Quantifying the Risk for Dollars at Stake as Washington State Contemplates a 9% Capital Gains Tax
As mentioned in our recent article, Federal capital gains for individual taxpayers are generally taxed at 20% for long-term investments, and the Net Investment Income Tax rate of 3.8% can apply for a total Federal tax of 23.8% on the gains in a company sale. While we don’t know exactly what will happen in the next one to five years, we can make an educated guess that President Biden’s tax proposal will result in some level of a tax increase for high-income earners at some point during his initial term in office. With Democrats in control of Congress, that likelihood is even higher.
If you’re in Washington state, you currently do not pay the state on capital gains, but state lawmakers are contemplating a 9% capital gains tax. This idea faces several legal challenges—not least because income tax is currently illegal according to the state’s constitution. (The IRS has said a capital gains tax is effectively an income tax.) This concept has reached the Washington State Supreme Court in prior cases, and the court ruled legislators must amend the constitution for any such tax to go into effect.
Amending the constitution to institute a capital gains tax would open the door for an amendment to introduce an income tax more broadly—and most in the state are unwilling to consider that as a viable option, especially as Washington’s median income has increased in recent years.
It is impossible to predict the precise details of what will move from campaign rhetoric into law or what state lawmakers will be able to impose. However, the materiality of the tax risk in these potential changes should be on every business owner’s mind.
We had a discussion with our friends at Moss Adams to assist in quantifying the total gross dollars of potential risk. We outline below the insights that Partner and Director of Tax Technical, National Tax Andy Cates and Bob Hinton, partner in charge Seattle shared with us.
For a hypothetical $100 million deal, businesses in Washington state should consider the following:
If President Biden’s tax plan is enacted as proposed, your incremental Federal gross tax risk sits at $19.6 million. That’s incremental risk—on top of the existing $23.8 million you would pay in Federal capital gains and Net Investment Income Tax if you sold today.
Your total Federal tax bill could be as high as $43.4 million.
If Washington state enacts a 9% capital gains tax as proposed, your incremental state gross tax risk sits at $9 million on a $100 million deal.
If both Biden’s tax plan and Washington state’s capital gains tax are enacted, your incremental gross tax risk is $28.6 million, and you would be looking at a total gross tax bill of roughly $52.4 million.
To learn more about additional considerations business owners should consider when contemplating a sale in 2021—including how the supply of capital and demand for high-performing companies is impacting valuations—read our latest article here.
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