During 2021 and 2022, more than thirty states returned to its residents revenue surpluses in the form of tax cuts, expanded deductions, and even rebates, i.e., checks. Washington was not among these states. Instead, Washington enacted a capital gains tax. See Revised Code of Washington, Sec. 82.87 et seq.
In 2022, the Washington Department of Revenue reported a 6% increase in its revenue. It now sits on a $15 billion dollar surplus, the largest in state history. Major General Fund-State (GF-S) revenue collections for the December 11, 2022 - January 10, 2023 collection period came in $87.8 million (3.9%) higher than forecasted in November. Cumulatively, collections are $83.3 million (1.4%) above the forecast.
Despite this, on January 20, 2022, a new proposed tax was read for the first time in the Washington state legislature.
This article describes three Washington state-specific wealth taxes, pointing out similarities between the three, and specific deductions and exemptions.
Statutory Citations
The Washington State Capital Gains can be found here, at RCW 82.87.
The Estate Tax statute, is RCW Sec. 83.100
Washington estate tax exemptions by year from inception year 2013 to 2023
The Department of Revenue's 2022 Revenue Report is
A PDF of Washington House Bill can be found here.
Key Points
The three Washington taxes, the estate tax, capital gains tax, and the new proposed tax, are, in the same order, a transfer tax, a income tax or excise tax according to the state, and an existence tax, i.e., a tax on the existence of wealth because it is fair to do so.
A annual tax on one percent of the entire value of an asset decreases the annual return of the investment in a much larger amount because the small rate is on principal whereas return is expressed as gain.
The rates for the estate tax, capital gains tax are 20%, 7%, and 1%.
The estate tax does not offer portability of each spouse's exemption and has no deductions for small business or farms.
The capital gains tax includes exemptions and deductions, to include special treatment for family-owned businesses.
The Estate Tax
Washington state is one of twelve states with its own estate tax. An estate consists of the property of a deceased asset owner and some gifts made before death can be clawed back into this tax definition. Examples include gifts with retained interests and revocable transfers. Like all estate taxes, Washington imposes its tax on the total fair market value of the estate at the time of the former owner's death to the extent the sum exceeds the state-specific exemption amount. Washington's tax rates fall between 10 and 20%, the highest possible rate in the country. Hawaii recently increased its tax to 20% but offers a tax exemption that allows its residents to pass $5.50 million tax free, compared to Washington's $2.12 million. Hawaii also allows portability between spouses. Portability refers to the ability to pass to a surviving spouse the deceased spouse's individual exemption, doubling the amount that passes tax free when it passes to the second generation. Washington is among the ten states that does not allow portability.
If you are married, you can achieve the same tax benefit as portability by a gift for your spouse's benefit in a Credit Shelter Trust.
New Capital Gains Tax
In April 2021, Washington enacted a new capital gains tax found at RCW 82.. This tax imposes a 7% tax when a resident sells (or transfers) long-term capital assets such as stocks, bonds, business interests, or other investments and tangible assets if allocated to the state of Washington.
Allocation refers to the rule to connect a transaction to a particular jurisdiction. The allocation rule is complicated but works this way:
- Washington domiciled.
If, at the time of sale of Intangible personal property, you were domiciled in Washington, the transaction is "allocated" and subject to the tax. Intangible personal property refers to property interest that are not located in the physical world. These include financial asset like stocks, funds, or bonds. - if either of the following are true when a tangible personal property is sold, then allocation applies:
- The property was located in Washington at the time of sale.
- The property was not located in Washington at the time of sale but all of the following are true:
- The property was located in Washington in the same year or the year before the sale took place.
- The individual was a Washington resident at the time of the sale.
- The sale was not subject to an income or excise tax by another jurisdiction.
Fortunately, if the allocated to Washington, the sale or transfer of many types of assets are excluded, to include: real estate, retirement accounts, business assets that are depreciable, and a few other special interest related assets.
Retirement accounts that are included within the exception are:
- Deferred compensation plan.
- IRA.
- ROTH IRA.
- Employee defined contribution plan.
- Employee defined benefit plan.
- Similar retirement savings accounts.
The tax applies only if the asset was owned by an individual. A properly formed business entity, is not subject to the tax.
There is an interesting issue related to trust owned assets. Under federal tax law, a grantor trust, e.g., a revocable living trust is disregarded. That is, the assets in the trust are considered to owned by the individual who created the trust. A non-grantor trust is recognized as a separate entity. This type of trust, for example, has its own taxpayer identification number and pays annual taxes on a IRS Form 1041. The statute, RCW 82.87.030 defines a non-grantor trust as a trust that is not a grantor trust under federal tax law. While this may seem like an avoidance of specificity, there is a verbose code sections that define grantor trusts as well as more than one tax court opinion. The Washington statute correctly point out that "[t]he grantor's transfer of assets to the trust is treated as an incomplete gift under Title 26 U.S.C. Sec. 2511 of the internal revenue code and its accompanying regulations." This rule is commonly an issue in estate tax cases and is explained in the estate tax masterclass mentioned above.
In addition to exempt assets, there are two notable deductions available. A resident can deduct $250,000 per year. If you own a family owned business that is "qualified," the sale can be deducted, as well. A standard deduction of $250,000 per year per individual, married couple, or domestic partnership. This amount is adjusted for inflation annually.
There is also a deduction for the sale of a qualified family-owned small business.
Charitable donations in excess of $250,000 per year per individual can deduct up to $100,000 per year per individual.
The tax has been challenged as unconstitutional under Washington's state constitution. Pending appeal, the State was issued a stay of proceedings. As a result, as of the time of this writing, the Department of Revenue notified the public that its tax collection system is set to go live in February and returns are due April 28, 2023.
Washington's newest tax proposal
Washington's newest attempt to tax wealth is House Bill 1473 and was read for the first time on January 20, 2023. Unlike the capital gains tax, this tax is described as a property tax but on "intangible" personal property, i.e., stocks, bonds, and other "financial intangible property." If the Washington Supreme Court eventually strikes down the capital gains tax as violative of Washington's prohibition of income taxation of its residents, this tax , upon the same property as the capital gains tax, could pass judicial review because it is triggered by its mere existence rather than its sale or transfer.
This bill is not ambiguous. The opening sentences explain the purpose of the new tax. it is "a property tax on extreme wealth." Pointing out that Washington has led the way in innovation and "many of the world's greatest innovators and artists, engineers and entrepreneurs, and scientists and social activists have called Washington home. But Washington's status as an economic and social leader is threatened by growing wealth inequality and a tax structure that perpetuates it."
The Bill defines the wealth that it intends to tax as "worldwide wealth," which is a person's worldwide wealth taxed at an annual rate of one percent. The Bill that refers to the tax rules listed above, common to estate, gift, and capital gain tax rules.
Conclusion
Tax policy in Washington state differs from forty-three states, arguably any other state. Many states tax income whether than wealth. Washington legal precedence prohibits the state from taxing its residents income. As a result, two new taxes, one enacted and the other pending, erodes its residents' investments.
