Washington State’s Capital Gains Tax: What it is and how you can prepare

As of March 1, 2022, Douglas County Superior Court Judge Brian Huber struck down Washington’s new capital gains tax. While supporters characterize it as an excise tax, critics say it’s an income tax and directly violates the state’s constitution. The issue will move to the state supreme court to decide if it ends up on the ballot for voters. Check back soon for more information. 

In April 2021, the state of Washington’s Legislature passed a state capital gains tax for individuals with Washington allocated gains. This 7% tax will be charged on long-term investments. The proceeds will fund early education and childcare programs for the state, and are expected to total nearly $415 million starting in 2023.

The tax will become effective January 1, 2022, and will not affect capital gains recognized in 2021. As of May 2021, there are two known lawsuits filed to challenge the legality of the tax under Washington state law. It is not yet known if these court cases will affect the viability of the tax or not.

While short-term capital gains and ordinary income are excluded, most gains from  long-term investments will be subject to the 7% tax. Gains from certain assets are exempt, including depreciable assets used in a trade or business, retirement account assets, real estate, livestock sales, and timber.

Long-term gains from the sale of qualified family-owned small businesses can also be deducted. Most tax filers will be able to deduct $250,000 of long-term capital gains before calculating their tax liability. Married couples filing separately are the only type of filer limited to a $125,000 deduction. (Thus a single taxpayer will still have a $250,000 deduction.) Taxpayers can also receive a deduction with a charitable donation of up to $100,000 to certain charities.

Washington taxpayers have about six months to prepare for the tax, assuming the tax is not overturned. What is good about capital gain taxes is that the timing is often controllable. One strategy for minimizing tax liability includes relocating/establishing residency in another state. Some less dramatic avoidance strategies include smoothing out capital gains, so that no year has over the $250,000 amount, or consider recognizing capital gains in 2021 to avoid the tax altogether.

Similarly, gifting is another way to plan for an added tax burden by sending assets to lower income family members. For additional information, check out Washington’s Department of Revenue.

As more changes and updates unfurl, we know it can be tough to stay ahead of the curve. Our advisors are here to help guide you through any tax policy changes that may come into effect. If you have questions about how the capital gains tax affects your finances or want to explore strategies to increase your tax efficiency, contact your Aldrich Advisor.