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

The latest: On November 30, 2022, the Washington Supreme Court voted unanimously to allow the Department of Revenue (DOR) to start collecting the capital gains excise tax while the Court is in process of hearing the case next year. The state is expected to create an online platform for taxpayers to report and pay the tax, along with making regulations with additional guidance. 

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 the sale of long-term investments exceeding $250,000, like stocks, bonds, businesses, and other assets. Real estate and land structures are excluded. The proceeds will fund the state’s early education and childcare programs and are expected to total nearly $415 million. 

In March 2022, however, Douglas County Superior Court Judge Brian Huber struck down Washington’s new capital gains tax. Supporters say the tax could help improve equity throughout the state, while critics argue it disproportionately affects startups and damages the state’s competitiveness.  

The controversy surrounding the capital gains tax relies on categorizing it as an excise tax rather than an income tax. Washington State is one of only nine states that does not have an income tax, which is deductible at the federal level. An excise tax is a legislated tax on the sale of specific goods, services, or activities. For example, there’s a federal excise tax on coal, certain chemicals, and kerosene.  

The Supreme Court will begin to hear oral arguments to determine the constitutionality of the tax on January 26, 2023. If ruled unconstitutional, all payments made before then would be refunded.  

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.