Main Menu

Rain on Olympic PeninsulaIt is a rainy day in the Pacific Northwest with chances of snow showers.  For those taxpayers that reside in the state of Washington or own highly appreciated capital assets located in the state, their day just got a bit gloomier. 

Earlier today, the Washington Supreme Court, in a 7-2 opinion, overturned the Douglas County Superior Court decision that had ruled the state capital gains tax enacted by the legislature in 2021 violates the Washington State Constitution.  

Majority Opinion

In its 50-plus page opinion written by Justice Debra L. Stevens, the majority of the court concludes:

“The court below [the Douglas County Superior Court] concluded the tax is a property tax that violates article VII’s uniformity requirement. In light of this ruling, the court did not address Plaintiffs’ additional constitutional challenges. We accepted direct review and now reverse. The capital gains tax is appropriately characterized as an excise because it is levied on the sale or exchange of capital assets, not on capital assets or gains themselves. This understanding of the tax is consistent with a long line of precedent recognizing excise taxes as those levied on the exercise of rights associated with property ownership, such as the power to sell or exchange property, in contrast to property taxes levied on property itself. Because the capital gains tax is an excise tax under Washington law, it is not subject to the uniformity and levy requirements of article VII. We further hold the capital gains tax is consistent with our state constitution’s privileges and immunities clause and the federal dormant commerce clause. We therefore reject Plaintiffs’ facial challenge to the capital gains tax and remand to the trial court for further proceedings consistent with this opinion.”

The court succinctly summarized the parties’ positions as follows:

Opponents Position

“Plaintiffs seek to facially invalidate the capital gains tax on three separate grounds. They first argue that the tax is a property tax on income pursuant to Culliton and that it violates the uniformity and levy limitations on property taxes set forth in article VII, sections 1 and 2 of the Washington Constitution. They also argue the tax violates our state constitution’s privileges and immunities clause and the federal constitution’s dormant commerce clause.”

Government’s Position  

“The State maintains that the capital gains tax is an excise tax, not a property tax, and that each of Plaintiffs’ constitutional challenges fails. Separately, Intervenors challenge the wisdom of Culliton. If the court were to hold the capital gains tax comes within the purview of Culliton’s holding that an income tax is a property tax subject to article VII, sections 1 and 2, Intervenors urge the court to overturn Culliton as incorrect and harmful or because its legal underpinnings have eroded.”

Justice Stephens, joined by Justices Gonzalez, Madsen, Owens, Yu, Montoya-Lewis and Whitener, ultimately concluded that the new tax is an excise tax.  She states:

“We hold the capital gains tax is an excise tax under Washington law. We decline to reexamine Culliton because article VII’s uniformity and levy limitations on property taxes do not apply. We further conclude the capital gains tax survives constitutional scrutiny under our state privileges and immunities clause and the federal dormant commerce clause. We therefore reverse the superior court’s grant of summary judgment to Plaintiffs and remand to the superior court for further proceedings consistent with this opinion.”

Dissenting Opinion

Justice McCloud (joined by Justice Johnson) wrote a 20-plus page dissenting opinion.  She succinctly points out, noting the broad state constitutional definition of property:

“’Capital gains’ are income.  In Washington, income is property. A Washington ‘capital gains tax’ is therefore a property tax.

The problem is that in Washington, our constitution limits any such property tax to one percent annually.  The Washington Legislature nevertheless enacted a new law, Engrossed Substitute Senate Bill (ESSB) 5096, 67th Leg., Reg. Sess. (Wash. 2021), codified at ch. 82.87 RCW, which taxes ‘capital gains’; at seven percent annually. That’s more than one percent. This new ‘capital gains’ tax therefore constitutes a property tax that violates the Washington Constitution’s ‘one percent’ annual limit on such a ‘property’ tax. In a contest between a Washington statute and the plain language of the Washington Constitution, the judicial branch has the duty to uphold the constitution.

I therefore respectfully dissent.”      

Justice McCloud goes on to state:

“The plain language of the statute shows that taxable incident is not the sale or transfer of the capital asset itself. Rather, the taxable incident is the realization of income derived from the sale of qualifying capital assets. Because the taxable incident or event is the realization of income—not the mere transfer of the asset—the tax is an income tax, regardless of the label placed on it by the legislature. Jensen v. Henneford, 185 Wash. 209, 217, 53 P.2d 607 (1936) (plurality opinion). The measure of the tax is indisputably the amount of income gained from the transaction. The fact that the tax is measured by the amount of net income only reinforces the conclusion that the taxable incident is receipt of income and that the capital gains tax is an income tax.


