Washington State Capital Gains Tax
Washington State Capital Gains Tax
What is it?
On May 1, 2021, Governor Inslee signed the Engrossed Substitute Senate Bill 5096 (RCW 82.87), which established a state-wide 7% tax on long-term capital gains. After much back and forth, on March 24, 2023, the Washington State Supreme Court upheld this legislation.
What RCW 82.87 does is impose a flat 7% tax on the sale or exchange of long-term capital assets (stocks, bonds, business interest, or other investments and tangible assets) and allocates this revenue to public education and child-care programs. It is expected to bring in approximately $1 billion in revenue to these programs over the next two years.
Income, Sales, and Excise Taxes – Oh My!
An income tax is typically based on a taxpayer’s earned wages and may be levied with progressive tax rates (in which higher income results in higher marginal tax rates), flat tax rates (where each taxpayer pays the same tax rate regardless of income), or regressive tax rates (taxpayers with higher income pay lower marginal tax rates). Think of filing your taxes at the end of the year and trying to make sense of the tax brackets applied to your W-2 income (or 1099 if you’re a contractor).
A sales tax is levied on retail sales of goods and services, typically at the point of sale as a percentage on the retail cost, is charged to the end user of a good or service, collected by the retailer, and passed on to the government. Think of buying a shirt from your favorite apparel company and taxes being applied at purchase.
An excise tax is a tax on a specific good or service at the time of purchase. They are mostly paid by merchants or businesses, who pass this on to the consumer through higher prices. Think of alcohol, gasoline, or cigarettes where the tax is baked into your price at the register or pump.
Washington State is one of few states that does not have a state income tax. Instead, the State relies on revenue generated in part by its sales and excise taxes.
Crucially, in upholding the RCW 82.87, the State Supreme Court determined that this tax is a constitutional excise tax and not an income tax, which would be prohibited under the State Constitution without an amendment to allow such a tax.
Who does this apply to?
This tax applies to:
Washington State residents
Non-Washington residents with property located in Washington
Both individuals and married couples with capitals gains in excess of $250,000 (that is, if married filing jointly, the threshold is still $250,000 for a couple, not $250,000 per individual or $500,000 overall)
What does this not apply to?
Most notably, this does not apply to:
Real estate
Short-term capital gains
Dividends or interest
Assets held within retirement accounts
Smaller family-owned businesses
Corporations or other entities
Hypothetical Example
Rhonda is in a period of transition. She:
Just retired from her employer, Kraken Tech Industries, where her compensation consisted of 20,000 stock options, currently valued at $50 per share.
Has a 401(k) worth $1,500,000.
Has a Roth IRA worth $500,000;
Is looking to sell her home in Redmond, valued at $2,750,000 (on which she owes no mortgage);
Plans to move to Ellensburg to buy a home valued at $750,000.
In addition, she owns two small rental properties in Tacoma, valued together at $1,500,000 that she no longer has the energy for managing and wishes to sell these as well.
Rhonda came to McKay Wealth Management, trying to get a handle on her situation and determine her optimal path forward. With regards to the Washington State 7% excise tax:
Her 401(k) and IRA, being qualified retirement assets, will not be impacted. However, they may well come with their own tax considerations and strategies.
Her properties, including the rental properties, being real estate, will also not be impacted. However, these too will face a myriad of consequences that she and her McKay Wealth team will navigate and develop a strategy to tackle.
Her 20,000 stock options, however, may well be impacted. Were these to be exercised at one time, she could be subject to up to $52,000 in capital gains excise taxes (([20,000 x $50] - $250,000) x 0.07 = $52,500). This will be a consideration for her and her McKay Wealth team as they put together her optimal path forward.
The hypothetical investment results are for illustrative purposes only and should not be deemed a representation of past or future results. Actual investment results may be more or less than those shown. This does not represent any specific product.
Closing
This law may be of particular interest to successful small and family-owned businesses and individuals who receive stock as part of their overall compensation package. Additional strategies, such as spreading out the timing of liquidating long-term capital gain assets or making charitable contributions to Washington State qualified charities, may be deployed against the 7% excise tax.
The example above is only illustrative but highlights how we work with clients and their families to partner together and enable them to invest in their best lives. If you’re unsure of where to start, we look forward to joining you on your journey and can be reached at 206-973-4484.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give tax or legal advice.
Sources:
Boze, D. (2023, March 24). State Supreme Court breaks precedent, opens door for state income taxes ... State Supreme Court breaks precedent, opens door for state income taxes. Retrieved April 13, 2023, from https://www.washingtonpolicy.org/publications/detail/state-supreme-court-breaks-precedent-opens-door-for-state-income-taxes
Capital gains excise tax—Overview and administration. WAC 458-20-300: (n.d.). Retrieved April 13, 2023, from https://app.leg.wa.gov/WAC/default.aspx?cite=458-20-300
Capital gains tax. Washington Department of Revenue. (n.d.). Retrieved April 13, 2023, from https://dor.wa.gov/taxes-rates/other-taxes/capital-gains-tax#:~:text=Background,tax%20only%20applies%20to%20individuals
Garcia, J. (2023, April 6). How do you file a Washington State Capital Gains Tax Return? Coldstream Wealth Management. Retrieved April 14, 2023, from https://www.coldstream.com/insights/filing-a-washington-state-capital-gains-tax-return/
Google. (n.d.). Google. Retrieved May 1, 2023, from https://www.google.com/
Soper, T. (2023, March 28). Will the new capital gains tax cause businesses to leave Washington State? GeekWire. Retrieved April 14, 2023, from https://www.geekwire.com/2023/will-the-new-capital-gains-tax-cause-businesses-to-leave-washington-state/
Taylor, K. R. (2023, March 28). Controversial capital gains tax upheld in Washington. Kiplinger.com. Retrieved April 13, 2023, from https://www.kiplinger.com/taxes/washington-state-capital-gains-tax
Washington Capital Gains Tax upheld by state Supreme Court: Questions answered. Perkins Coie. (2023, March 24). Retrieved April 14, 2023, from https://www.perkinscoie.com/en/news-insights/washington-capital-gains-tax-upheld-by-state-supreme-court-questions-answered.html