Capital gains tax court battle begins with Douglas County hearing

OLYMPIA – The legal battle over the new capital gains tax passed by the Legislature last year has begun.

Attorneys for the state, as well as both the Freedom Foundation and Opportunity for All Coalition – two groups suing over the constitutionality of the tax – gave their arguments Friday in front of Douglas County Superior Court Judge Brian Huber.

Huber said he would issue a ruling “as soon as possible.” He estimated it might be at least two weeks.

Friday’s hearing is expected to be the first in a long court battle still to come, likely ending with the state Supreme Court deciding whether the tax is considered an income tax, which is currently unconstitutional under state law.

It could take much of the year before a decision is reached.

The Legislature last year passed a 7% tax on the sale of stocks, bonds, businesses and other investments, if the profits exceed $250,000 annually. Exceptions include the sale of all real estate, livestock and small family-owned businesses.

It would bring in about $415 million for the state to pay for child care and early learning. The tax technically went into effect in January, but payments don’t begin being made to the state until 2023.

The tax would affect less than 1% of taxpayers, according to a fiscal analysis of the bill.

Opponents say it is an unconstitutional income tax while supporters say it is an excise tax.

The plaintiffs on Friday argued that when someone sells their stocks, bonds or investments, they are not conducting business, but rather generating income for themselves.

“That can be taxed, but by an income tax, not an excise tax,” former Washington Attorney General Rob McKenna argued for the plaintiffs.

The state, on the other hand, argued the tax does not apply when you own a stock, bond or other capital gain, such as a property tax would. Instead, Noah Purcell, representing the state, said it applies when you sell it. Therefore, he said, it is an excise tax.

While the plaintiffs argued it can’t be an excise tax because it exempts some people from paying it, Purcell said the business and operations tax as well as the estate tax also exempt people.

Education parties, including the Edmonds School District, joined the lawsuit on the state’s side. Attorney for the parties, Greg Wong, said Friday the tax is needed to fund education programs.

“Every dollar of education funding goes to our students, to our classrooms, to our schools, to our districts,” he said.

The capital gains tax debate is the latest in a decades-long fight over implementing an income tax in Washington.

The 14th Amendment of the state’s constitution, approved in 1930, says all taxes in the state must be “uniform upon the same class of property.” Property is defined as “everything, whether tangible or intangible, subject to ownership.”

Since then, the Supreme Court has shot down attempts from the Legislature to pass various forms of an income tax, saying it is unconstitutional because income is considered property.

Proponents of an income tax, however, say having one would help make the state’s tax code less regressive. A regressive tax code means lower-income taxpayers pay a greater share of their income on taxes than high-earners. Washington’s tax system relies heavily on a sales tax, which is the same for everyone regardless of income.

The capital gains lawsuit, assuming it makes it to the state Supreme Court, could give the court another chance to rule on whether the tax is considered an income tax and whether an income tax is constitutional in Washington.