A Washington State Capital Gains Tax?

Could Washington State soon have its own capital gains tax?

It is possible. Two Senators have proposed a bill that would impose a 5% capital gains tax on capital gains in excess of $10,000 for persons filing individual returns or $20,000 for persons filing joint returns. You can view a copy of the bill here: http://apps.leg.wa.gov/documents/billdocs/2013-14/Pdf/Bills/Senate%20Bills/5738.pdf The purpose of the tax is to provide funding for education.

When Would The Tax Go Into Effect?

The tax would go into effect on January 1, 2014. But it would apply to unrealized gains from before that date that were recognized after that date. For example, say you had bought that Microsoft stock back in 1997 and were still holding it… Before the bill becomes law, several things have to happen. Both the House and the Senate have to pass the bill, the Governor has to sign it, and the taxpayers have to approve it.

Taxpayer Vote

Section 501 of the bill requires the Secretary of State to submit the tax to a vote of the people at the next general election to be held in the state. When submitted to the voters, the tax bill would be described in the following manner.

“The legislature has passed Bill No. ____, concerning creating a capital gains tax to fund results in education. This measure would impose a 5.0% state excise tax on capital gains above ten thousand dollars per person, exempt gains on most residences, and provide that all capital gains tax revenues must be deposited into the education legacy trust account to fund education.”

What Is Exempt?

The law has some exemptions. For example, gain from the sale of a principal residence to the extent excluded under the Internal Revenue Code would not be taxed. There is no exclusion for qualified small business stock under Section 1202 of the Internal Revenue Code. So, if this law passes, Washington would follow California in imposing a tax on capital gains that is excluded under the federal law.

To Whom Would the Tax Apply?

The tax would only applies to natural persons–or individuals.

Good Idea/Bad Idea? Would this new tax in Washington be a good idea for our startup community? I don’t think so, but perhaps I am in the minority. I would love to hear what advocates on both side have to say. The best arguments I can think of against this tax?

  • It sets a bad precedent that once set will result in the rates creeping up over time (the slippery slope argument).
  • It would scare away investment capital at the margin.
  • It would remove one of our competitive advantages vis-a-vis Oregon and California.
  • There is no exemption for investments in startups (no corollary to federal tax code section 1202).
  • The tax would probably not be nondeductible federal income tax purposes.

The best arguments I can think of in favor of this tax?

  • It taxes individuals (as opposed to businesses) who most likely can afford the tax, and we need more money for education.
  • A 5% tax isn’t going to scare anyone away. It is a small “tip for the waiter.”
  • In fact, if the money improves our schools, our state will become a more attractive place in which to invest, despite the tax.

Conclusion

A new tax of this magnitude deserves a healthy public debate. I look forward to hearing your comments.

About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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