WA State Capital Gains Tax: What It Means for You

Earlier this year, the Washington State Supreme Court (SCOWA) ruled that the capital gains tax passed by the Washington State Legislature in 2021 was constitutional, allowing the legislation to move forward. The decision impacts an estimated 8,000 households across the state.

However, we know a lot of perspectives have been shared in the news and on social media, so we’re distilling the facts and details into a digestible format.

What is the Washington State capital gains tax?

This legislation levies a 7% tax on the sale of stocks, bonds, and other capital assets on non-retirement accounts where the profit is in excess of $250,000 annually. Revenue from the tax is supposed to be dedicated to the education legacy trust and the common school construction account for the benefit of K-12 education and early learning and child care. The anticipated revenue generated from the tax is estimated at over $500 million annually. There are exemptions built into this tax that include real estate, certain livestock related to farming or ranching, timber and timberlands, commercial fishing privileges, and goodwill received from the sale of a franchised auto dealership.

What does this mean for you?

If you have a brokerage account (e.g. an individual or joint account) that realizes a gain or earnings of more than $250,000 in a year, the amount above the $250,000 threshold will be taxed by Washington State at 7%. The gain will always be determined from the original value of the asset, also known as the cost basis.

Here’s an example: if Jane buys Stock A for $100,000, then sells Stock A and earns $200,000 on the sale, she will not be taxed, because the earnings do not meet the $250,000 threshold. Jane then re-invests her $300,000 in Stock B. Her new cost basis is $300,000. Shortly thereafter, Jane sells Stock B and earns $200,000, bringing her investment portfolio to $500,000. But because she did not earn more than $250,000 on the sale of the asset, the state tax does not apply. Jane takes the value of the portfolio and invests in Stock C. Her cost basis for Stock C is now $500,000. From her original investment of $100,000, Jane has realized overall gains of $400,000. But because she reached that amount by selling assets incrementally before her gains (per sale) reached $250,000, the tax does not apply, and her cost basis resets for each stock she buys.

What we’re keeping an eye on

Because the legislation targets stocks, it has made waves in the tech industry, where stocks are often a key component of employees’ compensation packages. If you have concerns about how this tax may impact your compensation, schedule a meeting with your CWM advisor to discuss options and strategies.

What is the controversy?

To understand the current situation, let’s start with a brief history lesson. In 1931, 70% of voters approved a change to the Washington state constitution to allow an income tax, and then held a vote to approve the income tax. Just two years later, SCOWA overturned the income tax - and Washington voters have never voted in favor of an income tax again. Why does this matter? Because the Washington State constitution determines that income is property and, as such, is not able to be taxed at a graduated rate. Any attempt to impose an income tax requires that the state constitution be amended.

The controversy of the capital gains tax is determined by the interpretation of what type of tax it is and how the proceeds from the sale of an asset are defined. Is it an income tax? Or is it an excise tax?

Supporters and ultimately seven out of nine state supreme court justices took the view that it is an excise tax because it applies to sales or transfers of assets, rather than income or property.

Dissenters view the capital gains tax as an income tax because “it is a tax on income resulting from certain transactions – not a tax on a transaction per se.” Aside from the logistical complexities and costs associated with record keeping, auditing, and implementing the new tax, an additional concern is that the tax as written applies to a fixed amount and does not adjust over time for inflation, meaning it could eventually impact a greater number of people.

What’s next?

The state began collecting the capital gains tax on April 18, 2023. If you’re not sure whether you owe this tax, discuss it with your tax professional. Even if you do not owe the Washington State capital gains tax, you may owe taxes to the federal government. Your tax professional can also help you determine if this is the case.

As always, if you have questions about how this tax impacts you and your investment portfolio please give us a call at (425) 778-6160 or Contact Us, we’re always happy to help at Comprehensive Wealth Management!

Additional Resources:

A Legislative Guide to Washington's Tax Structure (from 2020)

***Comprehensive Wealth Management (CWM), LLC does not offer tax advice. Please consult your CPA for specific tax questions.