Washington's Capital Gains Could Present Tax Challenges for Some Oregonians
On Friday, March 24, the Washington Supreme Court upheld the constitutionality of the state's new capital gains tax. Since 1929, the Court held the state's constitution regarded income as property and subject to uniformity and levy limitations on property taxes. To the chagrin of many progressive tax activists, these rulings functionally barred the state from imposing an income tax. During their 2021 session, however, Washington state lawmakers enacted a capital gains excise tax to overcome the constitutional barriers.
Jared Walczak at the Tax Foundation has a helpful breakdown of the Washington Supreme Court's ruling and the politically charged history the state's efforts to enact an income tax. Rather than diving into that discussion, you should read Jared's summary of the political and legal history.
While the merits of a capital gains tax as an excise tax are conspicuous in the state and local tax community, the Court held the excise tax workaround did not run afoul of the constitutional requirement. Absent a challenge to the United States Supreme Court, Washington is entering the world of income taxes. That means Washington residents and nonresidents, particularly those from Oregon, must now navigate a new frontier of tax issues.
It is fair to assume a new Washington tax will raise the taxes people pay to that state; however, Washington's new tax is likely to increase the taxes Oregon residents pay to Oregon. This post explores one of many challenges Oregonians are likely to face while navigating the northern state's new tax.
States Offer Credits For Taxes Paid To Another State
If someone has income from more than one state, they may need to file and pay taxes in their home state and others. This can create the challenge of double taxation, where an individual is required to pay income tax on the same income in more than one state. As a constitutional rule, states must provide "resident credits" to taxpayers to avoid double taxation.
State resident credits recognize a taxpayer's liability on income generated from another state. These credits are designed to avoid the double taxation of income between multiple states. Under the U.S. Supreme Court's decision in Complete Auto Transit, Inc. v. Brady (1977), the Court established that a state's tax system must be internally consistent if applied broadly. If a state imposes its tax on interstate activity, it cannot result in double taxation if the same rules were applied elsewhere.
For example, if Oregon imposed its income tax on activity occurring in another state, the U.S. Constitution requires the state to provide a remedy to avoid taxation if the state's own tax rules would include the activity as income. Oregon statutes, specifically ORS 316.082, prescribe the method the taxpayer credits those tax payments against their Oregon income tax liability. The credit is limited to the amount of Oregon tax that would be due on that same income.
Washington's New Capital Gains Excise Tax Presents Challenges for Oregonians
Since Washington crafted its new capital gains tax as an excise tax instead of an income tax, Oregon may not be required to provide a resident credit. States are conservative in applying their resident credits. As a constitutional requirement, a state only wants to credit the amounts required by law and nothing more to maximize its revenue. Washington may characterize its income tax as an excise tax to bypass its own state constitutional requirements, but that could come at the expense of Oregon taxpayers.
To be fair, Washington's designation of its tax as an excise tax is, at best, dubious. Jason Mercier of the Washington Policy Center shares regular reminders the state is the only jurisdiction in the world characterizing a capital gains tax as an excise tax. The federal government, every state revenue department, and every other country consider capital gains a component of income and tax it accordingly. For Washington, however, the court has ruled otherwise.
If Oregon does not recognize Washington's capital gains tax as an income tax, Oregonians with cross-border activity may effectively pay double taxation on income.
If a farmer in the Columbia River Gorge sells land, property, or another type of asset in Washington, they may be subject to the new excise capital gains tax. Assuming Oregon does not recognize the tax as a creditable tax, the farmer could end up paying both taxes on the same source of income. The farmer would receive a credit for those taxes in any other state.
Likewise, Washington may not consider the Oregon (or any other state) tax as creditable because it is alone with an excise tax on capital gains. In particular, a footnote in the Washington State Supreme Court's ruling confirms the peculiar treatment of creditable taxes.
[The plaintiffs] offer a hypothetical where a taxpayer with multiple residencies, such as Washington and California, could experience multiple taxation. But the statutory definition of “residency” ensures that an individual can have only one residency. RCW 82.87.020(10) (residency relates to domicile). Moreover, it appears Washington’s capital gains tax would not apply in Plaintiffs’ example because California taxes capital gains as income. (Emphasis Added)
Assuming states only provide resident credits as necessary, it is fair to assume states will look for ways to prevent taxpayers from claiming a credit against taxes paid for Washington state's odd capital gains tax. Overnight, another state's crazy tax politics result in a tax liability that would otherwise be avoidable if the other state followed everyone else's characterization of capital gains.
Oregon Policymakers Should Proactively Recognize Washington's Tax As Creditable
Oregon could, and arguably should, deem Washington state's new capital gains tax as creditable as a matter of policy. Washington's characterization of its tax as an excise tax rather than an income tax is, at best, constitutionally dubious, but the status quo presents a real opportunity for double taxation that is avoidable. Oregon should recognize the tax as creditable.
Washington's creative approach to circumventing its constitution deeming income as property and thus subject to uniformity requirements results in a politically charged tax that creates conflicts for cross-border activity. Considering that people on both sides of the border own businesses and conduct activity on each side of the Columbia River, the byzantine ruling is nothing short of a childish ploy to redefine an income tax. It also comes at the expense of Oregon taxpayers and the taxes they pay to Oregon.
Oregon cannot change Washington's policy choices, but it can recognize that income is income and provide the same multistate tax treatment it would for any other state. If Washington is unwilling, Oregon should at least be the adult in the room.