October 5, 2022

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Washington state capital gains tax update: Attorney general seeks appeal to reinstate controversial law

4 min read

Bob Ferguson
Washington state Attorney General Bob Ferguson. (GeekWire File Photo / Dan DeLong)

Seeking to overturn a lower court ruling blocking Washington state’s new capital gains tax, the attorney general’s office on Friday asked the state Supreme Court to take up the case on direct appeal.

Attorney General Bob Ferguson’s decision to attempt to bypass the state appellate court is, in essence, a legal acknowledgment that the fight over what constitutes an income tax is very likely to end up in Washington’s top court anyway. The state Supreme Court may decline the direct appeal but some legal experts said it is unlikely to.

“In this sort of case, it seems likely because either side would appeal an appellate court ruling they disagreed with,” said Hugh Spitzer, a University of Washington law professor and expert on state constitutional law. “I think (the state Supreme Court) will grant the appeal, just to save time and trouble for everyone.”

Others are not so sure. Eric R. Stahlfeld, an attorney with the Freedom Foundation who represents one of the groups opposing the tax, said the Supreme Court recently declined to hear a similar case out of Seattle. When the city tried to get the state’s top court to hear the successful challenge to its own income tax in 2017, the court declined.

“There is no guarantee at all the state Supreme Court will take this case immediately,” Stahlfeld said.

At issue is the statewide capital gain tax approved by the legislature and signed by Gov. Jay Inslee in 2021. The legislation placed a 7% excise tax on the sale of stocks, bonds, and businesses – the first tax of its type in state history.

The excise tax was not universally popular in the tech community because it sought to ultimately tax a common form of the industry’s compensation: stocks and stock options.

But the tax would have narrowly applied only to capital gains of more than $ 250,000. And it would exempt a laundry list of other potential capital gains including real estate land and structures; retirement accounts; livestock for farming or ranching; and the sale of timber and timberlands, among other exceptions.

A successful lawsuit filed in Douglas County blocked the new law three weeks ago. The plaintiffs asserted that a capital gains tax, even when called an excise tax, amounts to an income tax similar to the way it is categorized by the Internal Revenue Service.

And as an income tax it doesn’t pass legal muster under the state constitution.

In his ruling, Douglas County Superior Court Judge Brian Huber said in a written decision that the tax “shows the hallmarks of an income tax rather than an excise tax” as argued by state lawmakers.

At the time of the ruling, Ferguson vowed to fight and he hinted the state would appeal directly to the Supreme Court. “All the parties recognize this case will ultimately be decided by the State Supreme Court. We respectfully disagree with this ruling, and we will appeal, ”he said in a statement.

The appeal, Spitzer said, is likely to involve the ruling that has led to so many legal conflicts over state and income taxes: Culliton v. Chase.

Decided in 1933, the state Supreme Court overturned a popular, voter-approved graduated income tax when it ruled that income is property. State law dictates – then and now – that property taxes must be uniform at 1%, not graduated. So if income is considered property and property can only be taxed at 1% across the board, any income tax must be 1% or less under state law.

The 2021 capital gains tax signed into law is 7%.

But Spitzer said the judges then got it wrong. Income is not considered property in the other 49 states. This appeal, he said, is a chance to rectify nearly 90 years of flawed legal reasoning.

And on a more practical level, a tax on an event is an excise or sales tax, which is perfectly legal in Washington state. The tax on a sale of stock is an event. The stock is not taxed at all until it is sold.

“I think the judge was wrong and called it incorrectly,” Spitzer said. “I think (Judge Huber) just didn’t understand it.”

Even so, the battle might not end with the state Supreme Court, it should decide to grant the direct appeal. Currently, there are a handful of ballot measures opposing a capital gains tax filed with the Secretary of State’s office.

None have yet secured enough signatures for the ballot. But the one likely to get the most attention has not yet been assigned a number: The Repeal the Capital Gains Tax initiative.

The measure, simply put, seeks to repeal any law in Washington state that imposes a capital gains tax. While there is currently no capital gains tax, it should be reinstated, the initiative would cancel it.

Political consultant Heather Weiner likened it to a fail-safe or a backup plan for tax opponents.

And Weiner, a spokesperson for Invest Washington, which helped pass capital gains tax last year, said she expects this particular initiative to be distinct from the pack with its ability to pull in national money and political operatives.

“It’s not the Tim Eyman clown car,” she said, referring to the state’s anti-tax advocate.

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