Washington Estate Taxes – Planning for State-Level Peculiarities

Back for more estate tax fun? Of course, you are! If you missed our dive into Minnesota or Illinois’ estate taxes, check out those articles.

Now, let’s move on to Washington, where the estate tax game comes with unique rules. You know the saying, “Nothing in life is certain except death and taxes.” Well, whoever coined that phrase hadn’t encountered the peculiarities of state-level estate taxes! While the federal estate tax tends to steal the spotlight—especially with whispers of 2025 changes—it’s at the state level where many more families feel the pinch.

I’ve written about the federal estate tax and strategies in a few other places here on the Mission Wealth Insights blog (for background on the federal estate tax, check this article out!), but this article will focus more on one of the 13 states/territories that have an estate tax at the state level: Washington.

Washington vs. Federal Estate Tax: A Peculiar Match-Up

Washington’s estate tax starts out with a much lower exemption compared to the federal level. While the federal estate tax exemption for 2024 is a cool $13.6 million, Washington’s is just $2.193 million per person. And Washington’s exemption is supposed to adjust with inflation—but plot twist! The law specifically ties the adjustment to the consumer price index for the Seattle-Tacoma-Bremerton metro area.  However, in 2018 this metro index was eliminated by the Department of Labor and replaced with the Seattle-Tacoma-Bellevue index. Since the local inflation index it was tied to no longer exists, the exemption was frozen in time. If it had kept pace, we’d be talking about a $2,675,000 million exemption in 2023, but alas, the legislature hasn’t caught up.

And then there are Washington’s eight—yes, eight—estate tax brackets, ranging from 10% to 20%. Let’s take a quick look at how the rates break down:

*Value in excess of exemption.

Washington also differs from the federal estate tax in that the $2,193,000 exemption is not a figure that can be combined with the surviving spouse’s exemption. In Washington, just like at the federal level, one spouse can transfer assets to the surviving spouse without triggering any estate tax complications – this is called the “unlimited marital deduction.” However, at the federal level, if one spouse has an excess or unused exemption, the surviving spouse can file for “portability” and combine it with their own. In Washington, you can’t. It’s a use-it or lose-it offering. 

Special Washington Deductions: Farms, Businesses, and Timberlands, Oh My!

Washington also offers two unique deductions. First, there’s the Estate Tax Farm Deduction, which allows certain farms and timberlands (including land, structures, and equipment) to be deducted from the taxable estate. Second, the Qualified Family-Owned Business Interest Deduction lets estates knock off the lesser of the value of the qualified family-owned business or $2,500,000 from the estate’s taxable value. There are significant rules around qualification, but assuming max estate tax rates, this deduction can save up to $500,000 of estate tax!

Planning Strategies for the Washington Estate Tax

Now that we’ve walked through the basics, let’s talk strategy. There are several ways to effectively plan for the Washington estate tax and limit your potential future tax liability. 

1. Exemption Planning with Trusts

As previously mentioned, unlike the federal estate tax exemption, the Washington exemption is not a combinable tax credit. This means that for a married couple, the design of your estate plan needs to be different to use each of your potential $2,193,000 exemptions effectively.

For example, say that Sam and Annie have settled down in Seattle. They have 2 adult children to whom they would like to leave their estate. Sam and Annie have worked hard, lived within their means, and made smart investment decisions with their wealth management team.  Their total net worth is $8,000,000, and they’ve been responsible in their estate planning. Their estate plan leaves all their assets to the surviving spouse at first death and the balance to their children once they’ve both passed. However, this plan has a hidden danger as it does not include setting up a Credit Shelter Trust at the first spouse’s death. 

When Sam passes, his estate is administered as planned, and everything continues in Annie’s name. Because Sam left everything to his spouse, no estate tax has been triggered in Washington. Sometime later, Annie passes away, and the tax kicks in. Because Annie’s estate is valued at $8,000,000, her estate must file an estate tax return. Her estate would receive a credit against the first $2,193,000 of the estate and then pay taxes on the remaining $5,807,000. Annie’s estate would owe $875,260 in taxes. The remaining $7,124,740 would be transferred to their children.

