For more than 150 years, Washington state residents and nonresidents didn’t have to pay individual income taxes sourced to the state, but that’s about to change. And executives of large companies based in the state—including Amazon.com Inc., Microsoft Corp., Costco Wholesale Corp., Starbucks Corp., T-Mobile US Inc., and others—will be affected.
Gov. Jay Inslee signed S.B. 5096 in May 2021, creating a 7% excise tax on net long-term capital gains in excess of $250,000 for individuals. The new tax, which took effect on Jan. 1, 2022, has stirred up so much debate among Washingtonians that opponents launched a court challenge. They won a tthe trail court level, when the Douglas County Superior Court deemed the tax unconstitutional, but the state appealed the ruling.
On Jan. 26, 2023, the Washington State Supreme Court heard arguments that centered on whether the tax on long-term capital gains is an excise tax (triggered from sale or exchange) or is an income tax (generated due to the recognition of income), and whether the capital gains tax is constitutional. A decision won’t be made until after the April 18 deadline for the first excise tax payment. Taxpayers must make excise tax payments while the decision is pending to stay compliant with the law.
The calculation for the excise tax is relatively straightforward; the tax savings come from understanding the law’s nuances. The starting point is the federal net long-term capital gains or losses, defined as the excess of long-term capital gains over the long-term capital losses for the taxable year. A strategy to reduce the tax is to harvest long-term capital losses in a year the taxpayer expects to generate significant long-term capital gains.
The federal net long-term capitals gains are reduced by all capital gains and losses not allocated to the state. If you’re a Washington resident, all capital gains and losses are allocated to the state. If you’re not a state resident, only the capital gains sourced to the state are taxable. For example, if a California resident sold their business located in Washington state in an asset sale, the long- term capital gain is allocable to Washington.
An opportunity to reduce the Washington excise tax is for Washington non-residents to structure the sale of the business as a stock sale as compared to an asset sale. In this manner, the capital gain is considered an intangible and not subject to the Washington excise tax.
Any loss carryforwards reported on the federal return are removed. A deduction is permitted for donations made to charities directed or managed in Washington state. The amount of the charitable deduction is equal to total charity less $250,000 subject to a maximum deduction of $100,000 per year. The charitable deduction provides for a $7,000 maximum tax savings and may offer taxpayers incentive to donate to Washington state’s qualified charities.
A qualified family-owned small business deduction is permitted if certain requirements are met, such as a five-year holding period, and gross revenue must be $10 million or less. Other less-common deductions exist. Taxpayers, whether filing jointly or separately, reduce the income by a $250,000 standard deduction.
After the above modifications, the taxpayer arrives at their taxable amount, which is multiplied by a flat 7% tax rate to arrive at the Washington excise tax. The excise tax is further reduced by a credit for taxes paid to other jurisdictions on the same gains. The net amount is the excise tax due.
Long-term capital gains subject to the excise tax include gains from sale of intangible property, such as stock and bonds for Washington residents, and tangible assets allocable to Washington for both Washington residents and nonresidents. Cryptocurrency held long term by Washington residents is subject to the excise tax. Real estate gains and gains through retirement plans are exempt.
The beneficial owners of the long-term capital assets are responsible for the payment of the tax, including individuals who own pass-through entities, disregarded entities, or grantor trusts. Special rules apply to certain non-grantor trusts. Short-term capital losses may not offset long-term capital gains, and taxpayers may not carry over Washington capital losses to a future year.
Washington state generally conforms to the federal long-term capital gain recognition rules (such as installment payments). Additional guidance on this topic is pending. Credits are available for gains subject to the Washington business and occupation tax and for taxes paid to other states.
Due dates follow the federal individual income tax filing dates. The Washington excise tax due dates may be extended if the federal individual income tax return is extended. This is an extension of time to file, not an extension to pay. Penalties and interest will apply for late filings and late payments, and the online reporting system for the Washington excise tax is now live.
If the Washington excise tax is deemed unconstitutional, the state Department of Revenue must issue refunds to individual taxpayers within 30 days. Interest will accrue if the department fails to do so.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Alyssa Rausch is a senior tax manager in EisnerAmper’s private client services group. She has more than 15 years of experience in providing comprehensive tax compliance and advisory services to high net worth individuals, closely held businesses and their owners, S corporations, and partnerships.
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