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Capital Gains Tax Struck Down by Washington State Judge

March 2, 2022, 6:41 PM

Washington Attorney General Bob Ferguson will appeal a trial court judge’s ruling that the state’s new tax on capital gains is an unconstitutional income tax and not an excise tax.

Douglas County Superior Court Judge Brian C. Huber struck down the tax law Tuesday, ruling in favor of groups of farmers and business owners who challenged it. He granted their motion for summary judgment, pointing to past court rulings that prohibit state income taxes.

“All the parties recognize this case will ultimately be decided by the State Supreme Court,” Ferguson said in a prepared statement. “We respectfully disagree with this ruling, and we will appeal.”

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In his ruling, Huber pointed to eight features of the tax that are the hallmarks of an income tax rather than an excise tax, including state reliance on federal tax returns to determine the tax, its levy on long-term capital gains that the Internal Revenue Service considers income, its levy annually on aggregate gains rather than at the time of transactions that create a gain, and inclusion of a deduction for charitable contributions.

As an income tax, the measure violates a state constitutional requirement that it be uniform, because the 7% tax is imposed only on gains above $250,000, Huber said. It also exceeds the allowable 1% annual property tax rate.

Huber rejected arguments from Ferguson, a Democrat, that the tax is similar to the business and occupation tax and the estate tax, which have been upheld by the Washington Supreme Court.

“The stinging rebuke issued today by Douglas County Judge Brian Huber represents just the latest in a long line of legal decisions dating back almost 100 years in this state, all reinforcing the incontrovertible truth that income taxes—whether they are disguised as property taxes, excise taxes or capital gains taxes—must treat all Washingtonians equally,” said Eric Stahlfeld, chief legal counsel of the Freedom Foundation, which represented plaintiffs in the case.

The ruling is the second from Huber in the plaintiffs’ favor. In September 2021, he said they had standing to challenge the law before it took effect because of its impact on property values and financial interests.

The 7% excise tax on gains above $250,000 a year—with several exclusions, including for real estate—is expected to apply to less than one-tenth of 1% of state residents and generate about $500 million a year. Gov. Jay Inslee (D) signed the tax into law (S.B. 5096) on May 4 last year, and it applies to realized capital gains starting Jan. 1, 2022.

Huber’s ruling came almost a month after he heard oral arguments on a motion from the plaintiffs to strike down the law and a counter motion from Ferguson to dismiss the lawsuit challenging the tax.

Robert M. McKenna with Orrick, Herrington & Sutcliffe LLP, Callie A. Castillo with Lane Powell PC, and Allison Foreman with Foreman, Hotchkiss, Bauscher & Zimmerman PLLC represent the plaintiffs, which include the Freedom Foundation, a think tank that opposes higher taxes and unions. Solicitor General Noah Purcell and Assistant Attorney General Charles Zalesky represent Ferguson and the state.

The case is Quinn v. State of Washington, Wash. Super. Ct., No. 21-2-00075-09, 3/1/22.

To contact the reporter on this story: Laura Mahoney in Sacramento, Calif. at lmahoney@bloomberglaw.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergindustry.com; Kathy Larsen at klarsen@bloombergtax.com