A Douglas County Superior Court judge will soon decide whether a consolidated lawsuit against the state’s newly-enacted capital gains income tax will move forward after an Aug. 18 oral argument. The arguments made by state attorneys focus on a law they claim prohibits the plaintiffs from suing until they actually pay the tax.
Although the law took effect in July, any tax due from the income derived from the sale of a long-term capital gain isn’t due until 2023. State Counsel Noah Purcell told Douglas County Judge Brian Huber that because of that, “before they can litigate those issues, they have the burden that they have standing,” adding it’s “a burden they have failed to meet.”
While the enormous volatility of capital gains income taxes has been highlighted by detractors, it’s an attribute Purcell says only bolsters the claim that the plaintiffs lack standing. “Even if it’s true that plaintiffs are very wealthy and own significant capital assets, they cannot be sure that they will owe this tax.”
However, former state attorney general and plaintiff attorney Rob McKenna argued at the hearing that “the state is trying to insulate itself from judicial review.” McKenna is also representing the plaintiffs in an ongoing lawsuit against the state’s 2019 bank tax; a 2020 court decision overturned the tax, and the case will now be decided by the State Supreme Court. In that lawsuit, Purcell also argued that the plaintiffs lacked standing, though the case was allowed to proceed.
At the Aug. 18 hearing Purcell said “what the state is trying to do is enforce the basic procedural rules. The court has emphasized that those rules matter.”
Yet, McKenna said lawsuits against taxes can occur even if someone hasn’t paid the tax based on “reasonable inference and hypothetical facts.” He added that due to the new law individuals are “having to engage in active tax planning” such as deciding whether or not to buy capital assets that could be subject to the tax.
It’s unclear to what extent the 2017 lawsuit against the city of Seattle is applicable to that particular issue. Purcell pointed out that it involved a local rather than statewide tax, while McKenna said the absence of any references to that state law reflected a universal assumption that “the case could go forward. (There was) no question that the taxpayers in Seattle were allowed to challenge a tax.”
At the same time the plaintiffs are also challenging the tax’s legality, an exemption included in the state law cited by Purcell. Incidentally, at this time the state’s legal defense does not address whether it is an excise tax, as is claimed by proponents, or if it is instead an income tax. Although the law refers to it as an excise tax, no tax is owed if the sale of a long-term capital gain results in zero income, and no return must be filed with the state if there is a loss, whereas excises taxes are applied on the sale regardless of profit. During the lawsuit against its local income tax, the city of Seattle argued that it was an excise tax, then later that it was a tax on gross rather than net income, only to later argue that income isn’t money.
The big question on many people’s minds is when the lawsuits will openly address the elephant in the room: whether income is property as defined in the state constitution, and therefore subject to restrictions on property taxes such as uniform rates.
State lawmakers have admitted in emails that the primary purpose of the tax is to trigger a lawsuit allowing the current state high court justices to reconsider prior rulings that have consistently said income is property. The strategy was proposed as early as 2016 by University of Washington Law Professor Hugo Spitzer at an April 19, 2016 meeting of the Olympia City Council. Spitzer argued in a 1993 paper that the state legislature could enact a progressive income tax on “net income” without having to amend the state constitution.
At that meeting Spitzer said the case could also enable the courts to give local governments even greater taxing authority. While the city of Seattle’s income tax was struck down, the Court of Appeals also invalidated a 1984 state law prohibiting local income taxes. Since then, numerous cities have passed resolutions or propositions banning a local income tax.