The controversial capital gains tax in Washington state can move forward with collection, as an official legal ruling on the legislation is set to be made next year.
The Supreme Court issued a “stay” on a previous ruling from March when a lower court ruled that the tax was unconstitutional.
That means any effects of that decision are on hold and the state can begin issuing rules and set up collection before next year’s tax due date. It will set up an online system for taxpayers to report and pay the tax.
A Supreme Court case to determine the constitutionality of the tax is set to begin Jan. 26.
The tax targeting large stock sales for Washington state residents was approved by both the state legislature and the governor in 2021. After Gov. Jay Inslee signed the measure into law, its opponents successfully blocked it in Douglas County court.
Douglas County Superior Court Judge Brian Huber sided with opponents of the new tax who argued it was an illegal income tax under the state constitution, which sharply limits income taxes. Huber said in a written decision that the tax “shows the hallmarks of an income tax rather than an excise tax” as argued by state lawmakers.
Attorney General Bob Ferguson subsequently appealed the ruling directly to the state Supreme Court. Then this summer, the state’s highest court agreed to bypass the lower appellate court and take on the case.
Ferguson requested the “stay” earlier this month.
“The Department of Revenue is pleased that the Washington State Supreme Court granted the agency’s motion to stay the Douglas County Superior Court ruling,” a DOR spokesperson said in a statement. “While the stay does not resolve the issues surrounding the constitutionality of the capital gains tax, granting it protects potential taxpayers and preserves the agency’s ability to effectively administer and implement the tax and meet statutory obligations pending a final decision from the Washington Supreme Court.”
If the court rules the tax unconstitutional, any payments made before then would be refunded.
The statewide capital gains tax placed a 7% excise tax on the sale of stocks, bonds, and businesses — the first tax of its type in state history.
The central issue for the court: Is the capital gains tax an income tax or a sales tax? Proponents of the tax say it is not an income tax but instead an excise or sales tax that only is collected when a sufficient amount of stock is sold.
In nearly every state — and within the IRS — capital gains are classified as income. But Washington is an outlier for one legal reason: It’s the only state in the nation that classifies income as property. This has thwarted any attempts at approving any form of income tax because all income taxes are therefore subject to the sharp constitutional restrictions on property taxes.
There are no such restrictions on sales or excise taxes.
The Seattle tech community was at odds with the tax. Some see it as a necessary change to the state’s regressive tax system.
Others feel that the tax is detrimental to startups and tech companies because stock frequently is used as compensation.
A letter published last year by the Washington Technology Industry Association, which represents more than 1,000 tech startups and larger companies, warned the tax will “remove a meaningful attraction and retention mechanism” for startups and “harm our competitiveness.”
The tax would apply only to capital gains of more than $250,000. And it would exempt many other potential capital gains including real estate land and structures; retirement accounts; livestock for farming or ranching; and the sale of timber and timberlands, among other exceptions.
After the law was passed, some executives and business owners cashed out their stock holdings, according to Seattle-area wealth managers who spoke with GeekWire last year.
The tax faced two lawsuits that were consolidated. The first was filed by the conservative Freedom Foundation; the second filed by former Washington Attorney General Rob McKenna, representing manufacturing businesses and the Washington State Farm Bureau, among others.
