On March 30, 2025, Governor Bob Ferguson signed Engrossed Substitute Senate Bill 6346 (ESSB 6346) into law. After decades of relying solely on sales tax (the highest in the nation) and property taxes, Washington State is now implementing a state-level income tax.
This is a watershed moment for Washington tax policy. The new tax is significant, controversial, and already facing legal challenges. If you earn above a certain threshold, or if you're a founder or investor with capital gains, this law changes your tax landscape—starting in 2028.
Here's what the law does, why it passed, what it means for founders and high earners, and what you should do now.
The Tax: Who, What, and When
What is it? ESSB 6346 imposes a 9.9% state income tax on adjusted gross income over $1 million, effective January 1, 2028. This is separate from Washington's existing 7% capital gains tax (which applies to long-term capital gains over $250,000).
Wait—is it a capital gains tax or an income tax? It is structured as an income tax on adjusted gross income exceeding $1 million. This is distinct from Washington's existing 7% capital gains tax, which applies specifically to long-term capital gains over $250,000. The new tax applies to a broader base of income — not just capital gains, but any income that flows through to federal AGI above the $1 million threshold. For founders, this is significant because founder stock sales, compensation income, and business income can all contribute to exceeding the threshold.
What income does it apply to?
- Long-term capital gains: Gains from the sale or exchange of assets held more than one year (stocks, bonds, real estate, business interests)
- Excluded: Short-term capital gains (assets held one year or less), wages, salaries, self-employment income, business income, interest, dividends, and rental income
So the tax applies to appreciation in value, not to regular income or business profits. A founder earning $500,000/year in W-2 salary does not pay the tax on that salary. But if that founder sells company stock and realizes a $5 million gain, they pay tax on the gain.
Who pays it? The tax applies to:
- Washington residents on capital gains from any source, and
- Nonresidents on gains from Washington-source assets (e.g., a California resident selling a company headquartered in Washington)
What are the thresholds?
- For individuals: $250,000 of long-term capital gains per year (adjusted annually for inflation). For 2025 forward, the threshold is $250,000.
- For married couples filing jointly: $500,000 of long-term capital gains per year
- The tax applies only to gains above the threshold. So if you realize $300,000 in gains, you owe tax on $50,000 only.
How much tax? A flat 9.9% on capital gains above the threshold. So on $50,000 of taxable gains, you'd owe $4,950 in state tax.
When does it start? The tax is effective January 1, 2028. So capital gains realized starting in 2028 are subject to the tax. If you sell company stock in 2027, this tax doesn't apply.
What Income Is Included and What's Excluded
This is critical for planning. The tax applies narrowly to long-term capital gains. Here's what's included and excluded:
Included:
- Stock sales: Selling company stock, both public and private (including founder stock at exit)
- Business sales: Selling a business or partnership interest (typically taxed as a capital gain)
- Real estate: Selling real property (residential or commercial) with gains
- Investment gains: Selling stocks, bonds, mutual funds, cryptocurrency (long-term gains only)
- Intellectual property: Selling patents, trademarks, or other IP assets with gains
Excluded:
- Wages and salary: W-2 income from employment (no tax)
- Self-employment and business income: Pass-through business income from an S-corp or partnership (no tax). This is critical: if you're a founder running an LLC or S-corp and taking profits, the profits are not subject to the capital gains tax. Only the sale of the business itself is taxed.
- Investment income: Interest, dividends, and rental income (no tax)
- Retirement income: 401(k) and IRA distributions (no tax)
- Social Security: Not subject (no tax)
- Short-term capital gains: Gains from assets held one year or less (no tax)
- Losses: You can net losses against gains, reducing taxable gains
The "one-year" requirement: The tax applies only to "long-term capital gains"—gains from assets held more than one year. This is important for trading or quick exits. If you buy stock and sell it within a year, no state tax on the gain (though federal tax still applies).
Example: A founder realizes $1 million in gains from the sale of her company stock. She's married and files jointly with her spouse (who has no gains). The threshold for married couples is $500,000. So she owes tax on $500,000 of gains at 9.9% = $49,500 in Washington state tax (plus federal capital gains tax).
Another example: A software engineer receives options in a startup. She exercises them when the stock is worth $10/share (costing her $50,000 in exercise costs). Five years later, she sells the stock for $500,000. Her gain is $450,000. She's unmarried, with a threshold of $250,000, so she owes tax on $200,000 at 9.9% = $19,800 in state tax.
Federal Basis and How It Works
The tax is calculated on "long-term capital gains" as defined under federal law. So it's tied to federal tax rules for what counts as a capital asset, what counts as held "long-term," and how gains are calculated.
Generally, this means the sale price minus your cost basis equals the gain. If you bought stock for $100 and sold for $500, your gain is $400. The tax applies to the $400.
