Washington versus the world on capital gains income taxes
If you were curious about the tax treatment of capital gains income and took a globe of the planet and randomly placed your finger after spinning it, you would hear the same thing: A capital gains tax is an income tax. You could repeat this exercise over and over and the results would be the same unless your finger landed on Washington state. Thanks to a 7-2 decision by our state Supreme Court, Washington now stands alone on the planet claiming a capital gains tax isn’t an income tax.
For example, consider the following responses concerning the taxation of capital gains income:
- Australian Taxation Office: “You report capital gains and capital losses in your income tax return and pay tax on your capital gains. Although it is referred to as 'capital gains tax,' it is part of your income tax. It is not a separate tax.”
- California Franchise Tax Board: "California taxes capital gains as an income tax and they are taxed at the same rate as ordinary income."
- IRS: “This is in response to your inquiry regarding the tax treatment of capital gains. You ask whether tax on capital gains is considered an excise tax or an income tax? It is an income tax. More specifically, capital gains are treated as income under the tax code and taxed as such."
- Washington state Supreme Court: “We hold the capital gains tax is an excise tax under Washington law.”
As was true with Judge Dredd, a final ruling by the state Supreme Court is the law, but that doesn’t change the irrefutable fact that literally every tax professional in the world, from the IRS, to every other state, to other countries will tell you the same thing – capital gains are income and taxes on them are income taxes.
Curiously, the majority opinion appeared to be aware of this fact but decided Washington alone knows better. Consider this comment from the majority decision about why there wouldn't be double taxation violating the commerce clause (emphasis added): "Moreover, it appears Washington’s capital gains tax would not apply in Plaintiffs’ example because California taxes capital gains as income."
The dissenting opinion, however, clearly understood what a tax on capital gains income is – an income tax.
Some of the notable comments from the dissent:
- “Though not dispositive of this issue of state statutory interpretation, it is worth noting that the IRS and all 41 states that tax capital gains treat such gains as income and a tax on them as an income tax.”
- “The plain language of the statute shows that taxable incident is not the sale or transfer of the capital asset itself. Rather, the taxable incident is the realization of income derived from the sale of qualifying capital assets. Because the taxable incident or event is the realization of income—not the mere transfer of the asset—the tax is an income tax, regardless of the label placed on it by the legislature.”
- “The measure of the tax is indisputably the amount of income gained from the transaction. The fact that the tax is measured by the amount of net income only reinforces the conclusion that the taxable incident is receipt of income and that the capital gains tax is an income tax.”
- “I can find no Washington case upholding a tax as an excise where the measure of the tax was net income or gain. Instead, such taxes have consistently been invalidated as nonuniform property taxes.”
- “A tax is determined by its incidents, not by its legislative label. The structure of the capital gains tax shows that it is a tax on income resulting from certain transactions—not a tax on a transaction per se. Therefore, the tax is an income tax, not an excise tax. Under our constitution and case law, an income tax is a property tax. As enacted, this income tax or ‘capital gains tax’ violates the one percent levy limitation of article VII, section 2.”
The dissent was clear, factual, and consistent with the treatment of capital gains income across the world, but it only received two votes.
Some of the hot takes from national tax experts on Washington’s court discovering a new way to tax capital gains income have been very interesting. Here are some of the comments from a tweet thread by the Vice President of State Projects at the Tax Foundation:
- “You don't have to dig deeply into the Washington supreme court's decision in the capital gains tax case to find egregious errors. There's an obvious, and crucial, falsehood in the second paragraph.”
- “The justices spend a dozen pages outlining how they think the prior tax code is unfair, citing wildly inaccurate studies along the way. What's missing from the decision is any credible basis for believing the tax is constitutional.”
- “The state supreme court acknowledges that income taxes are unconstitutional, says this is distinguishable because it's somehow an excise tax, and tries to prove it by claiming that income taxes *are* excises taxes. They're contradicting each other from one page to the next.”
- “This case is incredibly simple. This dissent says everything that needs to be stated.”
- “I try to be respectful of court rulings, and recognize that state supreme court justices know much more about the law than I do, but I don't see any way to get around it on this one: the court wanted a capital gains tax so it ruled in favor even though the argument was ludicrous.”
Our state Supreme Court has ruled and the issue is “settled” now in Washington unless there is a federal challenge for violating the commerce clause or the voters respond with a ballot measure. With respect to the tax expertise of our state justices, I'll still stand with the rest of the planet in the clear understanding that excise taxes aren't applied to income - those are called income taxes.