Douglas County judge rules against state in capital gains tax lawsuit

OLYMPIA – A Douglas County Superior Court judge on Monday struck down Washington’s new capital gains tax – the first in a long court battle that could end up in the state Supreme Court.

Two groups, the Freedom Foundation and Opportunity for All Coalition, sued the state last year over the tax, claiming it is an income tax and unconstitutional under state law.

Judge Brian Huber ruled in their favor, writing in his ruling the capital gains tax is “properly characterized as an income tax … rather than as an excise tax as argued by the State.”

The Legislature last year passed a 7% tax on the sale of stocks, bonds, businesses and other investments, if the profits exceed $250,000 annually. Exceptions include the sale of real estate, livestock and family-owned businesses.

It would bring in about $415 million, which the state would use to pay for child care and early learning. The tax technically went into effect in January, but payments don’t begin being made to the state until 2023.

The tax would affect less than 1% of taxpayers, according to a fiscal analysis of the bill.

In a hearing last month, the state argued the tax does not apply when you own a stock, bond or other capital asset, such as a property tax would. Instead, Noah Purcell, who represented the state, said it applies when you sell that asset. Therefore, he said, it is an excise tax.

Excise taxes typically are levied on specific goods, such as cigarettes, alcoholic beverages or gasoline.

Huber’s ruling rejected that argument. The tax meets the definition of property tax by being “absolute and unavoidable” in a number of scenarios where the sale or transfer of the capital asset would not be voluntary, he wrote in his ruling.

The plaintiffs in last month’s hearing argued that when someone sells their stocks, bonds or investments, they are not conducting business but rather generating income for themselves.

“That can be taxed, but by an income tax, not an excise tax,” former Washington Attorney General Rob McKenna argued for the plaintiffs.

Huber in his ruling said the tax violates the uniformity and limitation requirements of the state constitution. It violates the uniformity tax by imposing a 7% tax on an individual’s long-term capital gains exceeding $250,000 but zero tax on capital gains below that threshold, Huber wrote. It violates the limitation requirement because the tax exceeds the 1% maximum annual property tax rate.

Huber pointed to a number of reasons why the tax “shows the hallmarks” of an income tax, rather than an excise tax. Those include the fact the collection of it relies on federal income tax returns, the fact it is levied annually and the fact it is levied on the gross value of the property sold but not on a net capital gain.

In a statement, Attorney General Bob Ferguson said the state would appeal the decision.

“There’s a great deal at stake in this case, including funding for early learning, child care programs, and school construction,” Ferguson said in a statement. “Consequently, we will continue defending this law enacted by the peoples’ representatives in the Legislature.”

The 14th Amendment of the state’s constitution, approved in 1930, says all taxes in the state must be “uniform upon the same class of property.” Property is defined as “everything, whether tangible or intangible, subject to ownership.”

Since then, the Supreme Court has shot down attempts from the Legislature to pass various forms of an income tax, saying it is unconstitutional because income is considered property.

The capital gains lawsuit could give the court another chance to rule on whether the tax is considered an income tax and whether an income tax is constitutional in Washington.

Proponents of an income tax say having it could help the state’s tax code be less regressive, which would mean lower-income taxpayers pay a smaller share of their income on taxes than high-earners.

The plaintiffs praised the ruling from Huber.

Opportunity for All Coalition President Collin Hathaway called it “a great day for the Washington constitution.”

“Judge Huber saw through the state’s attempt to enact this illegal capital gains income tax under the guise of an excise tax,” Hathaway said in a statement.

McKenna pointed to voters’ rejection of multiple ballot measures and amendments trying to enact a state income tax.

“Judge Huber’s decision rightly upholds those precedents and honors the voters’ clearly stated preference that we remain a state without a graduated income tax,” McKenna said.

Supporters of the tax criticized the court for siding with “the super rich.”

“By siding with a tiny number of extremely wealthy residents, the lower court is ignoring widespread public support for helping working families find child care and providing children with the education they need to succeed in life,” said Treasure Mackley, executive director of Members of Invest in Washington Now, a group of advocates who organized for the capital gains tax.