Want to be a Millionaire? It May Soon Get More Expensive to Be One in Washington State

The State of Washington is part of a small, well-appreciated group of states with no general income tax. However, the state imposes income taxes on long-term capital gains in excess of $278,000 and a gross receipts tax on businesses. With substantial budget deficits projected by the state, Washington may soon be leaving this exclusive group because of a proposed income tax on those earning over $1 million annually.  Legislation has already been passed by the state Senate (SB 6346) and is currently being debated by a House committee (HB 2724). Gov. Bob Ferguson has already announced his intention to sign the bill into law once the House passes it. Estimates vary, but government and economic experts expect revenue to exceed $3 billion annually. As currently drafted, the tax would take effect on Jan. 1, 2028.

The bill contains key items affecting personal and other state taxes and also explains how the tax is computed. It would appear that at least some business-related tax breaks that reduce tax revenue are being offset by the proposed income tax, though it is expected that income tax revenues would greatly exceed any revenue losses from the changes to business taxes.

Important Aspects of HB 2724

• An individual income tax levied at 9.9% on income exceeding $1 million
• Expanded eligibility for the Working Families Tax Credit, which is a refundable credit on retail sales or use tax paid by low to moderate-income Washington residents who meet certain income and age requirements.
• Increases in the credit against Business & Occupation (B&O) tax for small businesses, as well as doubling the annual exemption from $125,000 to $250,000
• The current 0.5% B&O surcharge for businesses having Washington annual revenues exceeding $250 million would expire at the end of 2027

Additional measures would exempt the legislation from the state’s previously passed prohibition on the state and its localities from imposing any form of tax on individuals’ incomes, as well as the default 10-year expiration that the state requires on any exclusions, deductions, exemptions, preferential rates, deferrals, and credits permitted with any tax.

If passed by the legislature and signed by Gov. Ferguson, the tax will undoubtedly face immediate legal challenges in the state’s courts, as nearly 100 years ago Washington’s Supreme Court ruled that income is a form of property, and the state’s constitution limits property taxes to a rate of 1% (see Culliton v. Chase, 174 Wash. 363, 289 P.2d 81 (1933)). As a result, several subsequent attempts to enact an income tax in the state have failed. Surprisingly, the Governor and legislature have not moved to amend the state constitution before attempting to enact this tax, perhaps because they think the state’s Supreme Court may not follow the Culliton decision as previous courts did. In 2023, the Court decided that the state’s capital gains tax was not an unconstitutional income-based tax but instead is an excise tax on transactions. However, it may be difficult to apply that same reasoning to a broadly-based income tax.

Computing the Millionaire’s Tax

The Senate and House bills, which are worded similarly, explain how the 9.9% tax is computed on personal income:

• The tax base begins with federal adjusted gross income net of all long-term capital gains and losses and interest income from federal bonds
• Then, any long-term capital gains subject to the state’s own capital gains tax (a 7% -9% tax on annual long-term gains that exceed $278,000) are added back, along with the standard deduction used to compute the Washington capital gains tax and charitable deductions to the extent the deductions reduced capital gains subject to the state capital gains tax
• Next, the following items must also be added to the tax base:
• Tax-exempt interest, except any interest paid on Washington state and local debt obligations
• State and local taxes deducted in computing federal adjusted gross income
• Loss carryforwards for tax years ending before Jan. 1, 2028 (effective date of the tax)

After computing the tax base, a $1 million exemption is subtracted for both single and married couples. This deduction will be adjusted for inflation and is also prorated for taxpayers who were not residents of the state for the entire year. Charitable contributions of up to $50,000 for individuals and married couples may also be deducted. The 9.90% tax is computed on this final income base, net of credits for:

• Income taxes paid to another state or political subdivision on the same income
• B&O or public utility tax on the same income
• An individual’s share of any elective tax paid by a pass-through entity on income taxed at both the entity and individual levels
• Washington capital gains tax paid on the same capital gains subjected to income tax

While residents of Washington must allocate all their taxable income to the state, nonresidents with any Washington source income must apportion their income to the state for purposes of the tax under a number of different methods:

• Wages are apportioned to Washington to either the extent services are rendered in the state, a ratio based on days worked in the state to total days worked, or another Department of Revenue-approved method.
• Business income is sourced to Washington using a single sales factor formula. Sales of services are sourced using market-based sourcing. A “throw-back” rule applies to sales of tangible personal property shipped from Washington to other states if the seller is not subject to tax in the destination state.
• Income of professional and student athletes will be apportioned using special rules applicable to them.

Part-year residents include all income earned while a resident, plus any Washington-source income earned while they were a non-resident; however, income from a passthrough entity is apportioned by the number of days the taxpayer was a resident of Washington over the total number of days in the tax year.

Pass-through Entity Taxation

Pass-through entities (partnerships and S corporations) may elect to pay the tax at the entity level at the same rate as individual owners, opting in by April 15 each year. The election cannot be revoked once it is filed. Guaranteed payments and investment income will be included in taxable income to the same extent these items would be included in an owner’s individual Washington income for purposes of the tax. Each owner will be allowed a credit against the tax imposed under law equal to their proportionate share of tax paid by the electing entity.

Filing and Payment Requirements, Deadlines, and Penalties

Returns for this new tax must be filed electronically by the same date as the federal income tax return, although if a six-month extension is requested for the federal return, the same is granted for the Washington tax return. Late filing penalties equal to 5% of the tax owed for each month or part of a month that the return is late, up to 25% of the amount due, can be imposed with applicable interest.

If you are a resident of Washington state with an annual income in excess of $1 million, or, if a nonresident, may have at least $1 million of income sourced to the state, please contact a CBIZ SALT professional to see how this proposed tax could affect you.