The results look different if their plan called for a Credit Shelter Trust to be funded at the first death. At Sam’s death, $2,193,000 would go into this irrevocable trust for Annie’s benefit. Annie could continue to use the assets in the trust as she needed. This also would reduce Annie’s net worth to $5,807,000. Then, at Annie’s death, her taxable estate (after using her exemption) would be $3,614,000, resulting in a tax bill of $488,240. By setting up a Credit Shelter Trust, they could shave nearly $400,000 off their tax bill. And any appreciation in the trust is safe from future estate taxes—win-win!

It’s important to note that careful planning includes being aware of beneficiary designations on accounts. Beneficiary designations can allow for a smoother transition of assets at death but can also undo any careful threshold planning done in revocable trusts. Beneficiary-designated accounts override anything in a Trust or Will, so even if your plan calls for setting up a Credit Shelter Trust at the first death, the beneficiary-designated assets will not get picked up by that careful planning.

2. Gifting

Washington has no gift tax, so gifting during your lifetime is a great way to reduce your taxable estate. Remember the federal annual gift limit of $18,000 per recipient. You can exceed this amount in a few ways – payments directly to providers for qualified education expenses and/or qualified medical expenses don’t count toward that $18,000 figure, and if you are thinking of funding 529 plans, you can fund up to 5 years’ worth of annual exclusion without using any of your federal exemption. If you give more than that to someone, you must file a federal gift tax return. 

Washington, just like at the federal level, does include any gifts more than your annual exclusion that occur within 3 years of death. 

3. Changing Residence

Yes, it sounds drastic, but relocating to a state without an estate tax could be a game-changer. Other than Oregon and Hawaii, every state west of the Rockies has no estate tax. However, packing your bags doesn’t free you from Washington’s grasp—at least not if you leave certain assets behind. The state has a complex formula for taxing non-residents based on the value of Washington-based property, so plan carefully if you’re thinking of becoming an estate tax escape artist.

Residents pay estate taxes on their whole taxable estate, though if they have out-of-state property, the estate tax is owed because the value of these assets is apportioned out. 

For non-residents, there is a multi-step process for determining your estate tax liability. You typically see this come up when someone leaves Washington but continues to own assets in the state. There’s a multistep process then for this class of individuals. You’d first determine your estate tax liability if you were a resident. You would pro-rate that estate tax liability by the proportion of your gross estate in Washington to the total value of your estate. 

For example, take the example of Sam and Annie from above. Assume they moved to Idaho before they passed but kept a $500,000 cabin in Washington. Once they both pass, their estate would calculate their estate tax liability if they were residents – in this case, $875,260. Then, they would calculate the portion of their estate in Washington – $500,000 for the cabin out of $8,000,000 or 6.25% of their total estate. Finally, they’d multiply $875,260 times that 6.25%, and the resulting $54,703.75 would be their final Washington estate tax liability. 

Business Interest Estate Tax Liability

Intangible assets have been a changing piece in the Washington estate tax calculation for non-residents. Business interests, most commonly LLC ownership interests, are intangible assets in Washington. However, for estate tax purposes, Washington has previously included Washington-based real estate owned by an LLC as a taxable asset if the LLC did not have a valid business purpose. However, in May 2020, the Washington Department of Revenue issued a special notice that they would no longer apply the “true business purpose” test to business entities going forward. This means that a non-resident who owns several rental properties in Washington can significantly improve their tax situation by holding those assets within an LLC rather than outright.

4. Charitable Giving

Want to reduce your estate taxes and feel great about it? Charitable donations reduce your taxable estate dollar-for-dollar, making them a powerful tool for reducing taxes while making an impact.

5. Life Insurance

Another way to manage estate taxes is through life insurance. There are specific rules around ownership of these policies to prevent the proceeds from being taxed to your estate. Still, with proper planning, life insurance proceeds can help cover any Washington estate tax liability without cutting into the inheritance you leave to your loved ones.

Washington Outlook

Washington residents should think about estate tax planning now, not later. There have been attempts to raise the Washington exemption, but the legislative committee has confirmed none of the proposals. At Mission Wealth, we’ll continue to monitor what’s happening in Washington and at the federal level for our clients and any impacts that may have on them. If you have any questions, please contact our Wealth Advisory and Strategy team today.

This article is not intended to provide any specific tax or estate planning advice. Advisory services are only offered to clients or prospective clients where Mission Wealth and its representatives are properly licensed or exempt from licensure. Consult a tax professional or attorney for specific advice.