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Washington enacts individual capital gains tax

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Jamie C. Yesnowitz
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Washington Gov. Jay Inslee recently signed legislation imposing a 7% tax on the long-term capital gains (LTCG) of individuals in excess of $250,000 resulting from the sale of certain capital assets.1 The LTCG tax is scheduled to take effect on Jan. 1, 2022, but it is already facing legal challenges.

Background Washington has unique restrictions limiting the imposition of state and local taxes. The Washington State Constitution provides that all taxes on property, defined as “everything, whether tangible or intangible, subject to ownership,” must be uniformly applied and cannot exceed an annual rate of 1%.2 In applying these limitations to previously adopted taxes, the Washington Supreme Court has ruled that taxes on net income are taxes on property subject to the constitutional uniformity and rate limitations.

In 1932, Washington voters approved a progressive income tax to pay for education, but the Washington Supreme Court, in Culliton v. Chase,3 found the tax to be invalid under the state constitution and advised that in order for a progressive income tax to be valid, it must come from a voter-approved constitutional amendment. However, Washington voters have rejected six constitutional amendments that would have allowed for the imposition of a progressive income tax, as well as four income tax initiatives.

In other cases, the Washington Supreme Court has held that taxes on a particular use or enjoyment of property, or on a voluntary act or privilege as distinct from mere ownership, are characterized as excise taxes not subject to constitutional uniformity and rate limitations.4

Imposition of tax The LTCG tax is imposed on the sale or exchange of long-term capital assets in excess of $250,000.5 The amount of the tax is 7% of an individual’s “Washington capital gains,”6 which is an individual’s “adjusted capital gain,” after certain deductions.7 “Adjusted capital gain” means federal net LTCG with specified adjustments under the legislation.8 Capital losses are not allowed to be carried forward or back, and the tax does not apply to short-term capital gains.9 The tax only applies to Washington "resident”10 individuals and does not apply to corporations or other entities.

Allocation and apportionment LTCG from the sale or exchange of tangible personal property are allocated to Washington if at the time of the sale or exchange, the property was located in the state. In addition, a sale is allocated to Washington even if the property was not located in the state at the time of the sale if: (i) such property was located in the state at any time during the taxable year or the preceding taxable year; (ii) the taxpayer was a resident when the sale occurred; and (iii) the taxpayer is not subject to tax on the LTCG by another jurisdiction.11

LTCG from the sale or exchange of intangible personal property, such as stocks, are allocated to Washington if the taxpayer was domiciled in the state at the time of the sale or exchange.12 However, a credit is allowed against the tax imposed for the amount of tax paid by the taxpayer to another jurisdiction on capital gains derived from capital assets within the other jurisdiction to the extent those gains are included in the taxpayer’s Washington capital gains.13

Exemptions and deductions Exemptions from LTCG tax The LTCG tax does not apply to the sale or exchange of real estate transferred by deed, real estate contract, or other legal instrument,14 interests in a privately held entity to the extent capital gains are directly attributable to the real estate owned,15 and assets held under retirement savings accounts.16 Other exemptions include: assets sold or exchanged with respect to condemnation proceedings; cattle, horses, or breeding livestock, under certain conditions; certain depreciable property used in a trade or business; timber, timberlands, dividends, and distributions from real estate investment trusts derived from gains from the sale or exchange of timber or timberlands; commercial fishing privileges; and goodwill from the sale of auto dealerships licensed under Washington law.17

Deductions from Washington capital gains Taxpayers are allowed a standard deduction of $250,000 per individual,18 adjusted capital gains from the sale or exchange of a taxpayer’s interest in a qualified family-owned small business,19 and up to $100,000 of charitable donations to Washington organizations20 from their Washington capital gains that would otherwise be subject to the LTCG tax. In order to qualify for the family-owned small business deduction, a taxpayer must meet the following criteria: (i) the taxpayer held a qualifying interest for at least five years immediately preceding the sale; (ii) the taxpayer or the taxpayer’s family materially participated in operating the business for at least five of the 10 years immediately preceding the sale; and (iii) the business had worldwide gross revenue of $10 million or less in the 12-month period immediately preceding the sale.21 In addition, the legislation also provides a business and occupation (“B&O”) tax credit, under which a credit is allowed against the LTCG tax on a sale or exchange that is also subject to the B&O tax.22

Due dates and expiration Taxpayers must file a return and pay the applicable tax on or before the due date of the taxpayer’s federal income tax return.23 Since the tax takes effect on Jan. 1, 2022, the first Washington LTCG tax return will be due in 2023. The legislation does not have an expiration date.

