On March 1, 2022, the Douglas County Superior Court ruled that Washington's new capital gains tax is unconstitutional. The tax, enacted in 2021, would have imposed a seven percent tax on long term capital gains over $250,000 reported by Washington residents and other individuals on their federal income tax returns. The law went into effect on January 1, 2022, and the first tax returns would have been due at the same time the individual's 2022 federal income tax return was due.
Lawyers from Lane Powell and the Freedom Foundation joined forces representing Washington residents impacted by the tax and promptly filed suit in Douglas County, Washington, to challenge the validity of the tax on April 28, 2021. The state initially sought to dismiss the case merely because no one had yet had to pay the unconstitutional tax. After the court ruled that state law permitted the suit as a proper way to challenge the validity of a tax statute, all parties filed motions for summary judgment asking the court to address the merits of the tax.
The court's ruling found 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." The court also emphasized that, like other income taxes, it is levied annually and is based on an aggregate calculation of net gains. In so ruling, the court rejected the state's attempt to characterize the tax as an excise tax on the transaction of selling capital assets. In this regard, the court noted that, unlike excise taxes, the capital gains tax is not imposed on a transactional basis and is not based on the selling price or value of the item sold.
While the plaintiffs argued that the tax violates both the state constitution and the federal constitution, the court found it sufficient to rule that the tax violated Washington's constitution, which prohibits both graduated income taxes and income taxes with a tax rate in excess of one percent unless the rate is approved by a vote of the people. While the court's ruling today is a welcome victory, we expect the state to appeal the decision, so the fight is not yet over.
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