Washington state has approved a 7% tax on capital gains for investors with over $250,000 of capital gains within one year. The new tax proceeds are earmarked exclusively for early education and childcare. The constitutionality of this legislation is currently being challenged in Washington state courts.
What is the tax and how does it work?
The tax will apply a flat rate of 7% specifically for long-term capital gains above $250,000 in any given year. It is important to note that ordinary income, short-term capital gains, qualified dividends, tax-exempt interest, retirement accounts, and most real estate assets are excluded from the tax.
There will be a flat standard deduction of $250,000 whether you are filing as an individual or as a married couple. This flat rate is in addition to the federal long-term capital gains tax rates (based on income). See table below.
|Filing Status||0% Rate||15% Rate||20% Rate|
|Single||<$40,400||$40,401 – $445,850||$445,850 +|
|Married filing jointly||<$80,800||$80,801 – $501,600||$501,600 +|
|Married filing separately||<$40,400||$40,401 – $250,800||$250,800 +|
|Head of household||<$54,100||$54,101 – $473,750||$473,750 +|
What is a long-term capital gain?
Long-term capital gains are the profits above the cost basis on the sale of an asset such as stock, land, business interests, etc. that are held for more than one year. Profits held less than one year are classified as short-term capital gains, which are taxed at an investor’s federal income tax rate.
When will the newly approved tax begin?
The law is set to begin January 1, 2022.
Who will pay the tax?
Individual residents domiciled in Washington state are subject to the tax. Capital gains from pass-through partnerships and LLCs are also included, but corporations and other entities are excluded.
Grantor trusts, which are trusts considered to be “owned by the creator of the trust,” are included. Nongrantor trusts, depending on how they were established, may be subject to the tax.
What can I do to avoid paying these taxes?
- Use tax-advantaged plans: Contributing to tax-deferred accounts such as retirement accounts (i.e., IRAs, 401(k), SEP IRAs, etc.) avoids the new tax since the gains in these accounts are not taxed.
- Contribute to 529 college savings plans: Contributions and account gains that are used for qualified education expenses are not taxed.
- Offset your gains with losses: You can offset your investment gains with an equivalent amount of losses through tax loss harvesting, which consists of selling underperforming securities to pick up losses that can be used to offset future gains in your portfolio.
- Charitable giving: Receive the tax benefit of the donation in addition to avoiding paying capital gains tax.
- Sell assets with a long-term gain in 2021 before the law takes effect.
- Change your residency status.
If you have questions on the 7% tax on capital gains, feel free to contact us today.
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