Over the weekend, Washington state lawmakers passed law that provides for a tax on profits made on the sale or swap of certain investments. The bill, signed by Governor Jay Inslee on April 27, 2021, provides for a 7% tax on profits from sales of stocks, bonds and other investments in excess of $ 250,000 for individuals and married couples (regardless of) whether they submit joint or separate declarations) to fund K-12 education, early learning, and childcare from tax year 2022. The tax is presented in part as an excise tax in order to avoid the long-standing precedent that the Washington Constitution forbids concluding income tax; However, this new tax is expected to be partially challenged in court as a prohibited income tax. In addition, the legislation specifically includes a language intended to provide income for education that is constitutionally required and potentially exempt from a possible voter referendum to reject the tax.
A. Exceptions.
In addition to the $ 250,000 Capital Escape Threshold, numerous other exemptions and deductions can reduce a taxpayer’s tax liability on capital gains. There are significant problems associated with the application of these issues that the Washington Department of the Treasury (“DOR”) is expected to address in its rule-making ability. The invoice exempts the sale or exchange of certain assets from the above tax, including:
- Any real estate transferred by deed, real estate contract, judgment or other lawful instrument transferring ownership of real estate and filed as a public record with the counties in which the real estate is located;
- Participation in a privately held company only insofar as a long-term capital gain or loss from such a sale or exchange is directly attributable to the real estate that belongs directly to this company;
- Assets held in a retirement account under Section 401 (k) of the Internal Revenue Code (“Code”), a protected pension or custodian under Section 403 (b) of the Code, a deferred compensation plan under Section 457 (b) of the Code Code, an individual retirement account or annuity under Section 408 of the Code, a Roth individual retirement account under Section 408A of the Code, a defined contribution plan, a defined benefit plan or similar retirement vehicle ;;
- Assets under or under threat of conviction by the United States, Washington State or any of its political divisions or local authority;
- Cattle, horses or breeding animals if, for the tax year of sale or exchange, more than 50% of the taxpayer’s gross income for the tax year, including the sale or exchange of capital assets, comes from agriculture or animal husbandry;
- Property that is depreciable under Section 167 (a) (1) of the Code or property that is eligible for an expense under Section 179 of the Code;
- Wood, woodland, or receiving Washington capital gains as dividends and distributions from real estate mutual funds derived from profits from the sale or exchange of wood and woodland;
- Commercial fishing rights; and
- Goodwill on the sale of a dealership licensed under Chapter 46.70 of the Revised Washington Code and whose activities are governed by Chapter 46.96 of the Revised Washington Code.
In addition to the $ 250,000 tax exemption noted above, when calculating a taxpayer’s Washington Capital Gain amount, a taxpayer may also deduct the amount of Adjusted Capital Gain that results from the sale or transfer of substantially all (i.e. 90%) of the assets of the A taxpayer’s interest in a qualifying family-owned small business if such an adjusted capital gain would otherwise be included in the Washington taxpayer’s capital gains. For such purposes, “Qualifying Family-Owned Small Business” means a business in which: (1) the taxpayer has held a qualifying interest for at least 5 years immediately prior to the sale or transfer; (2) the taxpayer or members of the taxpayer’s family have been instrumental in the business for at least 5 years in the past 10 years (unless the sale or transfer was made to a qualified heir); and (3) the company had gross worldwide sales of $ 10,000,000 or less for the twelve months immediately prior to the sale or transfer in question.
Finally, a taxpayer can deduct an additional $ 100,000 from the Washington taxpayer’s capital gains amount if the taxpayer has contributed at least $ 250,000 in contributions to a Washington-run or administered charity in the same tax year.
B. Registration Requirements, Required Payments, Penalties and Criminal Actions.
- Registration requirements.
Taxpayers who owe capital gains tax under this new invoice must file a tax return with the DOR on or before the date on which the taxpayer’s federal income tax return is due for each tax year. Such returns must be submitted electronically via the DOR’s online tax return service or another method of electronic reporting approved by the DOR. The DOR can, however, waive the electronic submission requirement provided for in RCW 82.32.080 for an important reason. - Payments Required.
A taxpayer who is required to file a tax return in accordance with the new invoice must pay tax to the DOR on or before the date set for filing the tax return without any assessment, notification or request, regardless of whether the filing is extended. This payment must be made via electronic transfers in accordance with RCW 82.32.085 or via the other electronic payment methods required by the DOR. However, for an important reason, the DOR can waive the electronic payment obligation provided for in Chapter 82.32 of the revised Code of Washington. - Interest and Penalties.
If the tax due under the new bill is not paid, the taxpayer will be charged interest and penalties under Chapter 82.32 of the revised Washington Code. In addition, if a tax return is not filed under the new invoice, the taxpayer will be penalized with a 5% tax penalty due for each month or part of a month in which the tax return is not filed (maximum 25%). However, the DOR may waive or waive the latter penalty if: (1) the DOR is satisfied that the taxpayer’s failure to file the tax return was due to circumstances beyond the control of the taxpayer; or (2) the taxpayer was unable to file a tax return due under this section of the new invoice in the previous five calendar years. - Criminal acts.
Any taxpayer who knowingly tries to evade paying this new tax is guilty of a Class C crime as provided for in Chapter 9A.20 of the Revised Washington Code. In addition, any taxpayer who knowingly fails to pay this tax, make declarations, or provide information as required under the new title will be found guilty of gross misconduct, as provided in Chapter 9A.20 of the Revised Washington Code.
C. Credits.
To avoid double taxation on the same sale or exchange under the Washington Business and Occupation (“B&O”) tax regime, credit will be granted on taxes due under the B&O tax regime if that sale or exchange is also included the new capital gains will be subject to VAT. The amount of the credit will be equal to the amount of tax charged under the B&O tax system on such a sale or exchange.
As we stated at the beginning of this article, we anticipate that the new capital gains tax in Washington will have legal challenges. Accordingly, we will continue to monitor such legal challenges and review whether these challenges affect the information provided above, as well as future guidance on how to manage capital gains tax.