It seems that our elected representatives never tire of seeking new or retrying old ways of separating the citizens from their money. This legislative session, a bill was introduced to establish a state capital gains tax. This bill, HB 2563, would impose a five percent tax on all gains from sales of property that are reported on federal tax forms 1040 or 1041. There is an exemption in the proposed tax for profit from the sale of a primary residence, and the first $5,000 of gain for a single taxpayer or $10,000 in gain for joint filers, is exempt from taxation.
Clearly capital gains are a form of property, and for investors they are a primary reason for entering into the investment. Some real estate investments are “buy and hold” investments but ultimately investors expect that they will reap a profit from selling at a price that exceeds their purchase price plus holding costs.
We have recently lived through a bruising campaign to establish a state income tax by initiative. That effort failed at the ballot box, and so there was no occasion for the courts to examine whether that proposed income tax would survive the Fourteenth Amendment to the Washington Constitution. That amendment states: “All taxes shall be uniform upon the same class of property within the territorial limits of the authority levying the tax and shall be levied and collected for public purposes only. The word 'property' as used herein shall mean and include everything, whether tangible or intangible, subject to ownership. All real estate shall constitute one class.”
It is reasonable to ask whether based on the Supreme Court’s precedents, a tax such as that which would be imposed by HB 2563 would meet the constitutional test of uniformity. The Supreme Court considered two different income tax measures in 1933 and 1936 and held that both of them were unconstitutional in light of the Fourteenth Amendment. In Jensen v. Henneford, the 1936 case, the court considered a tax that was graduated, and applied to all net income including gains from dealings in properties, but which allowed credits against such net income that differed between single and married taxpayers.
The court determined that income was property for purposes of the Fourteenth Amendment, because it was capable of being owned. Having made that determination, over the objection that income was income and property was something else, the court moved on to the uniformity question. The court easily concluded that the graduated tax, with a base rate of three percent for incomes less than $4,000 and a surtax of an additional one percent for incomes over $4,000, violated the uniformity requirement. The court decided that income was property and the Fourteenth Amendment required all property of the same class to be taxed uniformly and therefore a tax difference of one percent based on the level of income a person received was not a uniform tax.
The proposed tax in HB 2563 does not contain a graduated rate based on the amount of capital gains received in one year. However the bill does exempt gains from the sale of a primary residence and it exempts the first $5,000 of gains for a single filer and $10,000 of gains for joint filers in a single year. The court in Jensen v. Henneford also considered the effect of exemptions on the constitutionality of the tax in 1936. Based on that review, the court decided that exemptions of the first $1,000 for a single filer and $2,500 for joint filers also caused the tax to fail the uniformity requirement. This same structure exists in HB 2563. There was no exemption similar to the gains from sale of a primary residence exemption in the 1936 law but it seems clear that this exemption in HB 2563 also results in similar property, namely gains, being taxed differently based on the source of the gains, which would appear to violate the uniformity requirement.
During the recent campaign to adopt the “rich person’s income tax” by initiative, there was speculation that enough time had passed since 1936 and the composition of the Supreme Court had changed sufficiently that such an income tax would be upheld by that court. We have no recent case law from our court to guide us but we know that the courts are supposed to adhere to their own precedents until a reasonable basis for showing that they were erroneously decided, appears. Nothing has changed in the wording of the Fourteenth Amendment and it does not appear that HB 2563 would impose a tax that meets the uniformity requirement.
The preceding is for education only and should not be considered as legal advice.
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