If I-1098 Passes, High-income Taxpayers in Washington State Should Realize Capital Gains in December

As virtually everyone knows, the Bush tax cuts at the federal level are set to expire at the end of the year. Democrats favor extending virtually all the tax cuts for everyone except those at the top of the income distribution. For taxpayers with incomes above $250,000, they’d face higher taxes on wages, dividends, capital gains, etc. The tax rate on long-term capital gains would rise from 15% to 20%. Some may consider this a modest increase.

However, in Washington State, on the November ballot is a proposition to enact an income tax in the state that would, when first implemented, impose a 9 percent tax rate on adjusted gross income in excess of $1 million for married couples (and 4% tax on agi in excess of $400,000). That tax would be on wages, capital gains, and anything else in AGI.

The combination of the federal long-term capital gains tax rate going from 15% to 20% and the Washington state capital gains tax rate going from 0% to 9 means that the long-term capital gains tax rate faced by high-income Washington state residents would essentially be doubling from December to January (15% to 29%).

Such a huge increase over a short time period means that high-income taxpayers are likely to move capital gains realizations that they were planning on taking in 2011 into 2010. The additional return that is gained by holding on to an asset for another 3 months, 6 months or a year (or possibly even beyond) is likely to be smaller than the tax benefit that one would get from realizing the gain sooner. What this means is that capital gains tax realizations for Washington state will likely be relatively small in the first year of the proposed income tax should it pass compared to future years.

More on Washington State’s tax system.