The start of the new year is often a time when tax changes go into effect. At the Federal level, the Build Back Better Act, which had some significant tax changes, has not passed. For now, it is unclear if the legislation will pass in 2022. It is also unclear if any of the changes would apply in 2022 or would only apply to future years if it does pass.
In Washington State, 2022 brings the scheduled implementation of two new taxes that have the potential to impact many Merriman clients: the capital gains tax and the long-term care payroll tax.
Washington State Capital Gains Tax
Starting in 2022, Washington will apply a 7% tax on realized capital gains above $250,000. The most common assets that will generate income subject to this tax include:
- Sales of stocks and bonds (and mutual funds, ETFs, and other pooled investments)
- The sale of a business above a certain size
Other assets are specifically exempt from the capital gains tax, including:
- All real estate
- Sale of small businesses below a certain size
- Investments inside retirement accounts
- Restricted stock units (RSUs) at the time they vest (though their later sale could result in taxable capital gain income)
How the tax is calculated
This 7% tax is applied only on capital gains above the $250,000 threshold. It is not impacted by other income. The same threshold applies to married and unmarried households.
Example 1: John sold $500,000 of Microsoft stock in his taxable investment account that was acquired for $240,000. He has no other income in 2022. This results in $260,000 of capital gains. Since $260,000 – $250,000 exemption = $10,000, John would owe ($10,000 x .07 = $700) in capital gains tax.
Example 2: Sally has $800,000 of income from her job. She sold $500,000 of Amazon stock that was acquired for $300,000. Because the $200,000 of realized capital gain is less than the $250,000 exemption, she does not owe the capital gains tax. Her other income is irrelevant to this calculation.
Example 3: Matt and Molly are married taxpayers filing a joint tax return. Matt sells stock in his individual taxable account that realizes $150,000 of capital gains. Molly sells stock in her individual account that realizes $120,000 of capital gains. Even though they are both individually below the limit, because they are married and are filing a joint tax return, their total gains are $20,000 above the $250,000 limit; they would potentially owe $1,400 in capital gains tax.
When are payments made?
According to the state Department of Revenue webpage, the tax will be calculated on a capital gains tax return in early 2023. The tax payment will be due at the same time the taxpayer’s federal income tax return is due.
There does not appear to be a requirement to make estimated tax payments before the end of the year the way some taxpayers are required to do for federal income tax.
Potential court challenge
Opponents have challenged the law saying this capital gains tax is unconstitutional under the state constitution. A hearing is scheduled for February 2022. Any ruling is expected to go to the state supreme court later this year.
At this time, we are encouraging families who may be impacted by this new tax to plan under the assumption that it will go into effect.
Long-Term Care Payroll Tax
We have previously shared about Washington’s new long-term care payroll tax. The tax is 0.58% on all wages (including RSUs at the time they vest) and is used to pay for long-term care benefits ($580 on $100,000 of income).
Taxpayers were given the opportunity to exempt themselves from the payroll tax by securing a private long-term care insurance policy before November 1, 2021, and requesting an exemption from the state.
Delay in implementing the payroll tax
In December 2021, Governor Inslee asked the state legislature to delay implementing the payroll tax. That has not happened yet, and employers are technically still required to withhold the payroll tax from employee paychecks.
The requested delay was to allow time to address some concerns, including:
- The current program is limited to Washington residents. Residents could pay in for an entire working career, move out of state in retirement, and then not be eligible for benefits.
- The current program has no mechanism for new workers in Washington State to opt out.
- The current program requires workers to pay into the system who may never be eligible for benefits. Since you must pay in for 10 years to qualify for benefits, older workers who retire before reaching that point will pay in but not qualify for benefits. Military spouses and other out-of-state residents who work in Washington may be in a similar situation.
- The current program has no mechanism to ensure that individuals who opted out of the payroll tax maintain their insurance.
It is expected that implementing the payroll tax will be delayed, but it will still likely go into effect in some similar fashion in 2023 or 2024.
The biggest planning opportunity for the capital gains tax is remaining mindful of how much capital gains income is being realized each year. Several large area employers, like Amazon and Microsoft, along with many smaller employers have seen a significant increase in stock values.
At Merriman, we believe in the benefits of diversifying investments and not remaining too concentrated. For tax purposes, it is often beneficial to realize those capital gains over multiple years to spread out the tax impact.
Since the 7% state capital gains tax is in addition to the federal capital gains tax, it likely makes sense to limit those gains to $250,000 per year where possible.
For the payroll tax, there is a bit of a holding pattern. There was a rush of activity in 2021 to qualify for the exemption, and that deadline has passed. Now that implementation has been delayed, we will wait to see what adjustments, if any, happen and what clients should do to plan for it.
We will update with further adjustments for federal and state taxes. Your financial advisor can provide additional specific guidance.
Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable; however, Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal, or accounting advice, and nothing contained in these materials should be relied upon as such.