Washington Supreme Court allows capital gains tax administration to proceed

December 2022

In brief

The Washington Supreme Court on November 30 issued an order staying a lower court’s invalidation of 2021 legislation (ESSB 5096) to institute a tax on capital gains. Under the Supreme Court order, the lower court’s order is stayed pending a final decision in the matter.

Observation: While the Supreme Court order is unanimous, it does not set forth an analysis as to how the justices came to their conclusion and may not indicate a view one way or the other on the merits of the case. Pending a final decision or other guidance from the court, the order allows the Department of Revenue to administer and collect the tax. The capital gains tax return due date coincides with an individual’s federal return due date, meaning an extension with the IRS automatically grants an extension with Washington State. However, filing an extension does not extend the payment due date, and therefore the first payment is due April 18, 2023.

Arguments in the case are scheduled for January 26, 2023. In many cases, a decision may not be issued for up to nine months after argument. However, given the high profile of this case and the pending compliance deadlines, a decision may be made before the April 18, 2023 payment due date. In any event, it seems realistic to expect a decision by the extended return filing deadline of October 16, 2023.

In detail

In general, effective January 1, 2022, ESSB 5096 creates a 7% tax generally applicable to the recognized long-term capital gains reported on an individual’s federal income tax return. However, some adjustments to the federal determination of taxable capital gains may apply, in addition to certain Washington-specific carve-outs (such as real estate) and deductions (such as a standard deduction of $250,000).

If the capital asset is tangible personal property, the tax applies if the property is located in Washington at the time of the sale or exchange. If the capital asset is intangible personal property, then the tax applies if the taxpayer is domiciled in Washington at the time of sale or exchange. For more on the enacted law, see PwC’s Insight.

On March 1, 2022, the Douglas County Superior Court issued a decision finding that ESSB 5096 violated the uniformity and limitation requirements of article VII, sections 1 and 2 of the Washington State Constitution. Specifically, the court found that the capital gains tax violates the uniformity requirement by imposing a 7% tax on an individual’s long-term capital gains exceeding $250,000 while at the same time imposing no tax on capital gains below that threshold.

Regarding the limitation requirement, the court found the tax was invalid because it exceeds the 1% maximum annual property tax rate set forth in the state constitution. The court determined that under Washington case law, the capital gains tax is a tax on the receipt of income and therefore is “properly characterized as a tax on property.”

Observation: The Washington Department of Revenue has proposed rulemaking and has issued guidance regarding the implementation of the tax, notwithstanding the superior court’s decision. While a separate lawsuit was filed challenging the Department’s actions to continue implementing the tax pending appeals, the Supreme Court’s order clears the way for the Department to continue administering the tax.

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Ed Geils

Ed Geils

Global and US Tax Knowledge Management Leader, PwC US

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