The Washington Supreme Court published its opinion finding that the new Washington capital gains tax is constitutionally permissible in the decision of Quinn et al. v. Washington on March 24, 2023, which went into effect on January 1, 2022.
The court’s decision brings much needed clarity for taxpayers. On November 30, 2022, the Washington Supreme Court granted a stay of the Douglas County Superior Court and authorized the Washington Department of Revenue to draft regulations and enforce filing obligations and collection of tax.
Washington State’s constitution contains a clause for property tax purposes that reads, “All taxes shall be uniform upon the same class of property.” In this context, property has a very broad definition, and the Washington Supreme Court had historically held in Culliton v. Chase that a person’s income is property subject to this uniformity provision.
This has historically been understood to mean that state-imposed income taxes would be subject to these uniformity provisions, which would preclude a graduated tax rate structure like the federal income tax. The state constitution also includes a provision that state-level property tax rates cannot exceed 1%.
The Washington capital gains tax was originally challenged in Douglas County Superior Court on the grounds that the new tax constitutes a property tax, and it therefore violates the state constitution’s 1% and uniformity limits on property taxes, because it’s a 7% tax on long-term capital gains. Douglas County found in favor of the taxpayers challenging the tax and the decision was appealed directly to the state supreme court.
The supreme court’s decision reversed Douglas County Superior Court and upheld the constitutionality of the new capital gains tax on the grounds that it’s not a tax on income, but rather it’s an excise tax on individuals exercising their rights to sell the property generating the capital gain, notwithstanding the tax is measured by net capital gain.
The court reached its decision by creating a novel framework to analyze the issue that dissociates the measure of the tax, meaning net long-term capital gain, from the imposition of the tax, meaning the act of selling the property that generated the capital gain.
As a result, the Washington Supreme Court’s decision not only clears the way for the capital gains tax, but also fundamentally changes the state’s supreme court precedent on how taxes are analyzed under the state constitution’s uniformity provisions.
It’s possible this new framework could be a path to future expansions of the capital gains tax into a general income tax.
The Washington Supreme Court’s analytical framework of the nature of the tax versus labels of the tax stands in contrast to the United States Supreme Court precedent, summarized well in Trivona Corporation v. Michigan Department of Treasury, wherein the court stated "[a] tax on sleeping measured by the number of pairs of shoes you have in your closet is a tax on shoes."
This quotation has long stood for the premise that the labeling of a tax is irrelevant to determining its nature, and the nature of the imposition and measurement is the character of the tax. It’s unknown whether the taxpayers in this case will petition the United States Supreme Court for review.
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To learn more about how the Washington Supreme Court’s decision could impact you or your business, contact your Moss Adams professional. You can also learn more on our State and Local Tax page.