Opinion: Taxpayers object to effort to collect capital gains income tax before state Supreme Court ruling

Jason Mercier of the Washington Policy Center shares information from the attorney general’s motion asking the state Supreme Court to allow the Department of Revenue to collect before a final ruling on the case

Jason Mercier
Washington Policy Center

Nearly eight months after the capital gains income tax was declared unconstitutional, the Attorney General (AG) filed a motion on November 3 asking the state Supreme Court to allow the Department of Revenue (DOR) to collect the capital gains income tax before a final ruling on the case. In fact, the AG argued that those challenging the capital gains income tax “would be better off” if the Supreme Court allows DOR to collect the tax before it weighs in on the case. Last night taxpayers challenging the tax responded, objecting to the AG’s request to allow collection of a new income tax that has been ruled unconstitutional before final resolution of the case.

Here are some of the pull quotes from the brief objecting to the AG’s stay motion:

“A stay pending appeal is not warranted based on the speculation that this Court might rewrite nearly a century of precedent holding that individual income is subject to state constitutional limits on taxing property. The State tries to dodge the constitutional restrictions by calling the tax an ‘excise tax,’ but the tax plainly fails to satisfy the well-established test for excise taxes.”
“In short, the State will be affected little if the status quo prevails pending this Court’s decision, while Washington taxpayers will be concretely and unavoidably harmed if the State is allowed to collect the tax pending resolution of the appeal.”
“On March 22, 2022, the court entered an order declaring ESSB 5096 unconstitutional and ‘void and inoperable as a matter of law.’ The State and Intervenors sought direct review by this Court, which was granted on July 13, 2022. Briefing was completed by all parties on October 7, 2022. At no point in the 226 days preceding did the State question the superior court’s order declaring ESSB 5096 ‘void and inoperable.’ Rather, it was only after a non-party to this case submitted a letter to the Department of Revenue objecting to the agency’s rulemaking activities that the State filed its motion on November 6, 2022.”
“Here, the capital gains tax is imposed by reason of a Washington resident’s ownership of property — capital gains income — not because the ‘person sells, transfers, or uses property,’ as the State asserts. The State ignores the plain language of the statute that declares ‘[t]he tax applies when the Washington capital gains are recognized by the taxpayer.’ Under long-established Washington law, a tax on the receipt of income, untethered to any state-conferred privilege to engage in business or exercise a privilege within state boundaries, is a property tax, not an excise tax. This Court has had ‘no hesitancy’ in finding that a tax on income not based on the amount of ‘any business in this state,’ and ‘geared throughout to the Federal income tax legislation,’ is ‘a mere property tax ‘masquerading as an excise.’ ‘It is no longer subject to question in this court that income is property.’”
“In this context, however, the State’s requested stay would drastically disrupt the status quo by authorizing the State to enforce a recently enacted tax—which has never before been collected and which was held to conflict with nearly a century of precedent—on the eve of this Court’s adjudication of its constitutionality. The State’s unusual request to enforce this ‘entirely new tax’ after the superior court invalidated it but before this Court has decided the appeal should be rejected.”
“The State has identified no sound reason to disturb the status quo—and certainly no sound reason to do so now, when nearly eight months passed since the superior court’s decision without any motion to stay in the trial court or any request for interim relief. The State fails to articulate any concrete injury to the State’s own interests in the absence of a stay, and its claims of taxpayer confusion and implementation delays are without merit. By contrast, if the superior court’s judgment is stayed pending appeal, taxpayers may be forced to go through a costly, time-intensive process to obtain refunds if the decision below is affirmed, not to mention incurring professional expenses to prepare unnecessary tax filings.”
“The State appears to believe that if taxpayers pay the tax during the pendency of this appeal, and this Court later affirms the superior court’s decision, those taxpayers can be made whole by obtaining a refund, with interest. That overlooks the reality that the refund process will require significant time and expense, including professional fees, that taxpayers will never be able to recoup. Additionally, if the superior court is affirmed, taxpayers will also have been harmed by unnecessarily incurring the legal and accounting fees that come with filing new state tax returns, in addition to taxpayers’ personal time and effort, to comply with the State’s capital gains reporting requirements. And payment of interest after the fact cannot fully compensate taxpayers for opportunities they lose while they are deprived of funds that are rightfully theirs.”

According to the attorneys involved in filing the stay opposition brief, it is highly unusual for a losing party to wait nearly eight months before requesting a stay of a ruling.

In some irony, yesterday I received public records from the Department of Revenue with this draft statement that was circulated within the agency on March 3:

“Ruling Against Tax – On DATE, the Douglas County Superior Court granted the plaintiff’s motion for summary judgment. In doing so, the court held that the Washington capital gains tax is unconstitutional. Until further notice, the Department of Revenue is prohibited from administering the Washington capital gains tax.”

Instead of releasing this draft statement, DOR decided to move forward with its full implementation plans despite an Inslee-appointed Superior Court judge ruling on March 1 that the capital gains income tax “is declared unconstitutional and invalid and, therefore, is void and inoperable as a matter of law.”

In related news, a former IRS attorney recently said this about the state’s capital gains income tax arguments:

“Washington State is misguided in believing that just because there is a transfer of property involved, it provides a basis for the imposition of an excise tax. Frankly, I am unable to see why this matter is considered to be controversial. That is, I see no reasonable argument for saying that a capital gains tax is not an income tax, and for that reason could be subject to an excise tax. I am somewhat dumbfounded as to why the State of Washington believes it has any reasonable chance of ever prevailing in this case.”

The state Supreme Court has scheduled an en banc admin conference on November 29 to consider the AG’s stay motion request to allow DOR to collect the capital gains income tax before a final ruling. A decision should be available on that day.

Jason Mercier is the director of the Center for Government Reform at the Washington Policy Center.