Washington Court Hears Arguments Over Seattle ‘Rich’ Tax

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By Paul Shukovsky

The city of Seattle Nov. 17 defended its new municipal income tax on high-earners as the Washington Superior Court heard from several parties arguing that the regime should be struck.

At issue is a Seattle ordinance passed in July imposing a 2.25 percent tax on the “total income” of single filers making more than $250,000 and joint filers making more than $500,000 ( Kunath v. Seattle, Wash. Super. Ct., No. 17-2-18848-4, Oral arguments on cross motions for summary judgment 11/17/17 ).

But the stakes extend beyond Seattle with progressives aligned with the city’s elected leaders seeking the Washington Supreme Court’s buy-in on the proposition that taxing income in Washington—one of seven states without a personal income tax—is constitutional and that cities aren’t prohibited by statute from doing so. Many expect the case ultimately will move to the state Supreme Court.

Plaintiffs contend that cities can only tax with explicit legislative authority, which they say hasn’t been granted, and that a 1984 statute specifically prohibits cities from levying the tax.

But another argument—one the plaintiffs’ case is designed to avoid because an adverse ruling by the state Supreme Court could open the door to an income tax around Washington—is whether precedent stretching back to the 1930s effectively barring a progressive income tax is still good law or should be overturned. The justices have held that Amendment 14 to the state constitution means taxes must be uniformly levied within a class of property—including income. If that reading ultimately stands, it would preclude Seattle from imposing a tax that kicks in at the $250,000 threshold.

Superior Court Judge John R. Ruhl said he would rule before Thanksgiving.

Washington Taxes ‘Regressive’

Defending the tax on behalf of Seattle, Paul J. Lawrence, of the Seattle firm Pacifica Law Group, spoke of the challenge faced by the City Council in finding revenue in an economically booming community where blue-collar and middle-income residents are getting hammered by the high cost of living.

“The City Council also recognized that Washington state is perhaps the most regressive state when it comes to taxation in the nation,” Lawrence told the court. “The tax burden falls most heavily on the poorest people in the community.”

The ordinance, which levies the tax on “total income” reported to the Internal Revenue Service, chose to rely on IRS Form 1040, Line 22, Lawrence said. And the city derives its authority from a broad legislative grant to tax, including excise taxes and for “local purposes.”

Opposing the income tax was a team of attorneys that includes a former Washington attorney general. Attorneys with the libertarian-leaning organizations Freedom Foundation and Pacific Legal Foundation also argued against the tax for plaintiffs in the four separate lawsuits consolidated in the case.

Plaintiffs’ attorney Scott M. Edwards of Lane Powell’s Seattle office contended that the tax is imposed not on total income, but on net income, which is expressly prohibited by state statute, relying on RCW 36.65.030, which says that a city “shall not levy a tax on net income.”

‘Only Two Types of Income’

“There are only two types of income, gross income or net income,” Edwards told the court. “Every one of the lines that is a component part of line 22 is a net number.”

“The city has no statutory authority to impose an income tax,” Edwards told the court. “Their authority is limited to excise taxes and an income tax is not an excise tax. Not only do they not have the authority they need to impose the tax, they are expressly prohibited. This is a tax on net income. There is no such creature as total income. It’s either gross or net. This is net.”

Joining Seattle in defending the ordinance was the union-supported Economic Opportunity Institute, which promotes a broad progressive agenda including to “pass an income tax in one or more Washington cities to fund local/community investments as a step toward fair and ample state revenue.” Attorney Knoll Lowney, of the Seattle firm Smith & Lowney, rose for the Economic Opportunity Institute to argue that the statute doesn’t apply because “the city’s tax is not a tax on net income.” He added that “it’s an excise tax, not a property tax” to reinforce the contention that the city has the statutory authority to impose it.

An ‘Erroneous Assumption’

Former Washington Attorney General Rob McKenna—of Orrick, Herrington & Sutcliffe in Seattle—argued that settled Supreme Court precedent should be left intact with regard to its holdings that taxes must be uniform within a class of property and that income is property. “On this concept that the city’s counsel stated that income is earned, not owned, that’s not for the city to decide.” McKenna said. “It’s not even for this court to decide. It’s for the Supreme Court to decide.”

“An income tax in this state is definitely a property tax,” McKenna said. “Repeatedly the “Supreme Court has referred back to constitutional language put into place by Amendment 14 to find that income is property and has to be taxed uniformly.”

But Lawrence said the state Supreme Court rulings relied heavily on case law that has since been overturned. “And the Supreme Court also relied on the erroneous assumption that the majority of the courts at the time of its ruling in the 1930s considered income as property for tax purposes. That was not true then and it’s certainly not true now where an overwhelming majority of state courts and federal courts have not treated income as property for tax purposes.”

To contact the reporter on this story: Paul Shukovsky in Seattle at pshukovsky@bloomberglaw.com

To contact the editor responsible for this story: Cheryl Saenz at csaenz@bloombergtax.com

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