Capital gains tax proposal Q&A
Note: This information relates to a capital gains tax as proposed by Gov. Inslee in Dec. 2020. It does not fully reflect the bill as enacted. To leanr about the tax as enacted see information on the capital gains tax from the Dept. of Revenue.
Prepared by the Department of Revenue
Governor Inslee is proposing a capital gains tax on the sale of stocks, bonds and other assets to increase the share of state taxes paid by Washington’s wealthiest taxpayers. The state would apply a 9 percent tax to capital gains earnings above $25,000 for individuals and $50,000 for joint filers.
The new tax would affect an estimated 58,000 taxpayers in the first year. Sole proprietor income, retirement accounts, homes, farms and forestry are exempt. The proposal will raise an estimated $1.1 billion in Fiscal Year 2023. The actual amount collected will depend on fluctuations in the financial markets, and can be expected to vary from year to year. The state can manage these fluctuations through careful budgeting.
Earned income from salaries and wages are not capital gains and will not be taxed at all under this proposal.
Q&A about the proposed capital gains tax
What is the threshold amount for owing the proposed tax?
Do I have to file anything if I don’t have any capital gains?
What if I pay capital gains taxes to another state?
A “taxing jurisdiction” includes other states, territories or possessions of the United States, including the District of Columbia and the Commonwealth of Puerto Rico.
Federal taxes are not considered taxes paid to another taxing jurisdiction.
Does the proposed tax apply to short-term gains?
Do any federal tax exemptions or deferrals apply?
Do my capital losses carry over?
Will the proposed tax apply to sole proprietor income?
Will the proposed tax apply to my retirement accounts?
Will the proposed tax apply to sales of residential real estate?
What if I pay B&O tax on the gain from the sale of assets?
A B&O tax credit is available for the full amount of B&O tax due on the sale of capital assets, if the gain from that sale is also subject to the proposed Washington capital gains tax.
For example, if a taxpayer is engaged in the business of selling the type of asset at issue, B&O tax is generally due on the income from that sale. Gain from the sale of such assets is also potentially reportable under the proposed Washington capital gains tax. If both the B&O tax and the capital gains tax apply, a B&O tax credit would be available to avoid taxing the same amounts twice.
How does the tax work for a pass-through entity such as a limited liability company, partnership or S-corporation?
For federal tax purposes, when one of these “pass-through” entities sells a long-term capital asset, the entity does not report a capital gain. Instead, the capital gain is reported, and the tax paid, by the entity owner or owners (each paying a proportionate share).
Just like at the federal level, under the proposed Washington capital gains tax, when a pass-through entity sells a long-term capital asset, the capital gain would be reported and paid by the entity owner(s).
However, many sales of assets by a business entity are not capital in nature, such as sales of inventory. In addition, the proposed Washington capital gains tax expressly exempts many asset sales by a business, such as:
- A sale or exchange of certain depreciable property used in a business.
- A sale or exchange of certain expensed property used in a business, up to the federal limit.
In addition, capital gain income of C-corporations is not passed through to corporate owners (shareholders) and would not be subject to the proposed Washington capital gains tax.
Are distributions from my limited-liability company or dividends from a corporation considered capital gains?
Distributions are generally not treated as capital gains for federal tax purposes and would not be subject to the proposed Washington capital gains tax. While some types of ordinary dividends (“qualified dividends”) are reported as capital gains for federal tax purposes, they are not gains of the individual derived from the sale of assets and not subject to theWashington capital gains tax.
How does the tax apply when I sell my stock or ownership interests in my business?
However, there are some federal tax exemptions related to the purchase or sale of business stock, and those will also apply to the proposed Washington capital gains tax.
How does the capital gains tax apply to trusts?
Grantor trusts:
A grantor trust is a disregarded entity for federal tax purposes. Any long-term capital gains on the sale or disposition of assets held by the trust will be reported on the grantor’s federal tax return. Therefore, a grantor who is an individual will also report those capital gains for Washington capital gains tax purposes.
Non-grantor trusts:
In general, a non-grantor trust does not distribute income from the sale of capital assets. Gains from the sale of a capital asset are typically held as additions to principal and taxed at the trust level. Because a trust is not an individual subject to the Washington capital gains tax, no Washington capital gains tax would be due on gains retained by the trust. However, in some cases a non-grantor trust will distribute income that represents gain from the sale of capital assets rather than retain the income. Individual beneficiaries will need to report distributed long-term capital gain income under the proposed Washington capital gains tax.
There are also circumstances where the trustee will declare capital gain to be distributable income rather than an addition to principle, but not actually distribute the income to the beneficiaries. Under the proposed Washington capital gains tax, these amounts are reportable by individual beneficiaries when the income is declared as distributable.
How does the capital gains tax apply to distributions from real estate investment trusts (REIT)?
REIT income generally includes collected rents, interest income and gains from the sale or disposition of property. If the REIT income is retained as principal, capital gains would be taxed at the trust level. Because a trust is not an individual subject to the Washington capital gains tax, no tax would be due on gains retained by the trust.
Like other non-grantor trusts, a REIT may also declare capital gains income as distributable income. Individual beneficiaries will need to report any distributed capital gain income under the proposed Washington capital gains tax. If a REIT declares capital gain income as distributable income but does not actually make a distribution, the capital gain income is reportable by individual beneficiaries when the income is declared as distributable.
How do the proposed tax exemptions apply for agriculture and timber?
Agriculture:
The sale or exchange of cattle, horses or breeding livestock held for more than 12 months is exempt from the proposed Washington capital gains tax, provided more than 50 percent of the taxpayer’s gross income is from farming or ranching. The sale of agricultural land held for at least 10 years if the taxpayer has regular, continuous and substantial involvement in the operation of the agricultural land is exempt from the proposed Washington capital gains tax.
Timber:
The proposed Washington capital gains tax does not apply to the sale or exchange of timber or timberland, or to the receipt of Washington capital gains consisting of dividends and distributions from real estate investment trusts derived from gains from the sale or exchange of timber. This exemption applies to a taxpayer who cuts or disposes of timber and elects to treat the activity as a capital gain for federal tax purposes under Section 631(a) or (b) of the Internal Revenue Code.
