The new year is all about getting a fresh start–unfortunately for some Washington state residents, this means new taxes. On Jan. 1, 2022, the state’s controversial capital gains tax officially became active. The state legislature has been attempting to pass a capital gains tax for roughly a decade; supporters claim the new tax will make Washington’s tax system more equitable, especially since the state has no income tax. The money collected will be primarily used to support a bill focusing on early education known as “The Fair Start For Kids Act.”

Meanwhile, those against the initiative feel that it could negatively affect business in the state and serve as a stepping stone towards a broader income tax. No matter what side of the debate you fall on, there’s a good chance you’re wondering what the new tax could mean for you.

Many individuals that stand to be affected by the capital gains tax have already taken action, cashing out their stock holdings in response to its passage. Are you unsure how this tax could impact your life? Don’t panic–instead, read this quick explanation of the capital gains tax in Washington state and what you can do about it.

New Capital Gains Tax Explained

The capital gains tax in Washington state is a 7% tax on profits from the sale of long-term assets (that is, assets that taxpayers have owned for longer than a year before selling them). This is in addition to the federal long-term capital gains tax, which is 15% or 20% for most taxpayers, depending on their annual income. Remember that you'll also pay a 3.8% Net Investment Income Tax (NIIT), aka Obamacare tax, on capital gains if you make over $250k/yr married filing jointly ($200k/yr if single).

It’s important to clarify that the tax doesn’t apply to every sale of long-term assets–to name one example, real estate sales are exempt. Click here to see a full list of exemptions from the tax.

Meanwhile, a taxpayer’s profits from selling long-term investments need to exceed $250k for this tax to be applied. To be clear, this is NOT $250k of stock sales, it's $250k of gains. You could sell $750k of XYZ stock and only realize $100k of gains. In that example, you would not pay the additional 7% tax back to Washington state.

Capital gains under that $250k threshold aren’t taxed at the state level, either. With that said, this cutoff point won’t remain static in the future; instead, it will rise each year to match the inflation rate.

How It Works

Imagine that you’re a Washington taxpayer, you sell $300k of capital gains in 2022. Not $300k of money, $300k of gains. For the first $250k you’ll pay tax at the federal level, currently 15-20% plus 3.8% Obamacare, depending on your taxable income. For the next $50k, you’ll pay tax at the federal level, AND you’ll pay an additional 7% tax back to Washington state.

Who is Affected?

So far, you’ve had a chance to learn about the bad news. The good news is that the new capital gains tax won’t directly impact the vast majority of Washington taxpayers. In fact, Washington’s Department of Revenue has estimated that roughly 0.2% of all taxpayers in the state–or about 7,000 individual taxpayers–will actually need to pay this tax. Along with the previously-mentioned $250k threshold, there are quite a few noteworthy exceptions to the tax: 

• Retirement accounts

• Family-owned businesses making no more than $10,000,000/year

• Profits from selling timber/livestock used in ranching or farming

• Real estate sales 

Despite these exceptions, by the 2023 fiscal year (when the first payments under the new tax will become due), the capital gains tax should raise more than $440 million in annual revenue.

What We Recommend

With the first round of capital gains tax payments in Washington state due on sales made in 2022, it’s hardly surprising that many stockholders, executives, and people who have a large concentrated stock position have already sold large capital gains prior to December 31, 2021. That may include Satya Nadella, CEO of Microsoft–recently, he sold 50% of his stake in the corporation and divested around 840,000 shares, earning more than $285 million in the process. And yep, he'll still pay 20% + 3.8% Obamacare tax to the Feds on that. A cool $68 million bucks.

However, selling off long-term assets may not be the right move for your own financial plan strategy. Since the capital gains tax will affect just a fraction of Washington state’s taxpayers, it’s crucial to make sure the tax will actually impact you before making any rash decisions.

With that said, we feel that this tax is very plannable (we are planners, after all). We find that most of our clients aren’t realizing $250k of gains in a calendar year to begin with, and if they do need a larger sum of cash for a down payment, etc., they are typically able to source that cash by staying under $250k of gains by selling from multiple accounts or multiple positions.

If you have a concentrated stock position with a very large long-term capital gain, you could consider a selling strategy over multiple years to stay under the $250k threshold. If you’re in need of an amount of cash that would put you over this $250k threshold, securities loans can be a great option.

If your concentrated position has gotten too large and it’s keeping you up at night. It might be time to rip off the Band-Aid and sell to get back to your comfort level. As we like to say, “don’t let the tax tail wag the investment dog.” 

And remember, selling newly vested/purchased shares may be more tax-efficient than selling your oldest shares because the overall gain is less! Feel free to reach out to us as we may have some ideas to help you tie a selling strategy into your overall planning objectives.

Your Long Term Goals

Whether you’re considering adjustments in response to Washington’s capital gains tax or any other large-scale financial decision, avoid the temptation to act too quickly. Impulsive moves may feel smart at the time, but they may not be a good fit with your long-term investment goals. The most crucial step you can take is to consult your trusted wealth advisor and tax advisor first.

“Trusted” is the operative word here. Too many wealth advisors fail to take their clients’ best interests into account or muddle their advice with industry jargon that sounds impressive but makes meaningful communication practically impossible. Fortunately, Consilio Wealth Advisors can give you reliable, easily-understandable recommendations created with your own financial situation in mind.

Disclosures

The information provided in this article is for educational and informational purposes only and does not constitute investment advice and should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status, or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Consilio Wealth Advisors, LLC ("CWA") is a registered investment advisor. Advisory services are only offered to clients or prospective clients where CWA and its representatives are properly licensed or exempt from licensure.