For founders, this is important because it means if you receive founder stock (or options exercised), your cost basis is the amount you paid for the stock. If you received founder stock for free or at a discount, your basis is low, and any sale means a large taxable gain.
The Political Context: How It Passed
ESSB 6346 passed the Washington Legislature in April 2024 along party lines (Democrats supported it, Republicans opposed it). Washington Democrats have a supermajority in both chambers, so they didn't need Republican votes.
The bill's proponents argued that Washington's reliance on regressive sales tax (which hits lower-income residents harder) is unfair, and that a capital gains tax on wealthy residents and investors would fund education and healthcare. The opponents argued that the tax would drive away wealthy residents and businesses, and that it's unconstitutional.
Constitutional question: This is the sticky part. Washington's Constitution prohibits a tax on "income from wages, salaries, or other compensation for personal services." The legislature argued a capital gains tax is not income tax (since it doesn't tax wages), so it's constitutional. But multiple lawsuits have been filed challenging this.
The Constitutional Question: Is This Tax Legal?
Even as the ink dried on Governor Ferguson's signature, lawsuits challenging the constitutionality of the tax were filed. The Washington Supreme Court may ultimately strike down the tax—or uphold it.
The argument against constitutionality: Critics argue that capital gains are a form of "income" and that taxing them violates the state Constitution. They point to earlier cases where the Washington Supreme Court struck down an income tax on stock gains (a 1933 case and a 2010s-era litigation). They argue that no matter what the legislature calls the tax, it's functionally an income tax.
The argument for constitutionality: Supporters argue that "long-term capital gains" are not "compensation for personal services" but rather returns on investment, and that the Constitutional prohibition only applies to compensation. They also argue that the 2010s-era litigation was based on old precedent that should be reconsidered.
What could happen: The Washington Supreme Court could uphold the tax (likely by 2026-2027, just before it takes effect). Or it could strike it down, in which case the tax never goes into effect. This uncertainty is important for planning—don't bank on the tax going away, but be aware it could.
Federal courts might also get involved: Constitutional challenges could also be brought in federal court, arguing the tax violates the U.S. Constitution. This is less likely to succeed, but it's possible.
Comparison to Other States
How unique is Washington's law? Several states have capital gains taxes:
- California: 13.3% top income tax rate (applies to all income, including capital gains). One of the highest state income taxes in the nation.
- New York: Up to 10.9% top income tax rate, includes capital gains.
- Oregon: 9.9% top income tax rate (similar to Washington's capital gains rate), applies to all income.
- Illinois: Flat 4.95% income tax (on all income including gains).
- Vermont: Up to 8.75% income tax, includes capital gains.
Washington's 9.9% capital gains tax is a hybrid: it's higher than some state income taxes (like Illinois's 4.95%), but it applies only to capital gains, not wages. So it's targeted at founders, investors, and wealthy residents who realize large gains.
How does it compare to federal capital gains tax? Federal long-term capital gains tax is 15% or 20% (depending on income). So Washington's 9.9% is an additional layer on top. A founder realizing $1 million in gains could face combined federal (20%) + Washington (9.9%) = approximately 30% tax on the gains (before any depreciation recapture or other adjustments).
What This Means for Founders and Investors
If you're building a startup in Washington, or you're considering an acquisition or IPO, the capital gains tax has real implications:
Exits become more expensive. If your company is acquired or goes public, the exit is taxed not just federally but also at the state level. This reduces the amount you take home. For a $100 million exit, the difference between 20% federal capital gains tax and 30% (federal + Washington) is $10 million in additional taxes. This changes financial planning and impacts how much equity you need to take to make an exit worthwhile.
Timing matters. Since the tax doesn't take effect until January 1, 2028, an exit before then avoids the tax. If your company is likely to exit around that time, the incentive to accelerate the exit (to close before 2028) is significant. This is particularly important if the constitutionality question is still pending—there may be a race to close before the tax either becomes permanent or is struck down.
Relocation becomes relevant. If the tax goes into effect, high-income earners in Washington may be incentivized to move to states without income taxes (like Nevada, Texas, Florida, or Washington's neighboring Oregon, though Oregon has income tax). Founders and key employees who realize large gains might consider establishing residency elsewhere before closing a major transaction. This is not a new phenomenon—it's one reason so many millionaires live in Austin, Miami, and Las Vegas.
For investors: Venture capital funds based in Washington (of which there are several, especially in Seattle) will face a capital gains tax on exits that are Washington-source. This could make Washington a less attractive hub for venture capital, though the impact depends on whether the funds themselves (as partnerships) are subject to the tax, or only the limited partners (individual investors). The law is unclear on this.