A tax is determined by its incidents, not by its legislative label. The structure of the capital gains tax shows that it is a tax on income resulting from certain transactions—not a tax on a transaction per se. Therefore, the tax is an income tax, not an excise tax. Under our constitution and case law, an income tax is a property tax. As enacted, this income tax or ‘capital gains tax’ violates the one percent levy limitation of article VII, section 2.”

Impact on Taxpayers

As reported in prior blog posts on November 30, 2022, April 12, 2022, May 7, 2021 and April 29, 2021, Senate Bill 5096 created a capital gains tax regime in Washington state.  The purpose of the tax is to fund K-12 education. 

The tax went into effect on January 1, 2022.  Because the Washington Supreme Court did not strike down the new tax, most taxpayers subject to the tax are required by April 17, 2023 to file their first Washington Capital Gains Tax Return (for the 2022 taxable year) and pay any tax owing.

The tax is seven (7) percent on the long-term capital gains derived from the voluntary sale or exchange of stocks, bonds and other capital assets in excess of $250,000 per year (subject to an inflationary adjustment).   For this purpose, the new law defines "capital assets" by adopting the definition contained in Section 1221 of the Internal Revenue Code of 1986, as amended.  Long-term capital gains result from the sale or exchange of a long-term capital asset (a capital asset held more than one year).

The new law contains numerous notable exceptions.  The tax does not apply to:

    • Any real estate transferred by deed, contract, judgment or other lawful instrument.
    • Any interest in a privately held entity but only to the extent that the long-term capital gain or loss from the sale or exchange is directly attributable to real estate directly owned by the entity.
    • Retirement Accounts.
    • Condemnations or transfers under the imminent threat of condemnation.
    • Cattle, horses or breeding livestock provided more than 1/2 of the taxpayer's gross income during the taxable year is derived from farming or ranching.
    • Depreciable property (i.e., property qualifying for expensing under Code Section 179 or depreciation under Code Section 167(a)(1)) used in a trade or business.
    • Timber, timberland, dividends and distributions from REITs derived from the sale or exchange of timber or timberland.
    • Commercial fishing privileges.
    • Goodwill from the sale of an automobile dealership.

The "adjusted capital gain derived in the taxable year from the sale of substantially all of the fair market value of the assets of, or the transfer of substantially all of the taxpayer's interest in, a qualified family-owned small business" are also not subject to the new tax.  There are several components to this carve-out:

    • The business must be a "qualified family-owned business."
    • A "qualified family-owned business" is a business:  (i) in which the taxpayer held a "qualifying interest" for at least five years immediately preceding the sale or exchange; (ii) the taxpayer or members of his/her family materially participated (or both) in the business for at least five of the ten years immediately preceding the sale or exchange (unless the sale or exchange was to a qualified heir); and (iii) the worldwide gross revenue of the business is $10 million or less (subject to an inflationary adjustment) for the 12-month period immediately preceding the sale or change.
    • "Qualifying interest" means (i) an interest as a sole proprietor; (ii) an interest of at least 50 percent of a business that is owned (directly or indirectly) by the taxpayer and/or members of his/her family; or (iii) an interest of at least 30 percent of a business that is owned (directly or indirectly) by the taxpayer and/or members of his/her family and at least 70 percent is owned (directly or indirectly) by two families or 90 percent is owned (directly or indirectly) by three families.
    • For purposes of these requirements, "material participation" has the meaning prescribed by Code Section 469.  In general, it means being involved in the business on a regular, continuous and substantial basis.
    • "Qualified heir" means a member of the taxpayer's family.  In turn, "family" includes ancestors of the taxpayer, the spouse or state registered domestic partner of the taxpayer; lineal descendants of the taxpayer, of the taxpayer's spouse or state registered domestic partner, or of a parent of the taxpayer; or the spouse or state registered domestic partner of any lineal descendant of these individuals.
    • "Substantially all" means 90 percent (applied in terms of value).

The law provides a deduction of up to $100,000 from the taxpayer’s capital gains if the taxpayer made $250,000 or more in contributions to a charity directed or managed in Washington during the same tax year as the sale or exchange giving rise to the tax. 

To avoid double taxation on a sale or exchange of a capital asset under the Washington Business and Occupation (“B&O”) tax regime, a credit is allowed against taxes due under the B&O tax regime if such sale or exchange is also subject to the capital gains tax. In such cases, the credit is the amount of B&O tax incurred from the sale or exchange of the capital asset. 

The law comes with some compliance teeth.  In addition to civil penalties and interest for noncompliance, it is a Class C felony to knowingly attempt to evade the tax.  Also, it is a gross misdemeanor for knowingly failing to pay the tax, file returns or keep records or supply the taxing authority with information requested relative to the tax.


