Effective January 1, 2022, Washington has implemented a 7% tax on the sale or exchange of capital assets resulting in long-term gains in excess of $250,000. Revenue from the tax will be used to fund the Washington State statutory Education Legacy Trust Account and Common School Construction Fund.
Although the constitutionality of this tax was challenged in court, the Washington State Supreme Court upheld the law in its decision on March 24,2023. The Court determined that the capital gains tax is an excise tax – i.e., a tax on specific transactions, not on income – and therefore constitutional. The first payments and tax returns (or extensions) are due April 18, 2023 for the 2022 tax year.
The 7% tax will apply only to long-term capital gains over $250,000 for both individuals and married couples. Ordinary income, short-term gains, gain from real estate transactions, qualified dividends and tax-exempt interest are excluded. It’s important to note that while short-term losses may be used to offset long-term capital gains at the Federal level, they cannot be used for the purposes of the Washington State tax. The current threshold of $250,000 is applied as a standard deduction and will be adjusted annually for inflation.
Only individuals owing capital gains tax are required to file a capital gains tax return. I.e., if your total long-term capital gains do not exceed $250,000, you do not need to file a Washington return to claim the standard deduction. However, if you are above the threshold, you should report all transactions even if an exemption or deduction applies.
Additional deductions exist for long-term capital gains resulting from the sale of all—or substantially all—of a qualified family-owned small business, and for charitable donations in excess of $250,000 per year, per individual. The charitable donation deduction is limited to $100,000 per year, per individual, and applies only to donations made to charities managed or directed in Washington State. These amounts will be adjusted annually for inflation.
The tax will only apply to gains allocated to Washington State. This means that if you pay capital gains tax to another jurisdiction (U.S. states or territories) on an asset sold in another jurisdiction, a credit will be available on Washington taxes up to the amount of tax already paid. No credit carryforward will be allowed. This also means that tangible personal property sold in Washington may result in tax being owed, even if the owner of that property is not a Washington resident.
To avoid double taxation, a Business & Occupation tax credit is included for B&O taxes due on the same sale or exchange for which Washington capital gains tax is due. Capital gains from corporations and other entities are exempt unless the entity is a pass-through entity for income tax purposes, such as a partnership, LLC, or S-Corporation. In the case of pass-through entities, the tax is applied at the level of the individual owner of an interest in the entity, not on the entity itself. This means that individuals may be required to report and pay tax on transactions from which they have not yet received any distributions.
Most non-grantor trusts should be exempt from this tax because the trust itself pays taxes, rather than the grantor. However, non-grantor trusts to which an “incomplete gift” has been made for Federal gift tax purposes may still be subject to the tax. In addition, capital gains distributed to Washington resident beneficiaries from a non-grantor trust may still be taxable. If either situation applies to you, you should consult your tax advisor. The tax does applyto capital gains in a grantor trust (including revocable trusts, most SLATs and intentionally defective grantor trusts), however, the gains pass through to the grantor’s individual income tax return.
Several exemptions to this tax exist, including the sale or exchange of the following assets:
- Real Estate
- Interests in privately held entities to the extent any gains are attributable to real estate directly owned by that entity
- Certain retirement account assets
- Assets subject to condemnation (or assets sold or exchanged due to imminent threat of condemnation)
- Sales or exchanges of certain depreciable assets used in a trade or business
- Certain livestock related to farming or ranching
- Timber, timberlands, and dividends and distributions from Real Estate Investment Trusts derived from the sale or exchange of timber/timberlands
- Commercial fishing privileges
- Goodwill received from the sale of a franchised auto dealership
Both the tax return and payment are due at the same time as Federal tax returns and payments. Extensions for filing Federal tax returns will also apply to the capital gains tax return, however, the filing extension will not extend the due date of the payment. Refunds are available for overpayment of the tax if a later-filed return shows a lesser amount of tax due.
Significant penalties exist for both failure to pay and failure to file and are assessed independently. The penalty for failure to pay can reach a maximum of 29% within 3 months, while the penalty for failure to file can reach a maximum of 25% within 3 months. Interest will be applied to both the amount of tax due, and the amount of penalty owed as well.
Potential Action Items
- Consider tax loss harvesting to offset long-term gains, when appropriate, keeping in mind that short-term capital losses may not be used to offset long-term gains for the purpose of this tax.
- Spread large gains over multiple years in order to keep the realized gains in a given year under the threshold for the tax.
- Note that if you receive payments for an installment sale and the original sale took place prior to January 1, 2022, no Washington capital gains tax will be due on any of the payments you receive.
- Utilize highly appreciated assets for charitable donations or gifts to lower-income beneficiaries.
- This could include the use of Charitable Remainder Trusts to maintain an income stream from the assets, or the use of other non-grantor trusts.
- For those considering a change of residency, consider doing so prior to selling assets with large capital gains.
While the action items noted above may help reduce or eliminate tax owed in a given year, no action should be taken prior to consulting a tax professional. Your Freestone Client Advisor can help with an initial review and discussion of your situation, and can connect you with a skilled tax professional, if needed. Additional information regarding the tax and how to file can be found at the Washington Department of Revenue website.
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Important Disclosures: Nothing in this article is intended to provide, and you should not rely upon it for, accounting, legal, or tax advice or recommendations. We are not making any specific recommendations regarding any specific tax strategy, and you should not make any financial planning or tax decisions based on the information in this article. The intention of this article is educational, and it is intended only to discuss a few limited aspects of a very complex legislation. This article is not a comprehensive or complete summary of considerations regarding its subject matter. Each individual is in a different situation and has different items to address, and the options in this article are not appropriate for everyone. Please consult your Freestone client advisor and tax advisor regarding options specific to your needs.