Entity structure matters. If you're operating as an S-corp or LLC and you exit by selling the company, you trigger the capital gains tax on the sale proceeds. But if you're earning business income year-to-year (not from a sale), there's no tax. This might affect whether you should take a massive exit or instead take profits annually over time—though taxes are just one factor in that decision.
Practical Planning Steps for Founders and High Earners
1. Understand your expected tax liability. If you're a founder or investor likely to realize capital gains above $250,000 (or $500,000 if married), calculate what the 9.9% tax would be on your expected gains. For a $10 million exit, that's $99,000 in state tax (on $1 million of gains above threshold). Factor this into your financial plans.
2. Accelerate gains if possible before 2028. If your company is planning an exit around 2028, consider whether you can accelerate it to 2027. A secondary sale, dividend, or partial exit before 2028 could save you the capital gains tax. This is aggressive planning and requires careful tax advice, but for very large exits, it's worth analyzing.
3. Consider your state residency before a major gain realization. If you're likely to realize a very large gain (say, $10 million+), you might consider establishing residency in a no-income-tax state before closing the deal. This requires actually moving (not just claiming residency), so it's not trivial. But for a $100 million exit, moving from Washington to Nevada could save $10+ million in combined state taxes. Consult a tax advisor on the specifics of establishing residency.
4. Review your entity structure.** If you're operating as an LLC, the tax applies to gains when you sell the business. If you're operating as a C-corp, the same applies (the tax applies at the shareholder level when you sell stock). There's no entity structure that avoids the tax entirely, but if you have choice, don't change your structure just for this tax—the costs are usually higher than the tax savings.
5. Monitor the legal challenge.** The constitutional challenge to the tax will likely be resolved by the Washington Supreme Court by 2026-2027. If the court strikes down the tax, you're off the hook. If it upholds it, the tax is here to stay. Track the litigation. Your tax advisor should be monitoring this for you.
6. Don't overly optimize.** Many of the planning strategies (like moving to another state) are disruptive and have downsides beyond taxes. Don't make major life decisions solely to avoid a 9.9% tax. But do factor it in when you're making other decisions (like the timing of an exit that you're considering anyway).
7. Separate capital gains from operating income.** If you're taking annual profits from your business and also expecting a large gain on a future sale, remember that the 9.9% tax applies only to the sale proceeds, not the annual profits. Structure your cash flow and distributions accordingly. Annual profits might be subject to other Washington taxes (like the business-and-occupation tax), but not the capital gains tax.
The $250,000 Threshold and Annual Adjustments
The threshold ($250,000 for individuals, $500,000 for married couples) is not adjusted for inflation according to the law as written. So every year, the threshold stays at $250,000/$500,000, meaning more gains become taxable in real terms (due to inflation). Over time, this effectively increases the tax base.
Congress could change the threshold if they wanted to, so track any legislative changes.
Implementation and Administration
The Washington Department of Revenue will administer the tax starting January 1, 2028. There will likely be guidance documents, forms, and rules clarifying how the tax applies in edge cases (like installment sales, options, and complex securities).
When 2028 arrives, you'll report capital gains on your Washington state tax return (or estimated tax payments if you're realizing large gains during the year). If you're acquiring stock or selling real estate, you'll need to track the capital gains and ensure proper reporting.
Federal Tax Implications
The Washington tax is a state tax and doesn't directly affect your federal tax liability. But it's on top of federal capital gains tax. Together, Washington residents with large gains face significant combined tax rates. This is one reason why tax-aware founders and investors consider the full tax impact (federal + state + local) when planning major transactions.
The Bottom Line
Washington's capital gains tax is a significant new tax on investment gains, effective January 1, 2028. It applies at a flat 9.9% rate to long-term capital gains above $250,000 (individuals) or $500,000 (married couples).
For most wage earners, the tax is irrelevant—it applies only to capital gains, not salaries. But for founders, investors, and business owners expecting to sell companies or real estate, it's a major planning factor. An exit in 2028 or later will be 9.9% more expensive (on gains above the threshold) than an exit in 2027.
The tax faces constitutional challenges and may be struck down by the Washington Supreme Court. Until those challenges are resolved (likely by 2027), there's some uncertainty. But don't assume the tax will go away—plan as if it will take effect, then adjust if litigation changes the outcome.
If you're a founder or high-income earner in Washington, get professional tax advice from a CPA or tax attorney who understands both the Washington tax and federal implications. The stakes are large, and the planning strategies are complex.
Keep Reading
- Washington's New Income Tax: The Complete Guide for Founders, Investors, and High Earners
- Stock Option Exercise Timing: Planning Before Washington's 2028 Income Tax
- ING Trusts Won't Save You from Washington's Income Tax. Here's What Might.
- The Washington Supreme Court Just Fast-Tracked the Income Tax Referendum Case. Here's What It Means.
