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Politics

Judge overturns Washington state's new capital gains tax

A gavel on a countertop

A judge has overturned a new capital gains tax on high-profit stocks, bonds and other assets that was approved by the Washington Legislature last year, ruling that it is an unconstitutional tax on income.

In his written decision issued Tuesday, Douglas County Superior Court Judge Brian Huber agreed with opponents of the new tax who had argued it was a tax on income that violates previous state Supreme Court rulings and the state constitution because it is not a uniform taxation on property.

Huber cited several elements of the law that he said “show the hallmarks of an income tax rather than an excise tax," including a reliance on federal IRS tax returns that must be filed by Washington residents, the fact it is levied annually instead of at the time of the transaction, and that it is based on an aggregate calculation of capital gains over the course of a year.

“The State characterizes the new tax statute as a 'tax that applies on the sale or transfer of property' and argues that such taxes are excise taxes,” he wrote. “But as noted above, the new tax is not levied upon ’the sale or transfer' of capital assets. Instead, the new tax statute levies a tax on receipt, and thus ownership, of capital gains.”

Attorney General Bob Ferguson said in an email Tuesday his office would appeal to the state Supreme Court.

“There’s a great deal at stake in this case, including funding for early learning, child care programs, and school construction," he wrote. “Consequently, we will continue defending this law enacted by the peoples’ representatives in the Legislature.”

The measure imposed a 7% tax on the sale of stocks, bonds, and other high-end assets in excess of $250,000 for both individuals and couples. It was projected to bring in $415 million in 2023, the first year the state would see money from the tax.

The legal challenge stems from two lawsuits that were later consolidated. The first was filed last April by The Freedom Foundation, an Olympia-based conservative think tank. A month later, former Washington Attorney General Rob McKenna filed the second on behalf of state residents including manufacturing business owners, investors, and the Washington State Farm Bureau.

“Washington’s courts have twice rejected previous efforts by the legislature to enact an unconstitutional income tax, while Washington’s voters have rejected 10 straight ballot measures, including six proposed constitutional amendments, that would have created a graduated state income tax," McKenna said in a statement. “Judge Huber’s decision rightly upholds those precedents and honors the voters’ clearly state preference that we remain a state without a graduated income tax.”

Supporters of the tax say that Washington — one of a handful of states with no income tax on wages — leans too heavily on its sales tax, disproportionately affecting those with less income. When the governor signed the new tax into law last May, Washington joined 41 states plus the District of Columbia in having a capital gains tax.

Retirement accounts, real estate, farms and forestry were all exempt from the tax. Business owners were also exempt from the tax if they are regularly involved in running the business for five of the previous 10 years before they sell, own it for at least five years, and gross $10 million or less a year before the sale.

Under the new law, taxpayers could deduct up to $100,000 a year from their capital gains if they made more than $250,000 in charitable donations in the same tax year, something Huber cited in his ruling, noting that like “an income tax and unlike an excise tax, the new tax statute includes a deduction for certain charitable donations the taxpayer has made during the tax year.”

Because the state wasn't set to see any revenue from the tax until next year, it does not affect the work being done by lawmakers on the state supplemental budget this year.

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