Larry's Tax Law

It 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.”

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.

On 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.

As 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. 

Background

Early in the pandemic, I reported on the widespread newly created remote workforces resulting from stay-at-home orders issued by the governors of most states.  In many cases, neither the employer nor the workers were prepared to take this journey.

Fears were rampant among employers that workplace productivity would diminish, quality of work would be impacted, technology would not support remote workers, culture would be compromised, employee recruiting and retention would be harmed, and customer goodwill would be tarnished.  On top of that, many employers worried that employee fatigue (mental and physical) would accompany the new workforce model.

Preliminary Results

Now that we are over two years into the pandemic, employers and employees alike are surprised to find that their fears, for the most part, were misplaced.  In most cases, it is reported that the remote workforce model is working quite well.    

• • Employees generally like the remote workforce model;
  • In a large number of cases, employees desire to remain remote post-pandemic;
  • The lack of commuting to and from work reduces employee disruption, stress  and household expenses (commuting costs, daycare, meals and clothes), and allows more time for family and leisure activities;
  • Workplace politics are diminished;
  • It creates flexibility as to where employees may live, resulting in housing costs reductions in some cases; and
  • Employee absenteeism is diminished.

As I previously reported, the Washington state capital gains tax has had a turbulent ride, commencing with a rough ride through the legislative process where it almost hit disastrous terrain on at least six (6) occasions.  Then, it was hit with a lawsuit to strike it down as unconstitutional before Governor Inslee could even sign the legislation into law.  Days later, it was sideswiped with a second lawsuit to end its short life.

As I reported on March 2, 2022, the new tax regime took a near lethal blow when Douglas County Superior Court Judge Brian C. Huber struck down the newly enacted Washington state capital gains tax as unconstitutional. 

Judge Huber concluded:

ESSB 5096 violates the uniformity and limitation requirements of article VII, sections 1 and 2 of the Washington State Constitution. It violates the uniformity requirement by imposing a 7% tax on an individual's long-term capital gains exceeding $250,000 but imposing zero tax on capital gains below that $250,000 threshold. It violates the limitation requirement because the 7% tax exceeds the 1% maximum annual property tax rate of 1%.

As suspected by many local commentators, the state would not let the tax regime die without a fight.  It is now seeking a higher court review of Judge Huber’s ruling, hoping to bring life back into the tax.

On March 25, 2022, Attorney General Robert W. Ferguson filed a notice of appeal.  Instead of appealing to the Washington Court of Appeals (the normal course of review), Mr. Ferguson filed a petition requesting the Washington State Supreme Court hear the case. 

As previously reported on May 7, June 17 and November 4 of last year, two lawsuits were filed in Douglas County Superior Court in Washington, seeking a declaration that the state’s new capital gains tax is unconstitutional.  The court consolidated the cases.  The parties filed cross motions for summary judgment, along with legal briefs in support of their positions.  The lawyers for the State of Washington asked for a judgment that the tax regime meets constitutional muster.  On the other hand, the lawyers for the taxpayers that initiated the case sought a judgment that the tax regime is unconstitutional.

The Oregon Legislature, in House Bill 3373, created the Office of the Taxpayer Advocate within the Oregon Department of Revenue.  The new law became effective on September 25, 2021.  According to the Oregon Department of Revenue website, the office is open and “here to help.”

The mission of the Office of the Taxpayer Advocate is threefold:

1. To assist taxpayers in obtaining “easily understandable” information about tax matters, department policies and procedures, including audits, collections and appeals;
2. To answer questions of taxpayers or their tax professionals about preparing and filing returns; and
3. To assist taxpayers and their tax professionals in locating documents filed with the department or payments made to the department.

As previously reported on May 7 and June 17 of this year,  Washington state lawmakers enacted a new capital gains tax, set to go into effect on January 1, 2022, but two lawsuits were initiated to declare the tax unconstitutional.  To date, the court cases are continuing their way through the judicial process.

On November 2, 2021, as part of the statewide general elections process, Washington voters were not asked to vote on the new state capital gains tax; rather they were asked for their opinion on the tax.

The specific question posed, as written by the Office of the Attorney General, is as follows:

Last fall, the IRS announced, with respect to pass-through entities (LLCs or other entities taxed as partnerships or S corporations), that, if state law allows or requires the entity itself to pay state and local taxes (which normally pass through and are paid by the ultimate owners of the entity), the entity will not be subject to the $10,000 state and local taxes deductibility cap (the “SALT Cap”). 

On February 4, 2021, Senate Bill 727 (“SB 727”) was introduced in the Oregon Legislature.  SB 727 is Oregon’s response to the IRS announcement (see discussion below).

On June 17, 2021, after some amendments, SB 727 was passed by the Senate and referred to the House.  Nine days later, the House passed the legislation without changes.  On June 19, 2021, Oregon Governor Kate Brown signed SB 727 into law, effective September 25, 2021.  In general, it applies to tax years beginning on or after January 1, 2022.  Interestingly, SB 727 sunsets at the end of 2023.

In relevant part, SB 727 allows pass-through entities to make an annual election to pay Oregon state and local taxes at the entity level.  For pass-through entities that make the election, their owners will potentially be able to deduct more than $10,000 of Oregon state and local taxes on the federal income tax return.  However, it gets even better—SB 727 includes a refundable credit feature that may result in further tax savings for some owners of pass-through entities.