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Look at What the Tax Does and Raise Everything to Win!

The BR State + Local Tax Spotlight

The Washington State Superior Court, Douglas County, (“Superior Court”) recently relied on the Washington State Constitution to invalidate the new Washington Capital Gains Tax (“WACGT”). Quinn/Clayton v. Washington, Douglas Cnty Cons. Cause Nos. 21-2-0075-09 & 21-2-00087-09 (Wash. Super. Ct. March 1, 2022).

What happened: On May 4, 2021, Washington enacted a capital gains tax on individuals that came together in Engrossed Substitute Senate Bill 5096. S.B. 5096, 67th Leg., 2021 Reg. Sess. (Wash. 2021) (effective July 25, 2021). Several potential taxpayers filed suit very quickly. On March 1, 2022, less than one year after enactment, the Superior Court ruled that the WACGT violated the uniformity clause and the limitations clause of the Washington State Constitution.

The Department asserted that the WACGT is an excise tax to raise funds for education and, therefore, does not run afoul of the state’s longstanding hurdles preventing income taxes. Article VII, Section 1 of the Washington State Constitution provides:

“[a]ll taxes shall be uniform upon the same class of property within the territorial limits of the authority levying the tax and shall be levied and collected for public purposes only. The word ‘property’ as used herein shall mean and include everything, whether tangible or intangible, subject to ownership.” Quinn/Clayton at 7.

The Washington Supreme Court long ago held that property includes income and that a graduated income tax is invalid as a non-uniform property tax even if one were to frame the tax as a tax on the privilege of receiving income. Jensen v. Henneford, 53 P.2d 607 (Wash. 1936); Culliton v. Chase, 25 P.2d 81 (Wash. 1933).

In 1951, Washington enacted an “excise” tax on corporations for the privilege of doing business in Washington, measured by net income. This tax was invalidated by the courts because courts should analyze how a tax operates (not its label) and Washington net income tracked federal corporate income tax. Power, Inc. v. Huntley, 235 P.2d 173 (Wash. 1951).

The ruling: The Superior Court latched onto the crux of Power, Inc. that labels don’t carry the day and the goal of raising funds for education is irrelevant:

“it is the State’s choices about ‘who is being taxed, what is being taxed, and how the tax is measured’ that determine its ‘incidents’ and whether it should be deemed a tax on income as opposed to an excise.” Quinn/Clayton at 9.

It found that the WACGT relies on federal income tax returns, levies a tax on the same long-term capital gains that the federal income tax and the IRS characterize as income, is levied annually (like an income tax) and not by transaction (like an excise tax), is not levied on gross value but is levied on aggregate annual net gain, and permits a charitable deduction.

The Superior Court held that the tax violates the uniformity requirement of the Washington State Constitution because it imposes a seven percent tax on an individual’s long-term capital gains exceeding $250,000 but imposes zero tax on long-term capital gains below that threshold because it is an income tax that fails the uniformity limits on income taxes. Quinn/Clayton at 12. The Superior Court also held that the tax rate exceeded the one percent maximum rate on property taxes.

The takeaway: Look at how the tax operates and raise everything. Challengers often jump to federal Constitutional limitations, such as the Due Process Clause or the Commerce Clause. States have their own constitutional limits that include protections similar to the federal Due Process Clause as well as uniformity, single object, and procedure clauses (such as requiring supermajority votes or three readings on the floor). We can help analyze potential arguments. However, when commencing challenges, in addition to raising the statutes, regulations, administrative guidance, and U.S. Constitutional protections, raise the State constitutional protections. There are winners there too!


This article is one in a series of articles written for the March 2022 edition of The BR State + Local Tax Spotlight.


© 2022 Blank Rome LLP. All rights reserved. Please contact Blank Rome for permission to reprint. Notice: The purpose of this update is to identify select developments that may be of interest to readers. The information contained herein is abridged and summarized from various sources, the accuracy and completeness of which cannot be assured. This update should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.