The Washington State Supreme Court in Quinn v. Washington recently upheld the state's 7% excise tax on certain capital gains exceeding $250,000 in a calendar year. As a result, individual taxpayers in a state that does not impose a net income tax just became subject to capital gains excise tax and new filing requirements. Payment of the tax was originally due on April 18, 2023, with an extension for returns (but not payments) to October 16, 2023, for individuals who made a valid extension request with the Washington Department of Revenue (DOR). In July, the Washington DOR released draft rules, which clarify definitions and offer guidance on exemptions, deductions, and allocation of gains.

With the end of the controversial tax's inaugural year fast approaching, this article explains the background of the new levy, discusses who is subject to it, and how to calculate it.

Background

At issue before the Washington State Supreme Court in Quinn was whether the capital gains tax was a property tax or an excise tax. Washington's constitution prohibits the state from imposing a non-uniform property tax, which may include income derived from property. The court concluded that the capital gains tax was an excise tax because it is levied on the sale or exchange of capital assets and not on the assets themselves.

The tax took effect on January 1, 2022, but in March 2022, a lower state court found that the tax violated the Washington state constitution's uniformity provision. Pending its consideration of the issue, the Washington State Supreme Court stayed the lower court's ruling but allowed the Washington DOR to collect the tax and establish an online system for taxpayers to report and pay the levy. The Quinn decision allowed the Washington DOR to enforce the collection of the tax, which was due on April 18, 2023.

Imposition

The capital gains excise tax is imposed on the sale or exchange of long-term capital assets on or after January 1, 2022. The tax only applies to individuals, including individuals who are beneficial owners of qualifying assets held by a pass-through entity or trust to the extent of the individual's ownership in the entity. The tax applies to an individual's long-term capital gains exceeding $250,000 from the sale or exchange of certain long-term capital assets, such as stocks and bonds that are allocated to Washington. Married individuals and domestic partners are treated as one individual for purposes of the tax, regardless of whether they file joint or separate federal income tax returns.

The capital gains excise tax applies to both sales of tangible personal property and intangible property, each with separate allocation rules.

Capital gains from the sale of tangible personal property beneficially or legally owned by the taxpayer are allocable to Washington in two ways: (1) the tangible personal property was located in Washington at the time of the sale; or (2) the property was located in Washington at any time during the taxable year of the sale or the year preceding the year of the sale, the taxpayer was a Washington resident at the time of sale, and the taxpayer was not subject to income or excise tax on the long-term capital gain or loss by another taxing jurisdiction.

Domicile or Resident?

The term resident means (1) any individual who was domiciled in Washington during the taxable year, unless the individual during the taxable year had no permanent place of abode in Washington, maintained a permanent place of abode outside of Washington, and spent less than 30 days in Washington, or (2) any individual who was not domiciled in Washington during the taxable year, but maintained a place of abode in Washington and was physically present in Washington for more than 183 days during the taxable year.

Capital gains from the sale or exchange of intangible personal property, which includes intellectual property, such as software, and stock in corporations, beneficially or legally owned by an individual taxpayer are allocable to Washington if the taxpayer was domiciled in the state at the time of the sale or exchange. Here, the statute uses the term domiciled as opposed to resident for purposes of allocating the gain from the sale of intangible personal property.

Domicile is not defined in the statute. The draft regulations state that domicile "means a permanent place of abode, coupled with the intent to make the abode one's home." It is a place where a person has physically lived, regards as a home, and intends to return to, even if currently residing elsewhere. A person may be a Washington resident but not a domiciliary of Washington for purposes of the capital gains excise tax because the term domicile is defined by reference to a person's physical presence in addition to intent to live in or return to such location indefinitely (domiciliary intent).

Calculating the Tax

To determine Washington's capital gains excise tax, taxpayers start with their federal net long-term capital gain. Certain adjustments are made, like subtracting capital gains and losses allocated to places other than Washington. The sale or exchange of certain types of assets is excluded from the tax. These include transactions involving real estate, assets held in retirement accounts, and certain transactions involving livestock. The law further provides deductions for charitable donations and qualified family-owned businesses.

Taxpayers are allowed a credit against the tax equal to the amount of any income or excise tax paid by the taxpayer to another taxing jurisdiction on capital gains to the extent such capital gains are included in the taxpayer's Washington capital gains. This credit applies to both tangible and intangible personal property located in the other tax jurisdiction.

Reporting the Tax

The capital gains excise tax is reportable in the same tax year as the individual's federal income tax. Individuals must provide a copy of their federal tax return for the same taxable year with the capital gains excise tax return. An individual is entitled to an extension to file a capital gains excise tax return if the taxpayer provides proof of a federal income tax extension. Filing an extension does not extend the payment of tax. Individuals who have exempt capital gains or less than $250,000 capital gains allocated to Washington are not required to file a return. Unless an individual obtains an exception, the tax must be paid electronically.

The Takeaway

The Washington State Supreme Court recently upheld the state's capital gains tax, labeling it as an excise tax, rather than a property tax. Taxpayers, who were not subject to state capital gains excise tax given the state's lack of an income tax, must now file a capital gains excise tax return. To find out how the new capital gains excise tax impacts your situation, contact a member of Andersen's State and Local Tax Team.