With discussions continuing of imposing the first in the nation capital gains tax for a state without an income tax, questions have been raised about whether this would be an excise tax or an income tax. This distinction is very important since an income tax exceeding 1% would be unconstitutional in Washington.

At a recent Senate Ways & Means hearing an analogy was made comparing the proposed capital gains tax to the state's Real Estate Excise Tax (REET). Is that a fair comparison? Let's compare the two taxes.

According to the Department of Revenue the REET is:

. . . a tax on the sale of real estate. The real estate excise tax is typically paid by the seller of the property, although the buyer is liable for the tax if it is not paid. The tax applies to the seller. The tax also applies to transfers of controlling interests (50% or more) in entities that own property in the state.

As someone who recently had the "privilege" of paying the REET (despite taking a loss on my home) I can attest to the fact it is truly an excise tax based on the activity of selling and not a tax for making any type of income on the sale.

How about a capital gains tax? According to the various proposals a capital gains tax is an “excise tax” for the “privilege of selling or exchanging long-term capital assets.”

This isn't a tax on the "privilege" of selling property (like a house) that applies across the board but instead the tax only applies if the property sold results in income growth (a gain) above the specified exemption level.

A tax on the "privilege" of turning a profit on an asset sure looks, sounds and feels a lot like a tax on income. Perhaps this is why none of the states without a tax on income tax capital gains.

But rest assured, should the legislature decide to move forward with a capital gains tax the Court will be asked to settle the debate.

The fiscal note for House Bill 1484 assumes that litigation around the proposal will occur:

We assume that because the capital gains tax is a new tax actions challenging its constitutionality will be filed in Superior Court . . . We assume up to five Superior Court actions will be filed challenging the constitutionality of the capital gains tax and that such court challenges will be filed after the effective date of the capital gains tax, which is January 1, 2016.

Here are the legal arguments we can expect to hear. As described by Former Supreme Court Justice Phil Talmadge in his legal analysis of Initiative 1098 (legal citations omitted):

Washington law is unambiguous. Income is property. Beginning in Aberdeen Savings and Loan Association v. Chase, and continuing through a series of cases, the Washington Supreme Court has held that income is property. As such, this tax is subject to the provisions of the so-called uniformity clause, article 7, section 1 of the Washington Constitution, which provides that all taxes ‘shall be uniform upon the same class of property within the territorial limits of the authority levying the tax . . .’ Moreover, article 7, section 2 of the Washington Constitution establishes the upper limit upon ad valorem property taxes. That constitutional restriction essentially limits any property tax to no more than one percent of the value of the property.

On the issue of the Legislature trying to call an income tax an “excise tax” to pass constitutional muster, Justice Talmadge highlighted the decision in Jensen v. Henneford:

The Legislature attempted to describe the income tax as an excise tax on the ‘privilege of receiving income’ in the State of Washington. The Supreme Court was unmoved. The Jensen court stated that the 1935 Legislature’s effort to rename the tax did not make it an excise tax . . . Subsequently, in Power, Inc v. Huntley, the Legislature enacted what it described as a corporate excise tax, which was actually a graduated new income tax on corporations. Again, the Supreme Court indicated that legislative labels for a tax are not controlling.

Rather than tie the state budget up in the courts and break from the norm of the other states that don't tax income, Washington should continue to maintain its competitive advantage that the state Department of Commerce previously advertised by not taxing capital gains.

Additional Information
Proposed capital gains tax is likely an unconstitutional income tax and would be an unreliable revenue source
"Choose Washington" - No Capital Gains Taxes