Douglas County Superior Court Rules Washington’s Capital Gains Tax Unconstitutional

Posted on Mar 8, 2022 in Capital Gains Tax

Update: On March 25, 2022, the Washington Attorney General’s Office petitioned the Washington Supreme Court for direct review of the Douglas County Superior Court’s decision. The Supreme Court may accept direct review or may defer to the Court of Appeals to issue a decision before it accepts the case.

On Monday, March 1, 2022, the Douglas County Superior Court ruled Washington’s new capital gains tax, which took effect on January 1, 2022, violates the Washington State Constitution and is therefore invalid.

Background

Two lawsuits filed in the spring of 2021 by the Freedom Foundation and former Attorney General Rob McKenna were subsequently consolidated into a single case; the state initially asked the court to dismiss the case because no tax was due yet. After the court ruled that the suit could proceed, all parties filed motions for summary judgment asking the court to address the merits of the tax.

Ruling

The court determined that the tax is an income tax, noting that it relies on federal income tax returns and imposes the tax “on the same long term capital gains that the IRS characterizes as income under federal law.” More specifically, the judge stated:

“ESSB 5096 is properly characterized as an income tax pursuant to Culliton, Jensen, Power and other applicable Washington caselaw, rather than as an excise tax as argued by the State. As a tax on the receipt of income, ESSB 5096 is also properly characterized as a tax on property pursuant to that same caselaw.

This Court concludes that ESSB 5096 violates the uniformity and limitation requirements of article VII, sections 1 and 2 of the Washington State Constitution. It violates the uniformity requirement by imposing a 7% tax on an individual’s long-term capital gains exceeding $250,000 but imposing zero tax on capital gains below that $250,000 threshold. It violates the limitation requirement because the 7% tax exceeds the 1% maximum annual property tax rate of 1%.”

What’s Next

Although the decision is an emphatic victory for the plaintiffs, it is expected that the state will appeal the decision and that the validity of the tax will ultimately be determined by the Washington Supreme Court. Further updates will be provided as the case continues to work its way through the Washington courts.

If you have questions regarding the capital gains tax, please reach out to a member of Clark Nuber’s State and Local Tax team.

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