Seattle facing three legal challenges to high-earner income tax

The Seattle City Council expected legal challenges when it passed legislation creating a progressive income tax on the city’s highest earners. It now has three to contend with.

Under the tax, which will be applied starting Jan. 1, individuals will pay a 2.25 percent tax for income above $250,000, as will couples making more than $500,000 and filing jointly. Those who don’t qualify will not have to file documentation showing so.

The Trump-Proof Seattle coalition began pushing for an income tax of the city’s highest earners back in February, and was led by the Transit Riders Union.

The Seattle City Council approved a resolution on May 1 that set a timeline for considering a city income tax, voting on the July 10 deadline day to impose the tax.

Investment manager Michael Kunath was the first to file a lawsuit against the city of Seattle on July 17, followed by the Freedom Foundation and Opportunity for All Coalition on Wednesday, Aug. 9.

“Freedom Foundation has been talking about this for as long as the city council has been talking about this,” said David Dewhirst, litigation counsel for the nonprofit think tank, which has brought on Seattle law firm Lane Powell to represent it in this case. “They’re just the finest tax attorneys, tax litigators in the Pacific Northwest.”

Freedom Foundation’s eight-page complaint states the city is violating the state constitution and does not have statutory taxing authority to impose a net income tax under state law.

The Freedom Foundation had also opposed Initiative 1, a 2016 ballot measure to impose an income tax on high earners.

“We don’t ever support tax increases, absent some real present exigency,” Dewhirst said, “but that’s the thing that these tax proponents never consider is some tax burden that everyone shares.”

Initiative 69 was passed in 1932 by 70 percent of voters, and had included a net income tax on corporations. However, the state Supreme Court overturned I-69 in a 5-4 decision shortly after, determining income is a form of property. Therefore, all taxes must be levied equally.

“It is hard to see how they could craft viable arguments against 80 years of precedents and clear statutory requirements,” Dewhirst told the Capitol Hill Times.

Opponents also point to a 1984 law approved by the Legislature they say bans local municipalities from passing a net income tax.

“It had more to do with whether an income tax is, as I recall, uniform,” said Seattle City Attorney Pete Holmes. “If it’s a property tax, it has to be uniform. Is an income tax a property tax?”

Holmes said it was always expected that the income tax legislation would be met with well-funded opposition, and so far he has not seen any surprising arguments against it.

“We feel that we have a good path forward with an admittedly new approach,” Holmes said, the city attorney acknowledging there are at least three state Supreme Court cases from the 1930s that address income taxes. “The Supreme Court itself can correct its own precedent. We think we have a broad path forward.”

The city of Seattle has again contracted with Pacifica Law Group to handle the cases, which Holmes said could be consolidated by King County Superior Court Judge John Ruhl. He added the case could skip the appeals court, moving from a Superior Court trial to the Washington Supreme Court and be decided by early 2018.

The Supreme Court upheld Seattle’s tax on gun and ammunition sales on Thursday, Aug. 10, in an 8-1 decision. The Gun Violence Tax was challenged based on state law prohibiting local regulations on firearms, but the court determined the ordinance was a tax and not a regulatory fee.

Holmes said the Supreme Court in its decision acknowledged that Seattle, as a “first-class city,” has broad taxing authority that goes beyond what it provided for in state code.

“It is an example of the approach that we’re taking to this (income tax challenge),” Holmes said.

Former Washington Supreme Court Justice Phil Talmadge, whose law firm is part of a number of legal representatives for the Opportunities for All Coalition’s lawsuit, said Seattle could have a flat-rate income tax, but the legislation as approved creates a graduated tax.

“It graduates because you have that huge exemption,” Talmadge said. “If you start to play around with exemptions, it looks more and more like you’re trying to create graduations in the tax.”

Talmadge said what people lose sight of in the debate is that people could meet the threshold for the high-earner income tax if they see a significant gain through property sales. He said people could be penalized for selling their homes.

Business owners could also be negatively affected, Talmadge said. His law firm means shared income that comes in, but a lot of that goes toward offsetting expenses, such as staff, rent and other overhead.

“Under this ordinance, I pay what comes in the door, not what goes into my pocket,” Talmadge said.

Before the lawsuits end up before the state Supreme Court, Talmadge said it’s possible the Legislature could convene in January and pass a less ambiguous statute than the 1984 legislation regarding net income.

Just like with the stalled capital construction budget, the course taken could rest with how things shake out in the special 45th District election to fill a senate seat left open when Andy Hill died from cancer last year.

Republican Jinyoung Lee Englund and Democrat Manka Dhingra are going to the November general election.

“Whoever is going to be elected to that seat, if that shifts the focus on this Senate, this particular question could become a large question,” Talmadge said.

Seattle’s high-earner income tax is estimated to raise more than $140 million annually, and will be committed to lowering the burden of regressive taxes and addressing several city priorities. Those include addressing Seattle’s homelessness crisis, providing affordable housing, funding mental and public health services and creating green jobs. The high-earner income tax is also meant to cushion the city from potentially hard-hitting federal budget cuts.

Launching an information technology system to track tax returns and payments is estimated to cost $10-$13 million, and must be done before collecting the new tax. Staffing to carry out the process of tax collection is estimated at $2.5-$3 million annually, and the cost is expected to be about the same for an enforcement staff to review tax submittals and conduct audits and other investigations.

Julie Moore, communications director for the city’s Department of Finance of Administrative Services, tells CHT in an email the department has “not yet begun preparations for setting up the system for collecting the recently passed income tax.”

Holmes said he has not provided FAS with any legal advice to postpone implementation.

“The city is moving forward as if this is a valid tax that we believe it to be,” he said.