What Happened?
On November 5, Washington state's voters rejected ballot initiative I-2109 that would have repealed Washington state's 7-percent capital gains tax. As a reminder, we previously discussed the capital gains tax here. And as we predicted, this tax caused many to move from or avoid the state entirely (make sure to check our checklist here if you need to leave the state). But, don't move to Texas or Florida just yet!
Just in case you missed it, our country's voters elected a Republican president, Senate, and possibly House of Representatives. Accordingly, we predict, with a very high degree of confidence, there will be significant tax law changes in 2025.
Sunset of the SALT Cap?
One of the most anticipated changes for individual taxpayers will be the scheduled sunset of the annual $10,000 limitation for state and local tax deductions (a.k.a., the SALT Cap). Likely, no later than the end of 2025, Washington state's 7-percent capital gains tax will be reduced to an effective rate of only 4.41 percent [7% x (100 – 37% (highest marginal tax rate))] after taking into account federal deductibility of the state tax (at least for most taxpayers subject to Washington state's capital gains tax).
Wait, are we still debating whether this is an income or excise tax? Kind of.
At least that is the result if the Internal Revenue Service accepts that Washington state's capital gains tax is properly characterized as an income tax — rather than adopting the state supreme court's characterization as an excise tax. We note that IRS treatment of Washington's capital gains tax as an income tax, rather than an excise tax, is not without doubt, as we previously discussed here.
When can we expect relief?
This change will likely not impact 2024 capital gains taxes in Washington state, which are payable in 2025. However, since Washington's capital gains taxes for 2025 would not normally be paid until 2026, the effective rate reduction is only about seven weeks away.
Next Steps.
Wealthy taxpayers who have been considering a move away from Washington state to avoid this tax should consider whether such a move is still economically justifiable. Of course, any state and local tax analysis that involves Washington state now also needs to consider the Washington supreme court's recent decision in Antio that we discuss at length here.
For some, moving may still be in the cards.
Three final thoughts we think are worth sharing. First, remember the Alternative Minimum Tax still applies to individuals, and it can impact effective tax rate computations by limiting deductions for state taxes. Second, expect the legislature in Olympia to consider increasing the capital gains tax and/or lowering the exemption threshold (currently about $263,000). Finally, some members of the Seattle City Council are already talking about adding a Seattle-only version of the capital gains tax, as discussed here.
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