The New Washington State Capital Gains Tax: What You Need to Know

When President Joe Biden announced his $2 trillion infrastructure proposal, wealthy Americans presumably breathed a sigh of relief.

Despite the president’s campaign promise to increase the capital gains tax rate, the current plan makes no such changes.

When it comes to capital gains tax, though, the federal tax rate isn’t the only factor to consider. States can also set their tax rates, and some are expected to do so in the near future. The governor of Washington has suggested a capital gains tax that, if implemented, could raise about $1 billion.

Read on for more useful information about the new Washington state capital gains tax.

What is Washington gain tax? 

Capital gains tax is the tax you pay after selling an asset that has increased in value. Stocks, real estate, and cryptocurrency are among assets subject to capital gains tax. The profit you made from the transaction is subject to capital gains tax.

The way capital gains are taxed varies from state to state. Capital gains are generally taxed as income in the majority of states. In states that do this, the state income tax applies to both long- and short-term capital gains.

Washington doesn’t tax personal income or capital gains. There is currently a proposal to tax long-term capital gains earnings above $25,000 for individual filers and above $50,000 for joint filers.

The 2021 Washington State Legislature recently established a new 7% tax on the sale of long-term capital assets (including stocks, bonds, business interests, or other investments) if the gains exceed $250,000 annually. Individuals are only subject to this tax, though they may be liable for the tax due to their ownership interest in an entity that sells long-term capital assets.

The tax will go into force on January 1, 2022. The first returns will be due in 2023 on capital gains recognized during 2022.

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What assets will be subject to this new tax?

The tax is imposed specifically on long-term gains from the sale or exchange of capital assets. Ordinary income, short-term capital gains, dividends, and interest are thus all exempt from taxation. Certain asset types are also excluded, the most notable of which is real estate (whether held directly or through a privately owned entity). Assets held in retirement accounts and holdings in qualifying family-owned small companies are among the other exclusions.

The legislation defines a “family-owned” small business as one with gross worldwide receipts of $10 million or less in the 12 months preceding the sale. A qualified transaction involves the sale of 90% or more of the company’s assets or 90% or more of the individual taxpayer’s equity in the company.

An annual standard deduction of $250K is available to each individual and a married couple (unlike federal law, married couples are not allowed a higher shared amount). An additional $100K deduction is allowed for charitable contributions above $250K made to a Washington-based non-profit. Capital gains that exceed the deductible amount are taxed at a rate of 7%, with a limited credit possible if the taxpayer pays income or capital gains taxes to another state.

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How will this new tax be reported and paid?

Only those who owe capital gains tax are required to file a capital gains tax return and a copy of their federal tax return for the same taxable year. The taxpayer’s capital gains tax return must be filed at the same time as their federal income tax return. Taxpayers who receive a filing extension for their federal income tax return will also get the same filing extension for their capital gains tax return. However, a filing extension does not extend the deadline for paying the capital gains tax owed.

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What is the controversy around this tax?

Opponents of the capital gains tax had claimed that it violates the Washington State Constitution (both before and after it was enacted). The state constitution, in particular, demands uniform property taxes (i.e., a single tax rate on all property of the same class) and restricts the tax rate to 1%. Because income is considered a kind of property under Washington case law, the capital gains tax would violate both of these laws if it were found to be an income tax.

According to the state legislature, the tax is an excise imposed on the sale or exchange of capital assets. The legislature attempts to avoid the constitutional issue by classifying the tax as an excise or privilege tax rather than a tax on income.

Douglas County has received two lawsuits opposing the tax. Each lawsuit seeks the court to halt the state’s tax collection until the dispute is resolved. Other lawsuits may be filed.

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The bottom line

Washington state has instituted a 7% capital gains tax on Washington’s long-term capital gains over $250,000 starting January 1, 2022. The tax is generally imposed on Washington resident individuals, but the tax may also apply to nonresidents of Washington. Individual owners and beneficial owners of property that generate long-term capital gains should consider the impact of this tax.

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