Washington’s New Capital Gains Tax: What You Should Know
As you may have heard, Washington’s Legislature passed a new capital gains tax in 2021 which would levy a 7% tax on realized capital gains over $250,000 per year. Although income taxes are widely considered unconstitutional in Washington (and have been for nearly 90 years), the Washington Legislature has made the creative argument that this new capital gains tax is not an income tax at all, but rather an excise tax.[1] This tax was struck down in Douglas County Superior Court in early 2022, but the Washington Supreme Court has now intervened. One of the first decisions by the Washington Supreme Court was to reverse the stay imposed by the lower court, allowing the Department of Revenue (DOR) to implement the new tax before it has been found constitutional. This means that Washington residents need to be prepared to timely comply with a capital gains tax which went into effect January 1, 2022, wholly independent of whether that tax was even legal in the first place. With that in mind, we believe our clients should know the following facts about the new Washington capital gains tax encoded in RCW Chapter 82.87.
Washington’s capital gains tax hits married couples harder than individuals.
Each individual taxpayer in Washington gets a $250,000 exemption against capital gains. This is meant to roughly mirror the federal exemption of $250,000 per person for capital gains attributable to the sale of a primary residence. Unlike the analogous federal deduction, the state does not permit married couples to combine their exemptions—each married couple shares one exemption. Worse, couples who are married but file separately must split one exemption, even though each as individual single people would have gotten $250,000 apiece. Married couples face higher taxes because they are married.
Washington’s capital gains tax exempts most real estate.
Although the federal capital gains tax applies against all capital assets, Washington’s new capital gains tax exempts all real property (including real property in a business). Realized gains of stock or other intangible property is taxed, but land is not. If you thought Washington real estate prices were out of control now, just wait until you see what happens now that Washington has made every parcel of land in our state a tax shelter, no matter its size, purpose, or nature of ownership. If given the choice between owning land or owning public stocks, the tax incentive is obvious: only one of these will be taxed.
This tax is already in effect and filing requirements have already been triggered.
Although we do not know yet whether this tax will be found constitutional, it is nonetheless already here. The DOR is already well underway to begin collecting taxes attributable to the entire 2022 tax year. It is too late to do anything about decisions made in 2022 to realize capital gains. Taxes owing on these gains will be due April 18, 2023. As tax season quickly approaches, it is paramount that you seek guidance from your CPA about your newfound capital gains “excise” tax filing requirements in Washington.
Conclusion
There are many other tricky elements to this new capital gains tax which are important to get right by April of this year. If you were in any way involved in 2022 with transfers involving closely held businesses, administration of estates or trusts, or charitable donations, you should consider making an appointment with your attorney in addition to your CPA.
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[1] The federal capital gains tax is part of Subtitle A of the Internal Revenue Code (“Income Taxes”). It is exceedingly rare throughout the US to consider a tax on realized gain as anything other than a type of income tax.