Controversial Capital Gains Tax Upheld in Washington

Capital gains tax is back in the news. The Supreme Court in Washington recently ruled that the state’s 7% capital gains tax that was enacted two years ago, is constitutional. The controversial ruling, which essentially says that capital gains taxes are not property taxes in Washington state, comes on the heels of President Biden’s FY24 budget proposal calling for a near doubling of the national capital gains tax rate. 

Washington Governor Jay Inslee welcomed the state supreme court ruling, which paves the way for what was initially estimated to be $1 billion in projected revenue from the tax. 

“Washington’s capital gains tax helps right an upside-down tax structure where low-income Washingtonians ultimately expend a much larger share of their income in taxes than our wealthiest residents,” Inslee said in a statement.

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Update: As of April, the state's Department of Revenue reported over $830 million in revenue from the capital gains tax measure. (That amount, which comes from early state taxpayer filing data, is so far on pace to exceed the projected revenue for 2023 of $248 million). 

The Washington Policy Center, a nonprofit think tank that opposes the capital gains tax, called the court’s ruling in Quinn v. State of Washington, a distortion of the “clear language of the state constitution.” 

Washington State Capital Gains Tax

The Washington capital gains tax at issue is 7% on the sale or exchange of individual long-term capital assets (e.g., stocks, bonds, business interests, etc.) that exceed $250,000. Only the portion of gains above the threshold is subject to the tax and some assets are exempted from the tax. A small number of Washington taxpayers overall, (i.e., about 5,000 people) are expected to be subject to the tax.

The legal argument against the tax is mainly that capital gains are income and that income is property. Under the state's constitution, property tax is limited to one percent. So, opponents of the capital gains tax (and the court's two dissenting justices) contend that the 7% capital gains tax in Washington is unconstitutional. 

However, in the majority (7-2 ruling) the Washington Supreme Court found the capital gains tax in Washington to be a legal excise tax — not a property tax. Justice Debra L. Stephens wrote, “The tax is constitutional as an excise because it is levied on the sale or exchange of capital assets, not on capital assets or gains themselves.”

The ruling sets Washington state apart from other states (and the IRS) that consider capital gains taxes to be income taxes. Washington state officials say that the revenue collected from the capital gains tax will help fund public education in the state. Meanwhile, some opponents worry that the capital gains tax could discourage business in the state.

Excise Taxes?

The Washington capital gains tax case also raises questions about excise taxes. Excise taxes are special taxes on specific types of goods or services. (You may have heard of a gasoline excise tax or a tobacco or cigarette excise tax). Excise taxes are typically included in the price that you pay for the specific product (i.e., businesses typically pass the taxes onto consumers),

But some excise taxes are paid directly by consumers. For example, there are excise taxes levied on retirement accounts when account holders fail to take required minimum distributions (RMDs) on time. Additionally, property taxes can be another kind of excise tax that consumers pay directly.

The court ruled that the capital gains tax is an excise tax on the sale of certain goods — in this case, individual long-term capital assets that exceed $250,000. That’s because the Washington Supreme Court court found that in Washington, a property tax is a tax on “mere ownership” of property; while the capital gains tax taxes the power to sell and transfer the property. 

Which States Have Capital Gains Tax? 

Currently, forty-one states and the District of Columbia tax capital gains and the federal government taxes capital gains. But the 7% capital gains tax aside, Washington state does not have state personal income tax.