Does Washington's Capital Gains Excise Tax Reduce Taxable Gain?

• Published date: 22 August 2023
• Subject Matter: Tax, Income Tax, Capital Gains Tax, Tax Authorities
• Law Firm: Lane Powell
• Author: Mr Lewis M. Horowitz, Aimee Miller, Gary Kirk and Eric J. Kodesch

As many of our readers know, the Washington Supreme Court recently validated the state's new excise tax on the sale or exchange of long-term capital assets (the LTCAET)as a constitutional excise tax on the privilege of selling or exchanging certain capital assets. The tax is commonly, but perhaps incorrectly, referred to as the "Washington capital gains tax." In this article, we refer to it as the LTCAET to emphasize the Washington Supreme Court's determination that the tax is an excise tax, even though the amount of tax is generally measured by net federal long-term capital gains allocated to Washington state. (We sincerely hope someone more creative than we are will come up with a more mellifluous acronym than LTCAET).

Elsewhere we have written about the Supreme Court's decision and the operation of the LTCAET.As relevant to this article, we note that (1) the Washington Supreme Court specifically rejected the Superior Court's holding that the LTCAET was an income tax, and (2) the LTCAET does not apply to the sale of real property. Regardless of whether we accept the logic of the court, we have to respect the authority and wisdom of the Washington Supreme Court, at least until the U.S. Supreme Court tells us otherwise.

Many of our readers also know that an individual's federal tax deduction for non-business state and local taxes is capped at $10,000. IRC ' 164(a)(6). We have written about the Oregon workaround for this cap, which is consistent with the approach taken by other states. Washington does not have such a workaround so, for virtually everyone subject to the LTCAET, the tax is not deductible when computing federal taxable income (because most people subject to the LTCAET likely reach the $10,000 cap based on income, property, or sales taxes).

However, this does not mean that all hope is lost on obtaining a federal tax benefit for the LTCAET. We believe a reasonable position exists to treat the LTCAET as a capitalized cost of sale that reduces federal capital gains. Thus, the LTCAET may reduce a taxpayer's federal capital gains, even if it cannot reduce the taxpayer's federal ordinary income.

In upholding the status of the LTCAET as an excise tax rather than an income tax, the Washington Supreme Court drew an analogy to Washington's real estate excise tax (REET).For example, as part of upholding the LTCAET, the Washington Supreme Court, referring to the REET, stated: "[t]hough that tax clearly concerned property, we held it is a valid excise because it...