Wave of Washington State Tax Changes Demands Holistic Planning

Several recent tax bills in Washington state should prompt residents to consider how potential changes in the business and occupation tax, the state estate tax, and the long-term capital gains tax may affect them and plan accordingly.

The business and occupation tax, which calculates tax on gross proceeds of business activities, will increase. The timing of decisions, both tax and business, should be proactive and periodically reviewed. Depending on each business’s specific circumstance, business owners may want to relocate or change their primary business activities to a different state jurisdiction.

Business owners shouldn’t focus solely on tax consequences, though. Prudent business decisions must include tax analysis but may not be optimal to alter business activities primarily or solely on tax consequences.

The proposed state estate tax change will raise the taxable estate exemption amount from $2.2 million to $3 million and will revise or replace the current progressive estate tax rates from 10% up to 20% to rates ranging from 10% to 35%.

State taxable estates greater than $9 million currently pay 20% state estate tax on amounts exceeding this amount. Under the new law, state taxable estates greater than $9 million will pay 35%.

Washington state residents may wish to focus on holistic lifetime and estate tax planning. Lifetime gifts of various property, investments, and business interests may provide opportunities to reduce the impact of any additional state estate tax consequences.

For example, say an individual owns an asset worth $500,000 today and will grow in value, hypothetically, to $15 million. If no lifetime gifting is done today, that $15 million will be includible in the gross estate. Gifting it will remove that value from potential future state estate tax inclusion.

Taxpayers should consult with a professional when looking to remove value from their estate for state estate tax purposes. The Washington State Department of Revenue’s website says that generally, “outright gifts given prior to the date of death are not taxable for Washington estate tax purposes.”

However, careful and thoughtful planning analysis requires advisement from tax professionals. Lifetime gifting may be advantageous, but a transfer that allows the person who does the gifting certain access or benefits to that property may find that property isn’t excluded from a future estate tax consequence.

In Washington, an excise tax is imposed on the sale or exchange of certain long-term capital assets at the rate of 7% on gains over $270,000. An additional rate of 2.9% is imposed on the amount of long-term gain over $1 million.

Washington state provides that any installment sale occurring on or after Jan. 1, 2022, must include the long-term capital gain in the “measure of Washington capital gains excise tax in the same manner as the gain is reportable for federal tax purposes.”

If an individual sells an asset in the form of an installment sale, as defined for federal income tax purposes, and is reporting a proportional amount of gain over more than one year, this may be an opportunity to reduce state income taxes.

For example, if an individual sells an asset that has $3 million of long-term capital gain and receives proceeds over four years, this would report $750,000 of long-term capital gain each year. This amount won’t exceed the $1 million yearly threshold, subject to the additional excise tax.

Individuals contemplating investment changes may also contemplate timing of asset sales, the amount of total long-term capital, and whether structured changes over more than one tax year may mitigate state tax impact.

In some cases, individuals may want to coordinate estate tax and state capital gains tax planning. An individual may consider transfers to irrevocable trusts as part of beneficial estate planning.

Let’s say a business is selling for an amount of $1 million. The buyer-seller may agree this amount gets paid over two or more tax years. For five successive years, the seller will pay the buyer $200,000. If the installment sale rules are met, the buyer may include $200,000 in income in each of the next five years rather than the whole $1 million in year one. This is beneficial as the amount of income each year is a lesser amount.

The trust also may be a separate taxable entity known as a non-grantor trust. In other situations, the terms, rights, powers, conditions, or controls within the trust document language may cause the trust not to be a separate taxpaying entity. The trust is disregarded for federal income tax purposes and all the income, gains, deductions, and credits are taxable or attributable to the creator or the trust also known as the grantor.

Thus, a person may create a trust that is a separate legal entity and may have other individual beneficiaries of that trust. But certain tax rules may cause the person who creates the trust to be taxed with all income, gains, etc., although that person is not the legal owner or a beneficiary.

The state of Washington may differ or decouple from federal law on whether an irrevocable trust is a non-grantor or grantor trust. An individual may create a certain type of trust in which federal law imposes tax on the trust while Washington may impose the tax on the individual who created the trust. Specifically, the state may examine whether the individual’s transfer to a trust is a completed gift.

Individuals should work with tax professionals and be mindful that state tax savings opportunities may depend not only on transferring property to a trust in certain situations, but also on ensuring the property transfer has been “detached” from a benefit to that individual.

Washington’s proposed legislation is intended to impose greater taxes on individuals and businesses. Both individuals and businesses need to evaluate specific income, sale of assets, and estate planning circumstances to mitigate possible state taxes.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Thomas Kelley is director of income tax planning at Wilmington Trust.

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