Washington State Can No Longer Be A Tax Haven – A New Capital Gains Tax May Be On The Horizon | Foster Garvey PC
On April 25, 2021, the Washington State Legislature passed Senate Bill 5096 (SB 5096). The bill was immediately sent to Governor Inslee’s office for signature. It brings a new tax regime to Washington State.
Before going into the details of the new tax, I should mention that it was challenged even before the governor had a chance to sign it. A group of potentially affected taxpayers have filed a lawsuit in Douglas County, Washington, to overturn the new law as unconstitutional. It is therefore possible that the SB 5096 will never breathe life.
Knowing that the new tax system is under attack, it is always important to have a good understanding of it in case it survives the battle.
Goal: The purpose of the tax is to fund K-12 education in Washington.
Returned: The new law is expected to raise $ 415 million or more in annual tax revenue.
Tax: The tax is 7% on long-term capital gains from the sale or voluntary exchange of stocks, bonds and other capital property over $ 250,000 per year (subject to inflationary adjustment). To this end, the new law defines “fixed assets” by adopting the definition contained in section 1221 of the Internal Revenue Code of 1986, as amended. Long-term capital gains are the sale or exchange of a long-term fixed asset (a fixed asset held for more than one year).
Start date: The new tax is due to come into effect on January 1, 2022.
Exceptions: The new law contains many exceptions. The tax makes do not apply for:
- Any real estate transferred by deed, contract, judgment or other legal instrument.
- Any interest in a private entity, but only to the extent that the long-term capital appreciation or loss resulting from the sale or exchange is directly attributable to real estate owned directly by the entity.
- Retirement accounts.
- Convictions or transfers under imminent threat of conviction.
- Cattle, horses, or farm animals for which more than half of the taxpayer’s gross income in the tax year is from farming or ranching.
- Depreciable property (ie property eligible for expenditure under section 179 of the Code or depreciation under section 167 (a) (1) of the Code) used in a trade or business.
- Timber, timberland, dividends and distributions of REITs from the sale or exchange of timber or timberland.
- Commercial fishing privileges.
- Goodwill from the sale of a car dealership.
Obviously, several industries had good lobbyists. Real estate, agricultural, livestock, fishing and automobile concessions will receive favorable treatment under the new law. Unfortunately, other industries are not as privileged.
Not so fast, buried in Section 8 of SB 5096 is a significant exception. The “adjusted capital gain derived in the tax year from the sale of all the fair market value of the assets or the transfer of all the interest of the taxpayer in a small, qualified family business” are do not subject to the new tax. This exclusion has several elements:
- The business must be a “qualified family business”.
- A “qualifying family business” is a business: (i) in which the taxpayer held a “eligible interest“for at least five years immediately prior to the sale or exchange; (ii) the taxpayer or members of his family participated materially (or both) in the business for at least five of the ten years immediately preceding the sale or exchange (unless the sale or exchange was to a qualified heir); and (iii) the company’s gross worldwide turnover is $ 10 million or less (subject to inflationary adjustment) for the 12 month period immediately preceding the sale or change.
- “Qualifying Interest” means (i) a sole proprietorship interest; (ii) a participation of at least 50% in a company which belongs (directly or indirectly) to the taxpayer and / or members of his family; or (iii) a stake of at least 30% in a business which is owned (directly or indirectly) by the taxpayer and / or members of his family and at least 70% is owned (directly or indirectly) by two families or 90 percent belong (directly or indirectly) to three families.
- For the purposes of these requirements, “significant ownership” has the meaning prescribed in section 469 of the Code. In general, this means being involved in the business on a regular, ongoing and substantial basis.
- “Qualified heir” means a member of the taxpayer’s family. In turn, “family” includes the ancestors of the taxpayer, the spouse or domestic partner registered in the taxpayer’s state; linear descendants of the taxpayer, the taxpayer’s spouse or domestic partner registered in the state, or a relative of the taxpayer; or the spouse or state-registered domestic partner of any linear descendant of such persons.
- “Almost all” means 90 percent (applied in terms of value).
The new law provides for a deduction of up to $ 100,000 from the taxpayer’s capital gains if the taxpayer made $ 250,000 or more in contributions to a charity run or managed in Washington in the same tax year as the sale or exchange giving rise to tax.
To avoid the double taxation of a sale or trade under the Washington Business and Occupation (“B&O”) tax regime, a credit is given against taxes due under the B&O tax regime if such sale or trade is also subject to the new tax. In such cases, the credit is the amount of the B&O tax on the sale or exchange.
The new law comes with a few compliance teeth. In addition to civil penalties and interest for non-compliance, it is a Class C felony to knowingly attempt to evade tax. In addition, it is a serious offense for knowingly failing to pay tax, file returns or keep records or provide tax authorities with requested information regarding the tax.
Governor Inslee is expected to sign the new tax regime into law. Whoever will survive the ongoing trial is a guess at this point.
One thing is certain, Washington state lawmakers are looking for opportunities to increase tax revenues to fund fiscal needs. For taxpayers who plan to relocate to Washington to reduce their national and local tax burden arising from the sale or exchange of fixed assets, they should proceed with caution. Unless a predicted taxable event occurs before 2022 (the expected date of entry into force of the new law), these taxpayers could be at risk. Washington, the tax haven for Oregonians (and others) who anticipate a major capital gains event, may no longer be.
We’ll keep you posted as the controversy surrounding Washington’s new capital gains tax regime evolves.