On March 1, an Inslee appointed judge in Douglas County Superior Court ruled that the capital gains income tax adopted last year (SB 5096) is an unconstitutional graduated income tax. The judge said in his ruling:

"... some of the most significant 'incidents' of ESSB 5096 show the hallmarks of an income tax rather than an excise tax. They include the following:

• It relies upon federal IRS income tax returns that Washington residents must file and is thus derived from a taxpayer’s annual federal income tax reporting.
   
• It levies a tax on the same long-term capital gains that the IRS characterizes as ‘income’ under federal law.
   
• It’s levied annually (like an income tax), not at the time of each transaction (like an excise tax).
   
• It is levied not on the gross value of the property sold in a transaction (like an excise tax as demonstrated by the examples cited by the State), but on an individual’s net capital gain (like an income tax).
   
• Like an income tax, it is based on an aggregate calculation of an individual’s capital gains over the course of a year from all sources, taking into consideration various deductions and exclusions, to arrive at a single annual taxable dollar figure.
   
• Like an income tax, it is levied on all long-term capital gains of an individual, regardless of whether those gains were earned within Washington and thus without concern whether the State conferred any right or privilege to facilitate the underlying transfer that would entitle the State to charge an excise.
   
• Like an income tax and unlike an excise tax, the new tax statute includes a deduction for certain charitable donations the taxpayer has made during the tax year.
   
• If the legal owner of the asset who transfers title or ownership is not an individual, then the legal owner is not liable for the tax generated in connection with the transaction, unlike the excise taxes identified by the State . . .

ESSB 5096 is properly characterized as an income tax pursuant to Culliton, Jensen, Power and other applicable Washington caselaw, rather than as an excise tax as argued by the State.” 

The judge concluded his order by saying:

“ESSB 5096 is declared unconstitutional and invalid and, therefore, is void and inoperable as a matter of law.”

The Attorney General has filed an appeal motion for direct review with the state Supreme Court hoping to bypass the Court of Appeals. I had the opportunity to ask one of the lead attorneys for those challenging the capital gains income tax, former Attorney General Rob McKenna, for his thoughts on what happens next. Here is my exchange with McKenna:

1. The Attorney General has filed a motion for direct review by the State Supreme Court to appeal the ruling. Why are you objecting to this motion?

McKenna: “It is settled law that an income tax which is labeled an ‘excise tax’ by the legislature is still an income tax. There is no new question of law presented by this case that requires direct review by the Supreme Court. In addition, there is no fiscal urgency here, as the State is enjoying large budget surpluses and, in any event, the capital gains income tax statute dedicates revenues that it generates to a reserve fund, not current expenditures.”

2. I-1929 has been filed to ask voters to repeal ESSB 5096. Should this ballot measure be successful before any additional court action on appeal, what would that mean for the court case?

McKenna: “If Washington voters repeal the new tax before the Supreme Court rules on it, it is likely that the case will be mooted and no opinion will be issued, since courts do not issue advisory opinions.”

3. Anything else you think Washingtonians should know about this court case and appeal process?

McKenna: “Income tax proponents have spent many years trying to get the Washington Supreme Court to overturn a century of law holding that, under the state constitution, graduated income taxes are unconstitutional. In our democracy, any change in settled law that is based on our constitution’s plain language should be by vote of the people, not by judicial fiat. Washington voters have repeatedly rejected such proposals in the past, and just last November rejected the capital gains tax by a wide margin in an advisory vote.”

We likely won’t know until sometime this summer if the state Supreme Court plans to take this case, or instead will do the same thing it did a few years ago with the illegal Seattle income tax and allow the Court of Appeals to act instead.

As for I-1929, a ballot title challenge is being heard by Thurston County Superior Court at 2:30 p.m. today. Talking about this latest development, the Seattle Times wrote in an editorial:

“Washington’s experiment in creating a capital-gains tax ought to be weighed on its true merits. Unfortunately, the tax’s advocates cannot seem to resist putting a pinkie on the scale.

Rhetorical fog has consistently clouded the tax’s true effect, which actually is as straightforward as math. Most recently, and disappointingly, Attorney General Bob Ferguson tried attaching language favorable to the tax — a policy creation of his Democratic allies — to a ballot initiative to repeal it. Tuesday, he wisely reconsidered. That decision ought to set a new tone going forward for an evenhanded public conversation.

Ferguson had followed lawmakers’ example in attaching the words ‘excise tax’ to the issue like passive-aggressive Post-its. This stubborn branding doesn’t change reality. Senate Bill 5096, passed in 2021, taxes income. Any contention otherwise brazenly skews the debate . . .

Ferguson ought never to have signed onto the ‘excise tax’ malarkey, which is aimed to gaslight voters. A court hearing in Thurston County Thursday needs to result in clear, unbiased language for an initiative challenging the capital-gains tax that could go to the ballot this fall.

This debate needs to play out above board, not with rhetorical games.”

Can I get an amen?

Additional Information
Attorney General drops “excise tax” from new proposed ballot title for I-1929 (capital gains income tax repeal)
WPC played important role in capital gains income tax being ruled unconstitutional
TVW capital gains income tax debate (UW Constitutional Law Professor Hugh Spitzer and UW Tax Law Professor Scott Schumacher)