The Washington State Supreme Court has recently ruled that the excise tax on long-term capital gains is constitutional and valid. As such, the Washington State Department of Revenue will continue collecting the tax which is due April 18, 2023.
The 2021 Washington State Legislature recently passed ESSB 5096 (RCW 82.87) which creates a 7% tax on the sale or exchange of long-term capital assets such as stocks, bonds, business interests, or other investments and tangible assets that exceed $250,000. Only the portion of long-term capital gains above the threshold is subject to the tax and some assets are exempt from the tax. There are several deductions and exemptions available that may reduce the taxable amount of long-term gains, including the annual standard deduction of $250,000. The standard deduction applies per individual, married couple, or domestic partnership, except that in the case of spouses or domestic partners, the combined standard deduction is limited to $250,000 regardless of whether they file joint or separate returns.
The tax takes effect on Jan. 1, 2022, and the first payments are due on or before April 18, 2023.
Who owes the tax?
The tax applies to individuals. However, individual owners of entities that are pass-through or disregarded entities for federal tax purposes may owe Washington’s capital gains tax on gains from sales or exchanges made by such entities. Examples of pass through or disregarded entities include sole proprietorships, partnerships (limited liability or general), limited liability companies (LLCs), corporations electing Subchapter-S (S-corps), grantor trusts, and non-grantor trusts that would be includable in the grantor’s estate (sometimes called “incomplete gift non-grantor trusts”). Additionally, although non-grantor trusts are, generally, not subject to the Washington long-term capital gains tax, Washington beneficiaries of non-grantor trusts who receive distributions of long-term capital gains exceeding $250,000 may be subject to the tax on those distributions.
Individuals who are legally domiciled in Washington are generally subject to the tax, and individuals who are not legally domiciled in Washington (and who are in the State of Washington less than 183 days per year) are generally not subject to the tax (unless they recognize gain on the sale of tangible capital assets that are located in Washington).
The below questions from the Washington State Department of Revenue’s “Do you owe
capital gains” information may help you determine if you may owe any capital gains tax:
- Reporting to the IRS
Did you report long-term capital gains on your federal income tax return on Schedule D for this year?
If you answer Yes to the above question, continue to the Assets and Domicile section. - Assets and Domicile
If the long-term capital gains were from selling intangible assets, were you domiciled in Washington State at the time of sale (was Washington your permanent home at the time)?
Did you report long-term capital gains from selling tangible personal property that was located in Washington when it was sold?
Did you live in Washington State for more than 183 days during the taxable year?
If you answered Yes to any of the above questions, continue to the Amount section. - Amount
Was your amount of Washington State net long-term capital gains more than $250,000 after all exemptions, such as real estate or investments held in individual retirement accounts? See RCW 82.87.050.
If you answered Yes to the above question, you may owe Washington State capital gains tax.
Example 1:
One of the founders of a Washington company resides in Washington. If this founder realizes a $1,250,000 gain on the sale of founders’ stock in the Washington based company, they will pay the 7% flat tax on that $1,000,000 of the gain. If they sell a capital asset located in another state for a $1,000,000 gain, they probably also pay the 7% tax on that gain because they are a Washington resident.
Example 2:
Another founder in the same Washington-based company referenced in the above Example lives in Texas. This founder also realizes a $1,250,000 gain on the sale of founders’ stock in the Washington-based company. But they do not pay the 7% Washington State capital gain tax on this gain. Further, if they sells capital assets located in their home state of Texas and realizes another $1,000,000 of gain, Washington State does not tax that income.
- The property was located in Washington at any time during the taxable year in
which the sale or exchange occurred or the immediately preceding taxable
year; - The taxpayer was a Washington State resident at the time the sale or exchange occurred; and
- The taxpayer is not subject to the payment of an income or excise tax legally imposed on the long-term capital gains or losses by another taxing jurisdiction.
How to report and pay the tax
Only individuals owing capital gains tax are required to file a Washington State capital gains tax return, along with a copy of their federal tax return for the same taxable year. The capital gains tax return is due at the same time as the individual’s federal income tax return is due. Individuals who receive a filing extension for their federal income tax return are entitled to the same filing extension for their capital gains tax return. However, a filing extension does not extend the due date for paying the capital gains tax due.
Penalties will apply to late returns. Additional penalties and interest will apply to late payments.
Exemptions
The sale or exchange of the following assets are exempt from the Washington capital gains tax:
- Assets held in certain retirement accounts.
- Interests in a privately-held entity to the extent that the capital gain or loss from such sale or exchange is directly attributable to the real estate owned directly by such entity
- Real estate.
- Assets subject to condemnation, or sold or exchanged under imminent threat of condemnation Certain livestock related to farming or ranching.
- Timber, timberlands, and dividends and distributions from real estate investment trusts derived from gains from the sale or exchange of timber or timberlands.
- Commercial fishing privileges.
- Goodwill received from the sale of a franchised auto dealership.
Deductions
The following deductions apply:
- A standard deduction of $250,000 per year per individual, married couple, or domestic partnership. This amount is adjusted for inflation annually.
- The long-term capital gain from an individual’s sale of all or substantially all ofa qualified family-owned small business.
- Charitable donations in excess of $250,000 per year per individual. The charitable donations deduction cannot exceed $100,000 per year per individual. These amounts are adjusted for inflation annually.
Credits
The following tax credits are available:
- A business and occupation (B&O) tax credit for B&O taxes due on the same sale or exchange which is subject to the Washington capital gains tax
- A Washington capital gains tax credit for the amount of any legally imposed income or excise tax paid by the individual to another taxing jurisdiction on capital gains derived from capital assets within the other taxing jurisdiction to the extent such capital gains are included in the individual’s Washington capital gains.
Tax-Planning Strategies
- Utilize a C-Corporation (regular corporation) to own the capital assets;
- A taxpayer may consider changing residency/domicile to a different state. If an individual is not a resident of Washington and has established legal domicile in a different state, and stays less than 183 days per year in Washington State the capital gains that would otherwise be due on most capital assets can be avoided.
- Average out realized capital gains, so that no tax year reports over $250,000 of net long-term capital gains;
- Gifting assets to an irrevocable trust(s), and/or to other family members; or
- Recognize long-term capital losses to net against long-term capital gains.
This informational should be considered a starting point to provide a framework to comply with the new Washington State capital gains tax law. This information is only intended to summarize the content and applicability of the law in very general terms, and is not intended to provide legal advice or opinion. If you think that you, or your pass-through or disregarded business entity, might owe long-term capital gains taxes, please be sure to schedule a consultation with your CPA.