On May 4, 2021, Washington state Gov. Jay Inslee signed into law Senate Bill 5096, enacting a capital gains tax on the sale of long-term capital assets of individuals. The new tax has the potential to dramatically change Washington’s tax structure, as the state does not impose an income tax on either businesses or individuals. In lieu of an income tax, Washington has long-imposed a gross receipts tax on business activities called the business and occupation (B&O) tax.
How is the tax imposed?
Senate Bill 5096 provides that the capital gains tax applies to individuals at a rate of 7% on net gains in excess of $250,000 in a calendar year. The term ‘individual’ refers not only to taxpayers holding capital assets in their individual capacities, but also to individual owners of pass-through or disregarded entities holding capital assets. The taxable amount is based on the amount of federal long-term capital gains reported, although loss carryovers are not allowed. The tax is effective Jan. 1, 2022.
Exemptions and deductions
The new tax provides a number of exemptions. A high-level summary of exempt assets include:
- All real estate
- A controlling interest in an entity only to the extent that any long-term capital gain or loss from such sale or exchange is directly attributable to the entity's interest in real property and the sale or exchange was subject to state real estate excise tax
- Assets held in a retirement savings account
- Assets pursuant to, or under imminent threat of, condemnation proceedings by the government;
- Cattle, horses or breeding livestock if more than 50% of the taxpayer's gross income is from farming or ranching
- Property used in a trade or business depreciable under section 167(a)(1) of the Internal Revenue Code, or that qualifies for expensing under section 179 of the Code
- Timber, timberland, or the receipt of Washington capital gains as dividends and distributions from real estate investment trusts derived from gains from the sale or exchange of timber and timberland, and
- Goodwill received from the sale of certain auto dealerships
A deduction from the taxable amount is allowed on gains from the sale of a family-owned small business provided it meets the statutory definition of a ’qualified family-owned small business.’
An additional deduction is allowed for charitable contributions in excess of $250,000 made to a qualified organization, with the deduction capped at $100,000. A qualified organization is a non-profit organization eligible to receive contributions as defined in section 170(c) of the Code and is principally directed or managed within the state of Washington.
Allocation
Long-term net capital gains from the sale or exchange of tangible personal property are attributed to Washington if the property is located in the state at the time of the sale or exchange. In addition, long-term net capital gains are attributed to Washington if the property is located in the state at any time during the taxable year or preceding taxable year of the sale or exchange, the individual is a resident of Washington at the time of the sale or exchange and the net gain is not subject to a similar tax by another jurisdiction.
Net gains from intangible property will be attributed to Washington if the individual is domiciled in the state at the time of sale.
Filing
Electronic filing for the capital gains tax will be required, and the due date will coincide with the due date of the individual’s federal return. A copy of the federal return with all schedules and supporting documents must be submitted at the time of filing. If an extension for the federal return is granted, it will apply to the filing of the Washington form as well, but payment will remain due on the original due date. Penalties will apply for late payment and/or late filing. Filing status must be the same as that elected on the federal return, although the $250,000 exclusion will apply to both single and joint returns.
Takeaways
The passage of a capital gains tax has been a goal of the governor and the Democratic-held legislature over the last several legislative sessions. The legislature explains in the bill that Washington’s tax system is regressive, concluding that the present regime taxes a larger percentage of low-wage earners’ income than the income of high-wage earners. The legislature further explains that the intent of the new tax is to rebalance the state’s tax code. It is estimated that approximately 8,000 taxpayers will be subject to the tax in 2022. Other proposals introduced in this year’s session include a wealth tax and a statewide payroll tax on high-wage earners, neither of which passed.
Opponents of the capital gains tax claim it is an ‘income tax,’ while proponents have labeled it an excise tax. This distinction is important because income taxes have been held unconstitutional by the state’s Supreme Court. Additionally, Washington voters have rejected a state income tax numerous times. Even before the bill was signed, at least one complaint was filed challenging the constitutionality of the tax.
Washington taxpayers with sales or exchanges of capital assets, or that have property located in Washington that may be subject to the capital gains tax, should consult with their Washington state tax adviser with questions.