Unless the Washington state legislature repeals the law, it appears the recently enacted state capital gains tax regime is here to stay.  Taxpayers need to familiarize themselves with the new tax, its exclusions, its thresholds and the reporting requirements.  The penalties for noncompliance, just like other tax regimes, can be substantial.  


As I have discussed in prior blog posts (March 11, 2013April 9, 2013 and December 9, 2013), worker classification has historically been a focus of attention of various government agencies as well as others.  Misclassifying workers, even if unintentional, can create nightmares for businesses and their owners. 

The worker classification rules are not always objective, making them difficult to apply.  Additionally, the rules applicable to a particular business may vary depending on who is looking at the matter.  For example, in many cases, the laws applied by the Department of Labor (“DOL”) and the Internal Revenue Service (“IRS”) differ from the laws applied by state or local agencies.  On top of that, the laws of the states are not uniform.

As a result of the COVID-19 pandemic, we have seen a significant worldwide change in the structure of workforces caused by the emergence of the remote worker.  The number of remote workers has significantly multiplied in the last two years, adding one more factor to the worker classification analysis.  In and of itself, having workers performing services from remote locations (usually their personal residences) does not make the workers per se employees or per se independent contractors.  While the location where a worker performs services should be considered in making a classification determination (i.e., whether the business can or does control the worker), it is not a definitive factor.  Nevertheless, with a changed workforce model, which is likely here to stay, businesses should invest the time and energy in revisiting their prior worker classification conclusions to see if they remain valid today.    

2022, like the prior two years, has been difficult.  The COVID-19 pandemic and social unrest continues to be at the forefront of our existence.  On top of that, inflation and possible recessionary times are among us.

Thanks to the unwavering support of family, friends, clients, and colleagues, we are enduring through these turbulent times.  I am so grateful for these relationships!

I have had to constantly be mindful of the good things going on around us.  As American Poet Walt Whitman is accredited with saying:

By motion dated November 3, 2022, the Washington State Attorney General asked the Supreme Court of the State of Washington to allow the Washington Department of Revenue to implement and collect the capital gains tax struck down as unconstitutional by the Douglas County Superior Court, pending the high court’s ultimate ruling on the matter. 

As previously reported, the tax, which was set to go into effect on January 1, 2022 was struck down by the Douglas County Superior Court as unconstitutional.  The first tax payments under the new tax regime would be due on April 17, 2023.


Magnifying glassMore than two decades ago, the Service announced its intention to consider simplifying the entity classification rules in Notice 95-14.  It stated:

“The Internal Revenue Service and the Treasury Department are considering simplifying the classification regulations to allow taxpayers to treat domestic unincorporated business organizations as partnerships or as associations on an elective basis. The Service and Treasury also are considering adopting similar rules for foreign business organizations. Comments are requested regarding this and other possible approaches to simplifying the regulations.”

The Service asked for public comments on simplification of entity tax classification.  It scheduled a public hearing on the matter for July 20, 1995. 

In May 1996, proposed entity classification regulations were issued by Treasury.  About seven months later, on December 17, 1996, Treasury finalized the regulations.  The regulations are found in Treasury Regulation Section 301.7701.

The regulations were clearly designed to accomplish the IRS’s stated goal – simplifying entity tax classification.  The regulations, commonly referred to as the “Check-the-Box” regulations, successfully brought an end to much of the long existing battle between taxpayers and the Service over entity tax classification.  The regulations generally became effective on January 1, 1997.  In a little over a month from now, they will be 25-years old.  

The regulations, despite judicial challenge (e.g., Littriello v. United States, 2005-USTC ¶50,385 (WD Ky. 2005), aff’d, 484 F3d 372 (6th Cir. 2007), cert. denied, 128 S. Ct. 1290 2008)), have persevered, making the entity classification landscape free of many tax authority challenges and providing taxpayers with some objectivity and more importantly, much needed certainty.  That said, despite the simplification brought into the world of entity tax classification by the Check-the-Box regulations, for which tax practitioners applauded the government, several new hazards were created.  Whether these new hazards were intentional or unintentional is subject to debate.  Unfortunately, not all of these hazards are obvious to taxpayers and their advisors.  If taxpayers and their advisors are not extremely careful in this area, disastrous unintended tax consequences may exist.  Accordingly, a good understanding of the regulations and the consequences of making, not making or changing an entity tax classification decision is paramount.

Last month, I presented a White Paper that I authored on the regulations at the NYU 81st Institute on Federal Taxation in New York City, and I will be presenting it again for NYU in San Diego on November 17, 2022.  The paper provides exhaustive coverage of the regulations and covers numerous nuances and traps that exist for unwary taxpayers and their advisors.  An issue which is often overlooked by practitioners is whether using the regulations to change entity status for income tax purposes is always a good idea.  While I discuss the issue in some detail in the paper, the sub-issue of whether a taxpayer should use the regulations to change the tax status of a limited liability company (“LLC”) taxed as a partnership to a corporation taxed under Subchapter S needs discussion.  I explore that sub-issue below.

