Washington Court Finds Capital Gains Tax Unconstitutional

On March 1, 2022, Douglas County Superior Court Judge Brian Huber concluded the Washington State capital gains tax (CGT) to be unconstitutional under the Washington Constitution. Washington Attorney General Bob Ferguson announced that he intends to appeal this decision.

This holding in Quinn/Clayton, et. al. v. State of Washington, et. al. Douglas County is in response to lawsuits challenging the 7% CGT, which was enacted with SB 5096 in April 2021. The CGT went into effect on January 1, 2022. These challenges came by way of CGT rate inconsistencies, with 0% on gains below $250,000 and 7% on gains exceeding this amount. The Washington Constitution specifically mandates that all taxes in the state must be “uniform upon the same class of property.”

For nine decades, Washington courts invalidated graduated income taxes because of this constitutional provision and the controlling precedent that income is a form of property that’s subject to this uniformity provision.

Challenges Posed to CGT

SB 5096 attempted to circumvent this restriction by characterizing the CGT as an excise tax that applies to the sale, transfer, or other disposition of property. The plaintiffs challenged that, in substance, the tax violated both the uniformity clause and the 1% property tax rate limitation of the Washington Constitution.

The Douglas County Superior Court agreed with the challengers and found that the CGT violated both Washington Constitutional provisions. Judge Huber disagreed with the state’s contention that the CGT was an excise tax on the sale, transfer, or other disposition of property.

Court Findings on CGT

Judge Huber found the incidence of tax to be on the receipt of capital gains and that the tax had multiple characteristics of an income tax, including:

  • Application to net gains rather than gross receipts
  • Aggregate calculation of all gains occurring in the year
  • Contained deduction provisions such as the charitable contributions

Having established the CGT as an income tax, and therefore a property tax, the court found it was subject to the uniformity provisions of the Washington Constitution. Judge Huber held that the CGT wasn’t uniform because the 7% rate applied to capital gains exceeding $250,000, while gains below this threshold were taxed at 0%.

Since the rate was set at 7%, the judge also found that the CGT violated the constitution’s property tax rate limitation of 1%. Consequently, the court held the CGT violated the requirements of the Washington Constitution.

Decision to Appeal

The Washington attorney general announced the decision will be appealed either to the Division III Court of Appeals in Spokane or directly to the Washington Supreme Court.

As of this writing, the judge hasn’t enjoined CGT enforcement. If the enforcement of the tax isn’t forbidden by the courts, the CGT return will be due on April 15, 2023.

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You can also find additional resources with our State & Local Tax Services.

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