Washington capital gains tax

On May 4, 2021, Washington Gov. Jay Inslee signed legislation (ESB 5096, RCW 82.87), a bill which creates a new Washington excise tax on the sale or exchange of certain capital assets. Specifically, starting Jan. 1, 2022, Washington imposes a 7% excise tax on Washington residents for the sale or exchange of over $250,000 of long-term gain from capital assets reported on their federal tax return.

The Washington excise tax base includes all long-term capital assets with the exception of the following:

• All real estate assets;
• 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 under a retirement savings account, a tax-sheltered annuity or custodial account, a deferred compensation plan, an individual retirement account or individual retirement annuity, a Roth individual retirement account, an employee defined contribution program, an employee defined benefit plan, or a similar retirement savings vehicle;
• Assets pursuant to, or under imminent threat of, condemnation proceedings by the United States, the state or any of its political subdivisions, or a municipal corporation;
• Cattle, horses or breeding livestock if for the taxable year of the sale or exchange, more than 50% of the taxpayer's gross income for the taxable year, including from the sale or exchange of capital assets, is from farming or ranching;
• Property used in a trade or business that is 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 on the sale or exchange of timber and timberland;
• Commercial fishing privileges; and
• Goodwill received from the sale of certain auto dealerships.

In addition to the above exceptions, Washington residents are permitted a deduction from the excise tax base for the following:

• A standard deduction of $250,000 per individual, or in the case of spouses or domestic partners, their combined standard deduction is limited to $250,000, regardless of whether they file joint or separate returns;
• Any amount that the state is prohibited from taxing under the constitution of this state or the Constitution or laws of the United States;
• The amount of adjusted capital gain derived from the sale or transfer of the taxpayer's interest in a qualified family-owned small business;
• Charitable contributions in excess of $250,000 made to a qualified organization, with the deduction capped at $100,000.

Long-term capital gains or losses from the sale or exchange of tangible personal property are allocated to Washington if the property was located in Washington at the time of the sale or exchange. Long-term capital gains or losses from the sale or exchange of tangible personal property are also allocated to Washington even though the property was located in another state at the time of the sale or exchange if:

• The property was located in Washington at any time during the taxable year in which the sale or exchange occurred or the immediately preceding taxable year;
• The taxpayer was a resident at the time the sale or exchange occurred; or
• The taxpayer is not subject to the payment of an income or excise tax legally imposed on the long-term capital gains or losses by another taxing jurisdiction.

In addition, long-term capital gains or losses derived from intangible personal property are allocated to Washington if the taxpayer was domiciled in Washington at the time the sale or exchange occurred.

Current status/Legislature history

In March 2022, the Douglass County Superior Court in Washington held the Washington excise tax on long-term capital gains was unconstitutional. Specifically, the Superior Court determined the excise tax was an impermissible income tax due to the fact the income is considered property, and the constitution mandates all state taxes on property be uniform or taxed at the same rate. In addition, any tax on property cannot exceed 1%.

On Nov. 30, 2022, the Washington state Supreme Court granted a stay on the Superior Court’s unconstitutional ruling in order to authorize the Washington Department of Revenue the ability to administer the excise tax until it is legally decided. As a result, the Washington Department of Revenue has communicated its intent to enforce the excise tax filing and excise tax collection as permitted under law. The Washington Supreme Court started to hear oral arguments on Jan. 26, 2023.

On March 24, 2023, the Washington state Supreme Court decided with a vote of 7-2 that the capital gains tax is a valid excise tax under Washington law and therefore constitutional. Specifically, the Superior Court concluded that “the capital gains tax is appropriately characterized as an excise tax because it is levied on the sale or exchange of capital assets, not on capital assets or gains themselves,” which is consistent with Washington legal precedence. This decision reverses the Douglass County Superior Court in March of 2022. This decision may be challenged and appealed in the future, however, taxpayers will need to make sure they are compliant today.

For tax year starting Jan. 1, 2022, the Washington excise tax return is due on the original due date of April 18, 2023, or the due date with extension. However, the Washington excise tax payment is due no later than April 18, 2023, regardless of any extension. A valid federal extension will apply to the filing of the capital gains tax; however, a taxpayer is required to confirm this extension with the Washington Department of Revenue before the April 18, 2023 due date.

The Washington excise tax return and payment must be filed electronically on the prescribed Washington forms. Washington’s online system (https://secure.dor.wa.gov/home/Login) is available for Washington individuals to remit tax to the state. Registration for a capital gain account is required before making  payments or filing returns and can be done via https://secure.dor.wa.gov/home/Account/Register. In addition, the steps to confirm the extension are found via https://dor.wa.gov/manage-business/my-dor-help/capital-gains-my-dor-help#fileextension on the Washington Department of Revenue website. If the return and/or payment is late, Washington will impose penalties (from 5% and up to 25% in addition to all other applicable penalties) and interest.

Key takeaways:

• The Washington excise tax is 7% of the gain from long-term capital assets.
• Long-term capital assets generally include all capital assets, with a few exceptions.
• There are specific sourcing rules for gains from long-term tangible assets.
• The Washington excise tax payment and return are due by April 18, 2023. An extension can be filed via the state online systems; however, the extension is not for the payment of tax.
• A taxpayer may request a binding ruling for the capital gains tax through its online portal.

For additional information on the Washington capital gains tax, please contact a member of the Baker Tilly state and local tax team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.