NYC and San DiegoThe NYU 81st Institute on Federal Taxation (IFT) returns to in-person programming this year in New York City on October 23-28, 2022, and in San Diego on November 13-18, 2022. 

This year, I will be presenting my white paper “Entity Classification – The Check-The-Box Regulations Revisited."  Our discussion will cover recent developments in the law relating to entity classification, limitations under the check-the-box regulations, flexibility and planning opportunities created by the regulations, traps that exist for the unwary, and practical planning opportunities for tax advisers.

I am extremely grateful to have had the opportunity to present with IFT for more than a decade. During this year’s Institute, I will again be presenting as part of the Closely-Held Business program, chaired by my esteemed colleague Jerry David August, on the mornings of October 27 (NYC) and November 17 (San Diego)

GavelOn August 23, 2022, the Regular Division of the Oregon Tax Court issued its opinion in Santa Fe Natural Tobacco Co. v. Department of Revenue, State of Oregon.  The court determined that the taxpayer in that case is subject to the corporate excise tax. 

The taxpayer, Santa Fe Natural Tobacco Co., required that its wholesale customers located in Oregon accept and process returned goods.  In addition, the taxpayer’s in-state sales representatives, who did not maintain inventory, routinely confirmed and processed purchase orders between Oregon retailers and wholesalers.

Remote workerAs previously reported, due to the COVID-19 pandemic, remote workforces currently dominate the landscape of most U.S. businesses.  In fact, in many industries, remote workforces may be the new normal post-pandemic.  Unfortunately, as workers become more mobile, the tax and human resources issues become more challenging for employers.

I was asked by Dan Feld, Principal Editor, Tax Journals, of Thomson Reuters, to author an article on this topic for the July 2022 Practical Tax Strategies Journal.  With Dan’s approval, I have provided a link to the complete article, Remote Workforces: Tax Perils and Other Traps For Unwary Employers, for my blog readers. 

IRSThe Taxpayer Advocate Service (“TAS”) is an independent body housed within the Internal Revenue Service (the “Service” or “IRS”).  Its mission is to ensure taxpayers are treated fairly by the Service and that taxpayers know and understand their rights with respect to the federal tax system.  Further, the TAS was created by Congress to help taxpayers resolve matters with the IRS that are not resolved through normal IRS procedures.  Additionally, the TAS was established to address large-scale, systemic issues that impact groups of taxpayers.

The TAS is currently led by Ms. Erin M. Collins, who joined the TAS in March 2020.  She serves as the National Taxpayer Advocate (“NTA”).  The NTA submits two reports to Congress each year, namely an “Annual Report” in January and what is called an “Objectives Report” in June.

On June 22, 2022, the NTA submitted the TAS Fiscal Year 2023 Objectives Report to Congress.  In addition to identifying the TAS’s objectives for the upcoming fiscal year, Ms. Collins sets out the good, the bad and the ugly relative to the Service’s performance during the year.  As a report card, it does not appear Ms. Collins gave the IRS all A’s.  She expressed critical comments centered primarily around three areas of customer service that include unprocessed paper-filed tax returns, delays in responding to taxpayer correspondence and failures in answering taxpayer telephone inquiries.  Whether the criticism is warranted may be debatable.

CheckboxMore than 25 years ago, effective January 1, 1997, Treasury issued what have been called the “Check-the-Box” regulations (the “Regulations”).1  The Regulations ended decades of battles between taxpayers and the IRS over entity classification.  Further, the Regulations simplified entity classification and brought much needed certainty to most entity classification decisions.

Under the Regulations, a business entity with more than one owner is either classified for federal tax purposes as a corporation or a partnership.2  Likewise, a business entity with only one owner is either classified as a corporation or is disregarded for federal income tax purposes as being separate and apart from its owner.3 

If a business entity is disregarded, its activities are generally treated for federal tax purposes as the activities of its owner.  There are five notable exceptions to that rule. 

Search This Blog



Larry J. Brant

Larry J. Brant is a Shareholder and the Chair of the Tax & Benefits practice group at Foster Garvey, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; Washington, D.C.; New York, New York, Spokane, Washington; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long-term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.

Recent Posts


Select Category:


Select Month:

Upcoming Speaking Engagements


Back to Page

We use cookies to improve your experience on our website. By continuing to use our website, you agree to the use of cookies. To learn more about how we use cookies, please see our Cookie Policy.