington residents must file and is thus derived from a taxpayer’s annual federal income tax reporting.

It levies a tax on the same long-term capital gains that the IRS characterizes as “income” under federal law.

It’s levied annually (like an income tax), not at the time of each transaction (like an excise tax).

It is levied not on the gross value of the property sold in a transaction (like an excise tax as demonstrated by the examples cited by the State), but on an individual’s net capital gain (like an income tax).

Like an income tax, it is based on an aggregate calculation of an individual’s capital gains over the course of a year from all sources, taking into consideration various deductions and exclusions, to arrive at a single annual taxable dollar figure.

Like an income tax, it is levied on all long-term capital gains of an individual, regardless of whether those gains were earned within Washington and thus without concern whether the State conferred any right or privilege to facilitate the underlying transfer that would entitle the State to charge an excise.

Like an income tax and unlike an excise tax, the new tax statute includes a deduction for certain charitable donations the taxpayer has made during the tax year.

If the legal owner of the asset who transfers title or ownership is not an individual, then the legal owner is not liable for the tax generated in connection with the transaction, unlike the excise taxes identified by the State.

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