On July 15, 2019, the Washington Court of Appeals found that Seattle’s graduated income tax was unconstitutional because of the tax’s graduated rate structure, but not because the tax was fundamentally a net income tax. Washington is one of seven states that impose no personal income tax, at the state level, and the state legislature has also expressly prohibited counties and cities from imposing a net income tax. Seattle’s tax, originally scheduled to be effective on Jan. 1, 2018, was challenged on the day the law was signed, with a complaint alleging the tax was unconstitutional under state law.
In November 2017, a lower court determined the graduated income tax was prohibited because it was imposed on income and was not a permissible excise tax. The lower court did not address any of the state constitutional arguments in its opinion.
The tax
Enacted in 2017, and originally scheduled effective on Jan. 1, 2018, the 2.25% tax was to be imposed on the income of Seattle individual taxpayers exceeding $250,000 and married taxpayers exceeding $500,000. For example, a married couple earning $600,000 would be liable for 2.25% of the $100,000 exceeding the $500,000 threshold.
Court of Appeals decision
The Washington Court of Appeals’ decision rested on the idea that income can be taxed as property. In contradiction to the King County Superior Court’s finding, the Court of Appeals concluded that a 1984 state law enacting a prohibition on counties and cities from imposing a “net income tax”—one of the rules this tax was alleged to have violated—was unconstitutional under the state’s “single-subject” rule. The single-subject rule requires that no bill address more than one subject. In reviewing the 1984 legislation, the Court of Appeals noted there was no rational unity among the five sections of the original bill, and so it was therefore unconstitutional in its entirety. Accordingly, there was no statutory prohibition on Seattle from levying a property tax on net income.
However, the Court of Appeals also found that the Washington Constitution explicitly requires all taxes to be “uniform upon the same class of property.” The court reviewed a series of Washington Supreme Court decisions establishing that income was considered a class of property and, therefore, a tax on income must be applied uniformly. Here, Seattle’s graduated income tax was imposed on two different classes taxed at two different rates depending on its classification—2.25% for income above $250,000 and 0% for income below that threshold. Consistent with previous case law, the Court of Appeals concluded that a graduated income tax resulted in a non-uniform application of the tax to property and was therefore unconstitutional.
Ultimately, the Court of Appeals agreed with the lower court that the Seattle graduated income tax was impermissible, but the ruling rested on different arguments.
Is a solution hiding in plain sight?
In the context of the appellate court’s opinion, the city may have alternative solutions to the graduated income tax’s apparent constitutional infirmity. On the surface, one alternative is that instead of effectively imposing the tax at two separate rates, the city could impose the tax on all income at one rate with an allowance for a $250,000 standard deduction. While such a mechanism has not been vetted under Washington law, the standard deduction—available to all taxpayers, may circumvent the prohibition on a graduated income tax. Regardless, Seattle individual taxpayers will likely need to follow this litigation for some time to come as an appeal to the Washington Supreme Court is anticipated.
