Washington state capital gains tax marches on: What the new law would do, and who is affected

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The Washington state Capitol in Olympia is pretty quiet these days as legislators work from home. (GeekWire Photo / John Cook)

Washington state legislators this week approved a new tax on capital gains. But the bill, SB 5096, was held up in the state Senate late Thursday where it must pass by Sunday to get the governor’s signature.

The ongoing argument around the legislation is centered around whether the tax is a necessary way to help level the playing field among taxpayers in Washington state, or whether the action amounts to an unconstitutional state income tax that would ultimately drive businesses and entrepreneurs out of state.

And the argument in the Senate? Whether voters have a say with the new tax. This problem appears to need a solution before the bill can move through the legislature before the session ends.

Here’s a quick explainer of the legislation that has divided lawmakers along party lines.

What is a capital gains tax?

A simple explainer comes from the state Senate staff report on the measure: “A capital gains tax is a tax on the profit realized on the sale of non-inventory assets purchased at a lower price than the sales price. Common examples are capital gains realized from the sale of stocks, bonds, mutual funds, boats, and real estate.”

What does this legislation do?

If you live in Washington and you pay capital gains taxes, you likely pay them only to the federal government. SB 5096 would change that by adding an additional 7% tax payment to the state for specific capital gains over $250,000. This, opponents argue, amounts to a personal income tax, which is not yet constitutional in Washington, though in 2019 a lower state court opened the door for the Washington Supreme Court to change that. Proponents of the measure have argued that it is a legal excise tax, not an income tax.

And as for those federal capital gains taxes you might already be paying? Those, too, might be going up under a new Biden administration proposal.

What sales would be taxed?

The bill is fairly narrow, as far as capital gains taxes go. Stock sales over a certain threshold (see below) would be taxed. Real estate would not be. The first $250,000 of capital gains would be exempt from the tax. From the staff analysis: “Excluded (from the proposed capital gains tax): all real estate land and structures; assets held in a retirement account; assets transferred as part of a condemnation proceeding; livestock related to farming or ranching; certain types of property used in a trade or business such as machinery and equipment that have been immediately expensed; timber and timberlands; and goodwill received from the sale of a franchised auto.”

Who likes this?

Democratic lawmakers who have long complained that the state is too dependent on regressive taxes such as sales and property taxes to fund the state. State officials estimated the tax would pull in $550 million annually starting in 2023.

Who doesn’t?

Republican lawmakers. They have long opposed any tax that resembles a state income tax. This fight goes back to the Great Depression.

What about the tech industry?

Washington state’s startup community has been locked in a tense debate over the legislation, one of several proposed taxes targeting the wealthy in a state with a tech industry that has surged over the past year. A letter published by the Washington Technology Industry Association, which represents more than 1,000 tech startups and larger companies, warned the tax will “remove a meaningful attraction and retention mechanism” for startups and “harm our competitiveness.”

But many tech workers have lobbied the legislature in favor of the bill as part of a coalition called Tech4Recovery. In an open letter on the Tech4Recovery website, the group notes that the tech industry has been booming during the pandemic while other parts of the economy suffer.

Tech employees delivered a similar message during a February hearing on the proposed billionaire tax.

Civic Ventures, a progressive think tank formed by early Amazon investor Nick Hanauer, called the WTIA claims “absurdly, obviously false” in its own letter to the state legislature.

“The WTIA letter’s central claim is that adopting a tax on extraordinary capital gains will make Washington inhospitable to startups and lead them to locate elsewhere, but this is demonstrably false,” Civic Ventures wrote. “Virtually every state that is a leader in high-tech startups — like California, Massachusetts, New York, and Virginia — also has a state tax on capital gains.”

What happens next?

It depends on what the Senate does. A significant point of contention remains: whether or not this legislation should then head to the voters as a tax referendum. Currently, the bill has language that will allow it to bypass a voter referendum. But not every Democrat agrees with this workaround and late Thursday the Senate refused to agree on the voter bypass language. What version of the bill is finally approved by the entire legislature is an open question, even at this late stage. The legislative session ends on Sunday so the state Senate must pass it by then. If passed, it would head to Gov. Jay Inslee’s desk.

And then?

Likely to court. Republicans and conservative anti-tax law groups such as the Pacific Legal Foundation have said the law violates the state prohibition on income taxes — the city of Seattle lost its bid to pass a city income tax in 2020, for example — so a court challenge is probable. Democratic Rep. Noel Frame, the bill’s sponsor, said she “fully expects” the bill to be challenged in court if signed. “But I think we have a really strong case that this is an excise tax,” she said Thursday in an interview.

Editor’s note: This story has been updated with comments from Rep. Frame and additional information. 

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