While Washington is famous for having no state income tax, it is a mistake to assume that high-net-worth individuals are free from state-level tax liability. In recent years, Washington has introduced and refined specific tax regimes that can materially affect high earners and larger estates.
For residents in the Seattle area, particularly those in the tech sector or with significant investment portfolios, the following strategies are often central to preserving wealth.
1. The Washington State Estate Tax and Credit Shelter Trusts
A common misconception is that if an estate is below the federal exemption, there is no need to worry about estate taxes. This can be risky for Washington residents because the state maintains its own standalone estate tax with a much lower exclusion threshold.The Current Reality
Effective July 1, 2025, Washington increased the estate tax exclusion amount to $3 million per person, indexed for inflation. For deaths occurring in 2026, this exclusion amount has been adjusted to $3,076,000.While this is an improvement over the prior $2.193 million threshold, the state also increased the top marginal rate. The tax is graduated, and the top marginal rate of 35% applies once the Washington taxable estate (after the exclusion and allowable deductions) exceeds $9,000,000.
The Portability Trap
Unlike the federal exemption, Washington’s exclusion is not portable between spouses. If the first spouse dies and leaves the entire estate outright to the surviving spouse, the first spouse’s Washington exclusion is typically not preserved for use at the survivor’s later death.
Incorporating a Credit Shelter Trust (often called a Bypass Trust) can help preserve the first spouse’s Washington exclusion. With proper planning, this allows a married couple to protect roughly two exclusion amounts (over $6 million total in 2026) from state estate tax.
2. WA Capital Gains Tax and the Tiered Rate Structure
Washington’s excise tax on long-term capital gains has been upheld by the courts and has been expanded into a tiered rate structure.
The Tiered Rates
The tax allows for a standard deduction which is indexed annually for inflation ($278,000 for 2025). Gains above this deduction are taxed as follows:
- 7% on the first $1 million of Washington taxable capital gains.
- 9.9% on capital gains exceeding $1 million (due to the additional 2.9% surcharge).
Strategic Implications
This tax generally applies to long-term capital gains from assets such as stocks, bonds, and business interests. However, certain assets remain exempt, including real estate and assets held in many retirement accounts.
As a result, liquidity events in taxable financial assets can create Washington capital gains exposure that would not apply to exempt asset sales. High-income earners may need to coordinate timing, charitable planning, and asset selection to manage exposure to the higher 9.9% tier during major liquidity events.
3. Real Estate Professional Status for High Earners
High-income professionals often purchase rental properties to generate tax losses. However, for most taxpayers, these losses are passive and generally can offset only passive income, not W-2 wages or other active income.
The REPS Exception
If one spouse qualifies as a Real Estate Professional (REPS) for federal tax purposes, rental real estate losses may be treated as nonpassive, but only if the taxpayer also materially participates in the rental activity. In addition, each rental activity is generally treated as separate unless an election is made to group rentals for participation purposes.
When these standards are met, depreciation and other rental losses can potentially offset the other spouse’s active income. To qualify, the spouse generally must spend:
- More than 750 hours per year in real property trades or businesses.
- More than 50% of their personal service time in those activities.
This strategy can be effective, but it carries elevated audit risk. It requires meticulous documentation, including credible time logs and support for material participation.
4. S-Corp Strategy for Tech Consultants and Contractors
For independent contractors earning significant income, operating as a sole proprietorship can result in higher employment tax costs because net earnings are generally subject to self-employment tax.
The S-Corp Election
By electing S-corporation status, a consultant can generally split compensation into two categories:
- W-2 Wages: Subject to payroll taxes.
- Business Profit Distributions: Generally not subject to employment taxes, though still subject to income tax.
A shareholder-employee must receive reasonable W-2 compensation for services performed. When profits materially exceed reasonable salary, remaining distributions generally are not subject to employment taxes. This strategy is highly dependent on facts and requires careful support for the reasonable compensation determination to withstand IRS scrutiny.
5. RSUs, ISOs, and NSOs: Managing the Tax Bracket Hit
For many Seattle-based clients, compensation comes in the form of equity, which can create volatile income years.
The Withholding Gap
Restricted Stock Units (RSUs) are taxed as ordinary income when they vest. Employers often withhold federal tax at the standard supplemental wage rate of 22% (or 37% once supplemental wages exceed $1 million). This 22% rate is often insufficient for taxpayers in the 35% or 37% brackets, potentially leading to large unexpected tax balances at filing time.
Incentive Stock Options (ISOs)
ISOs offer potential tax advantages but can trigger the Alternative Minimum Tax (AMT). While exercising ISOs does not generally create regular taxable income, the spread between the exercise price and fair market value is an AMT adjustment. Strategic timing is required to hold shares long enough to pursue long-term capital gains treatment (up to 20% federally) while managing potential AMT exposure in the year of exercise.
Disclaimer: This article is for general information purposes only and does not constitute legal or tax advice. Tax laws, particularly Washington State thresholds, are subject to change. Please consult with a qualified CPA regarding your specific situation.