Commentary The enactment of this legislation has been controversial and not a single Washington Republican legislator voted in favor of the tax.24 The LTCG tax is intended to provide additional funds to support the state’s K-12 education system.25 Proponents of the tax believe that the excise tax is permissible and that it will provide the funds needed to enhance the state’s educational system. Governor Inslee claimed that the tax will provide funding for another bill he signed, H.B. 1297, which provides an expanded sales and use tax rebate for lower- and middle-income families. The rebate, modeled on the federal earned income tax credit, was created in 2008 but was never funded.

Critics of the legislation contend that while it may be characterized as an excise tax in the statute, it operates as an unconstitutional income tax. Opponents also have argued that while the tax will provide additional funds, it is an unpredictable revenue source due to market volatility. Furthermore, Washington is the home to several large publicly traded companies which provide significant stock compensation to many employees that will be impacted by the tax, likely resulting in planning and structuring to avoid the tax before it becomes effective. Lastly, and perhaps most significant to critics, they believe that the LTCG tax is the first step toward a broader, individual income tax regime.

Despite the fact that the LTCG tax will not be imposed until next year, the tax is already being challenged in court. A law firm preemptively filed a lawsuit in Washington Superior Court for Douglas County on behalf of several taxpayers on April 27, 2021, alleging the tax is unlawful and an invalid income tax under the state’s constitution.26 The plaintiffs have claimed the measure treats similarly situated taxpayers in different ways in violation of the state constitution’s uniformity clause. Given the significance of the legislation, the legal proceedings could progress all the way to the Washington Supreme Court.



1 Ch. 196 (S.B. 5096), Laws 2021. This legislation was enacted on May 4, 2021, and is effective July 25, 2021.
2 WASH. CONST. art. VII, §§ 1, 2.
3 174 Wash. 363, 25 P.2d 81 (1933).
4 See Jensen v. Henneford, 185 Wash. 209, 53 P.2d 607 (1936), and Power, Inc. v. Huntley, 39 Wash. 191, P.2d 173 (1951).
5 S.B. 5096, § 5(1). Additionally, under § 5(4), the tax applies regardless of “whether the taxpayer was the legal or beneficial owner of such assets at the time of the sale or exchange.”
6 S.B. 5096, § 4(13).
7 S.B. 5096, § 5(1).
8 S.B. 5096, § 4(1). To the extent included in calculating federal net LTCG, plus (i) any amount of long-term capital loss that is exempt from the tax; and (ii) any amount of long-term capital loss or loss carryforward that is not allocated to Washington under § 11. A subtraction is made for any amount of LTCG that is not allocated to Washington under § 11 or is exempt from the tax.
9 S.B. 5096, § 5(3).
10 S.B. 5096, § 4(10)(a) defines “resident” as an individual “(i) [w]ho is domiciled in this state during the taxable year, unless the individual (A) maintained no permanent place of abode in this state during the entire taxable year, (B) maintained a permanent place of abode outside of this state during the entire taxable year, and (C) spent in the aggregate not more than 30 days of the taxable year in this state; or (ii) [w]ho is not domiciled in this state during the taxable year, but maintained a place of abode and was physically present in this state for more than 183 days during the taxable year.”
11 S.B. 5096, § 11(1)(a).
12 S.B. 5096, § 11(1)(b). Note that the allocation provisions for tangible personal property are based on whether the taxpayer was a resident at the time the sale or exchange occurred whereas the allocation provisions for intangible personal property are based on whether the taxpayer was domiciled in the state at the time the sale or exchange occurred. The new statutes provide a definition of “resident” but do not define “domicile.” As indicated by the definition of “resident,” the terms have different meanings.
13 S.B. 5096, § 11(2)(a). (“The amount of credit under this subsection may not exceed the total amount of tax due under this chapter, and there is no carryback or carryforward of any unused credit.”)
14 S.B. 5096, § 6(1).
15 S.B. 5096, § 6(2)(a).
16 S.B. 5096, § 6(3).
17 S.B. 5096, § 6(4)-(9).
18 S.B. 5096, § 7(1). The same $250,000 standard deduction also applies to joint filers.
19 S.B. 5096, § 7(3). The qualified family-owned small business deduction is addressed in S.B. 5096, § 8.
20 S.B. 5096, §§ 7(4); 9(2); but see § 9(1) (a taxpayer may only deduct amounts of charitable donations in excess of $250,000).
21 S.B. 5096, § 8(2)(d).
22 S.B. 5096, § 16(1).
23 S.B. 5096, § 12(1)(a), (3).
24 The bill was passed in the Washington House of Representatives by a 52-44 vote and in the Senate by a 25-24 vote.
25 S.B. 5096, § 1.
26 Quinn v. State of Washington, Department of Revenue, filed in Washington Superior Court for Douglas County.



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