Washington state residents have recently challenged the state’s efforts to tax long-term capital gains, in an intriguing legal showdown that pivots around the state and federal constitutional considerations. The dispute, teetering on the edge of constitutional and tax law, emerged from a legislative measure passed by Washington’s Democratic-controlled legislature in 2021. The enactment proposed a 7% excise tax – a tax on the sale or exchange by state residents – on long-term capital itself.
Washington, similar to South Dakota, does not impose an income tax, and taxes on property, considered inclusive of income by the state constitution, are capped at a meager 1%. Consequently, the state explores different methods to generate revenue. The excise tax presented a creative workaround to the taxation constraints imposed by the state constitution. It is, however, essential to note that several exceptions were made in enforcing this tax, such as the sales of real estate, retirement accounts, and charitable donations, among others, and it applies primarily to the sale of assets exceeding $250,000 per annum.
However, a group of state residents, led by Chris Quinn, dared to challenge this tax as soon as it came into effect in January 2022. They contended that the measure essentially functioned as an income tax and thus contradicted the provisions of the state constitution. Moreover, if the tax were accepted as an excise tax, it should be on the wrong side of the dormant commerce clause, they argued.
The dormant commerce clause, a doctrine sprung out from the Constitution, refrains states from imposing excessive burdens on out-of-state commerce. Framed implicitly in the grant of power towards Congress’ regulation of interstate commerce, this doctrine was put into the limelight by the Supreme Court in a divided ruling in South Dakota v. Wayfair, where South Dakota’s right to tax large, out-of-state online retailers was upheld.
In the initial stage, the state trial court in Washington accepted the challengers’ arguments and pronounced the measure unconstitutional. When approached, however, the Washington Supreme Court overturned the ruling and upheld the tax. Notably, the court dismissed the challengers’ claims and ruled that the enactment did not violate the dormant commerce clause. Instead, it held a “significant nexus” to the in-state activity of residents choosing to sell their capital assets.
Undeterred, the residents have now taken their dispute to the Supreme Court in Quinn v. Washington, seeking to overturn the Washington Supreme Court’s decision. The ultimate query before the justices remains whether a state perceivably overreach its jurisdiction by imposing tax on out-of-state transactions.
Details of these cases can be found at SCOTUSblog.