The Washington State Supreme Court’s determination of its new capital gains tax as constitutional predominantly pivots around the tax’s categorization as an excise tax under state law, a legal nuance tax professionals around the world should be acutely aware of. While the US Supreme Court deliberates on taking the case, the Washington capital gains tax, applying to individuals at a rate of 7% on net gains surpassing $250,000, provides useful insights for tax professionals and their clients. Tax-loss harvesting—incurring capital losses to counterbalance gains—is confined to long-term capital losses. Washington State does not implement short-term capital losses to offset capital gains that its tax code subjects to its new capital gains tax. (Bloomberg Tax)
This distinction forms part of the intricate technicalities of Washington’s state law and it additionally emphasizes the reality that a state’s law may diverge from federal income tax provisions. The dissimilarity between state and federal tax rules can be beneficial for tax professionals and their clients to understand and analyse, especially in their attempts to uncover potential tax-reduction avenues.
Moreover, several state laws may impose compulsory state income tax payments at the establishment level on distinct activities owned through the means of pass-through entities, such as partnerships or S corporations, or permit elections so state income tax payments at the entity level can be assigned to the respective or distributive share of income to the owners of those entities. (IRS Notice 2020-75) The implementation and potential reduction of federal tax benefits by state authorities greatly underscores the significance of focusing on meticulous state tax planning.
State tax rules can considerably diverge from federal tax principles, thereby necessitating a careful state-specific analysis to identify opportunities to minimize state income tax exposure. There are potential tax-reducing strategies across various state jurisdictions as states may impose taxes on nonresidents on certain types of activities or assets within that state. The case being discussed in the public domain, Quinn v. Washington, U.S., 23-171, should be kept on watch for further legal developments.
The article is penned by Tom Kelley, National Director of Income Tax Planning at Wilmington Trust, where he provides analysis and insights on income tax planning, charitable planning, and estate planning to high-net-worth families and business owners.