The Washington State Legislature passed Senate Bill 5096 at the conclusion of the 2021 legislative session, enacting a state capital gains tax, which Governor Jay Inslee signed into law May 4, 2021.
The tax is a 7% tax, applicable to net long-term gains on capital assets (stocks, bonds, business interests, and other investments/tangible assets) over the standard deduction (of $250,000) and applicable exemptions each calendar year. It is set to take effect January 1, 2022, with the first tax payments due on or before April 17, 2023 (for the calendar year 2022).
Who does this apply to?
The tax is imposed specifically on long-term capital gains derived from the sale of capital assets. Other investment income, such as short-term gains, dividends, and interest are excluded. Taxpayers subject to the tax include individual persons and not business entities – however, gains from the sale of property held via a passthrough or disregarded entity are still deemed to be allocated to the individual owner(s).
Nonresident taxpayers may also be subject to the tax on any capital gains derived from tangible property located within Washington, but only those domiciled in the state are subject to tax on gains from intangible assets.
Each individual or married couple is allowed an annual standard deduction of $250,000 per calendar year (indexed for inflation), while married taxpayers filing separately are eligible for a standard deduction of $125,000 each. Filing status for the Washington capital gains tax return must agree with how taxpayers filed for federal income tax purposes.
A copy of your federal income tax return for the related calendar year must be included with the state capital gains return and taxpayers will be required to reconcile federal net long-term capital gains to Washington net long-term capital gains, by accounting for applicable exemptions and deductions.
Exemptions, deductions, and credits
There are several exemptions from the tax, most notably are exclusions for sales/exchanges of real estate (and interests in business entities to the extent gains/losses relate to real estate), assets in retirement accounts, certain livestock related to farming/ranching, assets used in a trade or business to the extent they are depreciable or qualify for expensing under internal revenue code, and timber/timberlands.
In addition, there are also deductions and credits available (in addition to the $250,000 standard). The law also provides for an exemption for charitable donations over $250,000 but limits the deduction to $100,000 per year per taxpayer. An additional deduction is available for long-term capital gains from the sale of ‘all or substantially all of a qualified family-owned business,’ which has additional tests to determine eligibility.
Credits are available for a.) B&O taxes due and paid on the same sale/exchange subject to the capital gains tax and b.) taxes paid to another jurisdiction on capital gains to the extent such gains are included in Washington capital gains.
As mentioned, the tax allows for a family-owned small business deduction but has numerous qualifiers to determine eligibility. The deduction does not apply to any business that had more than $10M (indexed for inflation) in gross receipts in the 12 months preceding the sale and only applies when ‘substantially all’ of the business assets and/or taxpayers’ interest in the business are sold. ‘Substantially all’ refers to 90% or more for purposes of this test.
Certain characteristics must exist to be considered ‘family-owned,’ including a requirement to have held a ‘qualifying interest’ in the business for at least 5 years preceding the sale. A ‘qualifying interest’ includes a.) ownership as a sole proprietor, b.) ownership when the individual and family members own at least 50% of the business, or c.) ownership when the individual and family members own at least 30% of the business and either i.) 70% of the business is owned directly or indirectly by members of two families or ii.) 90% of the business by three families.
Additionally, family members claiming the deduction must have materially participated 5 of the 10 years preceding the sale, unless the sale is to another family member, in which case the material participation requirement is waived.
Does a state capital gains tax violate the Washington State Constitution?
A state capital gains tax in Washington has been a topic of discussion for the past few years, ever since Governor Jay Inslee initially proposed the idea as part of his 2015-2017 budget proposal. The tax has been and remains a subject of controversy as those opposed continue to argue that it violates the Washington State Constitution, which does not permit a state income tax.
According to the law, the tax is considered an excise tax imposed on the sale or exchange of capital assets, which some argue is attempting to circumvent to issue of constitutionality. Multiple lawsuits have been filed as to whether the tax is constitutional, but lawmakers are optimistic it will survive legal challenges.
Questions? Get in touch.
Please contact Shannon & Associates with any questions as we continue to monitor developments surrounding the state capital gains tax.
By Kevin Klinkman