Income or excise? Figuring out how state Supreme Court might rule on challenge to capital gains tax

Apr 8, 2022, 11:34 AM | Updated: Apr 11, 2022, 8:57 am
capital gains tax...
The Internal Revenue Service headquarters building. (Getty Images)
(Getty Images)

Is Washington’s capital gains tax an excise or income tax? That’s the question that could soon be presented to the state Supreme Court, and which two University of Washington experts debated over on Thursday night.

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The state’s capital gains tax was approved by state lawmakers in 2021, imposing a 7% tax on capital gains above $250,000 for all 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.

In early March, a Douglas County Superior Court ruled the tax unconstitutional, siding with plaintiffs in supporting their definition of capital gains as income. State Attorney General Bob Ferguson then filed a request for direct review with the state Supreme Court, which has yet to render a decision as to whether it will hear the case right away, or kick it down to an appeals court first.

If or when it does end up in front of the state’s highest court, University of Washington constitutional law professor Hugh Spitzer believes that it is “more than likely” justices will side with the state in defining the levy as an excise tax.

Under existing court precedent, the state defines income as property, making it a violation of the state’s constitution to tax either at a graduated rate. Speaking during a debate on TVW’s “Inside Olympia,” Spitzer pointed to how Washington’s definition of an excise tax gets around that mandate.

“Under Washington law, an excise tax is a tax on an activity, on an event; property tax is a tax on standing property,” he described.

Essentially, an annual tax on property owned by someone in Washington falls under the “income tax” umbrella. But when that property is sold, the money from that sale is levied as an excise tax based on a separate decades-old state Supreme Court ruling.

“That’s how the capital gains tax was structured from a state perspective,” Spitzer added. “It’s a tax on the activity of selling certain kinds of capital assets measured by the amount of the gain — it’s a very technical issue, but I think that the state Supreme Court is going to understand this issue, and will make this ruling under Washington law.”

Taking issue with that position was UW tax law professor Scott Schumacher, who believes that the capital gains tax is unconstitutional.

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“The way it’s measured how it’s reported, the various deductions and exemptions, make it seem more like an income tax than an excise tax,” he posited. “I think the indicia of the tax make it more like an income tax, and as such, there are 70, 80 years worth of Washington Supreme Court decisions on this saying that an income tax or tax on property is unconstitutional.”

As Schumacher further points out, money made from capital gains is also reported on federal income tax returns.

“Professor Spitzer is correct that this is a state tax question, but just the way it’s calculated, the way it’s reported, you have to file your federal income tax return to show that the capital gains tax that you’re reporting to the federal government is equivalent to or equal to the capital gains you’re reporting to the state of Washington,” he continued. “To me, it just has the indicia of an income tax. It tracks the federal definition and provides deductions and exemptions for the charitable deduction that goes against that.”

That’s the primary argument made by plaintiffs in the lawsuit seeking to overturn the tax, who point to a series of similarities between how income taxes are calculated and how the capital gains tax was designed.

You can watch the full debate between Spitzer and Schumacher here: 

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Income or excise? Figuring out how state Supreme Court might rule on challenge to capital gains tax