A Friday ruling upholding Washington’s new state capital gains tax already has its challengers eyeing the US Supreme Court.
The state high court rejected arguments that the tax is unconstitutional, finding it is a permissible excise tax.
“The capital gains tax is appropriately characterized as an excise because it is levied on the sale or exchange of capital assets, not on capital assets or gains themselves,” Justice Debra L. Stephens wrote for the 7-2 court.
The ruling provides clarity for Washington taxpayers and the state ahead of Tax Day when the payments will be due for the first time. The high court previously ruled that the state tax department could start collecting the new levy while the case was pending.
The Freedom Foundation, a conservative think tank that represented the plaintiffs, is considering an appeal to the US Supreme Court, spokesperson Ashley Varner said in a written statement.
“The Washington State Supreme Court’s stupefying decision today to subordinate the state constitution and the expressed will of the people to the political whims of Washington’s tax-and-spend liberals should outrage every Washingtonian,” Varner said.
Washington Gov. Jay Inslee (D) and Democratic legislative leaders celebrated the ruling, while denying they plan to rely on it to seek an income tax or expand the capital gains tax.
“No,” Inslee said during a call with reporters in response to a question about plans to enact an income tax. “It’s a pretty simple one-word answer. The Republicans just delight in this bogeyman and they think it can get them elected and it hasn’t worked for 20 years.”
Tax on Transfer
A trial court struck down the tax law in May, siding with farming and business groups that argued past court rulings categorized income taxes as property taxes, which under Washington’s constitution aren’t allowed to exceed 1% annually. The tax, which took effect on Jan. 1, 2022, is 7% on gains over $250,000 per year, excluding those from retirement account sales, real estate, and certain small businesses.
Supporters argued it is a proper excise tax on transactions rather than on property. Revenue from the tax, expected to top $500 million a year, is earmarked for education and child care. The tax is among various efforts to tax the rich that continue to pop up in progressive states around the country.
The Washington Supreme Court declined to revisit its 1933 ruling in Culliton v. Chase, which held that income counts as property, based on its view that the tax focuses on the transaction of selling or transferring capital assets rather than merely owning them.
“Plaintiffs vigorously argue the taxable incident is not the transaction but the realization of capital gains beyond $250,000,” the court said. “Plaintiffs confuse the tax’s subject matter with its measure. The tax is not levied on capital gains; rather, it is measured by capital gains.”
‘Most Regressive’
The plaintiffs’ constitutional arguments fared no better. The court found the provision doesn’t implicate a fundamental right of state citizenship, which would run afoul of the federal privilege and immunities clause. And a substantial nexus exists to support the state’s taxation of gains from the sale of property located out-of-state to assuage commerce clause concerns.
The court left the door open for the plaintiffs to bring future challenges to the tax if they argue it is applied in an unconstitutional way.
The majority noted the state’s unique tax system, made up of sales, property, and business and occupation taxes rather than personal or corporate income taxes.
“Washington’s tax system has earned the regrettable title of most regressive in the nation,” the court said. “Washington’s upside-down tax system perpetuates systemic racism by placing a disproportionate tax burden” on Black, indigenous, and people of color.
Justice Sheryl Gordon McCloud authored a dissent, joined by Justice Charles W. Johnson. She would have upheld the trial court’s ruling striking down the measure, which she characterized as a tax on the realization of income, not the transfer of the asset.
“Deciding whether to retain our regressive tax structure or to replace it with a more equitable one is up to the legislature through legislation and the people through constitutional amendment,” she wrote.
Wealth Tax, Budget Implications
Sen. June Robinson (D), author of the bill enacting the capital gains tax, said Friday’s ruling clearly shuts the door on a state income tax.
“The court ruled in favor of both people who like a capital gains tax and people who are worried about an income tax this morning,” Robinson said.
But some progressive Democrats said they will turn their focus to other taxes.
“Our next step is to ensure parity in taxation on wealth,” said Sen. Noel Frame (D) author of a pending bill (S.B. 5486) to enact a wealth tax. “Middle-class homeowners have been paying property tax on their houses for decades, but the wealthiest few don’t have to pay property tax on their main source of wealth: stocks, bonds, and other financial assets.”
Inslee and lawmakers said they are relieved they can count on capital gains taxes in the state budget they are planning to enact in the next month.
“Washington has been waiting for 134 years for a fairer tax system, one where we didn’t impose an inequitable and unfair burden on the shoulders of working people,” Inslee said. “This is a truly historic day.”
Lane Powell PC and Orrick, Herrington & Sutcliffe LLP and others represented the challengers.
The case is Quinn v. Washington, Wash., No. 100769-8, 3/24/23.
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