Washington’s New Capital Gains Tax Elicits Lawsuits, QSBS Likely Unaffected if Tax Remains

Washington State QSBS

New Capital Gains Tax Met with Lawsuits

The State of Washington’s recent introduction of a new capital gains tax was met with two lawsuits within a matter of weeks. The first lawsuit was filed by the Freedom Foundation, a conservative think tank based in the state, which took action just three days after the tax law was passed. The second lawsuit was filed by the Opportunity for All Coalition, along with former Attorney General Rob McKenna and the Washington Farm Bureau as representation. 

The new tax legislation that has been stirring up contention would impose a 7% tax on capital gains above $250,000. This levy is expected to bring in an annual revenue of $455 million to the state. 

In response, current Washington Attorney General Bob Ferguson filed a motion this past Tuesday arguing that the lawsuits have no legal basis and urging the Superior Court judge to dismiss both claims. Ferguson points out that the law does not take effect until 2022, and the tax would not be due until 2023. The Attorney General concludes that the plaintiffs cannot actually know whether they will be adversely impacted this far in advance. He adds that only a small percentage of Washington taxpayers will be subject to the tax, due to tax exempt categories like real estate, family-owned small businesses, and certain retirement accounts. 

Progressive income tax, in which the tax rate increases as the taxable amount increases, has been illegal in Washington since 1936. The court case that prompted this ruling determined that the state’s constitution required all property to be taxed at the same rate, and income counted as property. 

Based on that precedent, the two current lawsuits claim the new tax bill is unconstitutional. They request that the court void the tax and require the state to pay the plaintiffs’ legal fees. The core issue is whether the court will determine that the capital gains tax is an income tax or an excise tax, as it was deemed by Governor Jay Inslee, who signed the legislation. 

Should Stockholders Be Concerned?

As Washingtonians await the outcome of these lawsuits, stockholders may be wondering whether they should be preparing for possible tax consequences. According to certain experts in business law, qualified small business stock (QSBS) is unlikely to be impacted by the new tax, since QSBS capital gains are excluded from federal gross income altogether. 
Remember that QSBS receives a special exemption from the IRS that allows stockholders to exclude up to 100% of capital gains from these stocks. To determine whether a company’s stock will qualify for this benefit, you can find resources on QSBS criteria on QSBS Expert’s website.

Additional Information on Washington and QSBS

This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.

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