United States: WA DOR Updated Guidance on the Administration of the Tax: In the Shadow of the November Ballot Initiative to Repeal the Entire Tax

The Washington Department of Revenue continues to update its guidance on Washington’s excise tax on long-term capital gains, resulting in the most recent proposed rule, WAC 458-20-301. There are several important changes from the last iteration of the proposed rule, including:

• Contains explicit language providing that the long-term capital gain or loss must be from a sale or exchange to be subject to the Washington excise tax on long-term capital gains (i.e., the regulation is now more consistent with the statute). Thus, for example, partnership distributions of cash in excess of the partner’s tax basis – treated as long-term capital gains under IRC section 731 for federal income tax purposes – need to be subtracted from federal net long-term capital gains when calculating the tax on Washington capital gains subject to the tax.
  
• Only gains or losses from an IRC section 1256 contract realized from a contract that was actually sold after being held for more than a year are subject to the tax, consistent with the preceding bullet point, but reversing the guidance issued by the Department last year (which was rescinded in January 2024). Taxpayers should consider whether they should amend their return filed for the 2022 tax year.^[1]
  
• Eliminates the Department’s prior presumption that if a taxpayer is domiciled in Washington at any time during the tax year, the taxpayer is presumed to be domiciled in Washington for the entire calendar year. Presumably, this was removed to avoid litigation, as we do not believe it was supported by jurisprudence.
  
• Confirms that any loss from IRC section 1244 stock is excluded from the Washington capital gains tax calculation because such losses are reported as an ordinary loss for federal purposes. Hopefully, this clarification confirms that the Department will not attempt to impose the excise tax on gains from IRC section 1202 Qualified Small Business stock to the extent that such gains are excluded from taxable income for federal tax purposes.
  
• Clarifies that donations to donor-advised funds (DAF) are considered donations to qualified Washington charities (eligible for the $105,000 deduction) if the organization that owns or controls the DAF is a “qualified organization” principally directed or managed within the state of Washington (such as the Seattle Foundation, but probably not a DAF sponsored by Fidelity/Vanguard/Schwab) under RCW 82.87.080.
  
• Clarifies, via examples, the treatment of carry forwards from prior-year out-of-state losses, treatment of short-term capital losses, gains invested in qualified opportunity funds, and sales of qualified opportunity funds.

The proposed rule may not be relied upon until it is formally adopted. Taxpayers affected by the changes generally should secure extensions of time to file.^[2] Another public hearing will be held on April 9 at 1:00 PM to collect comments on the proposed rule.

Outside of these developments, efforts to repeal the tax continue to march forward toward the November election. Initiative 2109 would repeal Washington’s excise tax on capital gains entirely. In a December poll, 57% of the respondents indicated they favor repealing the excise tax on capital gains. If this tax is repealed, questions will arise as to whether it will retroactively apply to the entire 2024 calendar year or if returns will need to be filed for the period prior to the election. If passed, the initiative does not have an explicit effective date, but does repeal any obligation to file tax returns.

^[1] DOR’s interim statement on Section 1256 contracts was canceled on January 26, 2024, and replaced with the statement: For section 1256 contracts, only gains and losses recognized from a taxpayer’s sale or exchange of a section 1256 contract are included in the Washington capital gains excise tax base, and only if the contract was held for more than one year. In this situation, the taxpayer should report the long-term capital gain or loss they recognized for federal tax purposes from the sale or exchange, i.e., 60% of the total gain or loss.

^[2] The capital gains tax return is due at the same time as the individual's federal income tax return. To receive an extension for filing your Washington Capital Gains tax return, you must request an extension by submitting a request electronically through MyDOR on or before April 15. To qualify for the extension, you must receive a filing extension for your federal income tax return. A filing extension does not extend the due date for submitting a payment.

This client alert should not be viewed as legal advice, as this is a developing field and each taxpayer’s situation is unique. Lane Powell’s team of tax attorneys is here to help you determine the right course of action for your individual needs. For more information, please contact Scott Edwards, Lewis M. Horowitz, Gary Kirk, Eric Kodesch, or Aimee L. Miller. Keep up-to-date by subscribing to Lane Powell’s Legal Updates.