Despite Washington's new 9.9% income tax, QSBS remains one of the few ways founders and angels can still exit entirely free of Washington tax. Here's what the current landscape actually looks like — and why the story getting lost in the policy noise is largely a good one.
With SB 6346 taking effect in 2028, many founders are asking whether QSBS planning still matters in Washington. The answer is yes — and it just got better.
The passage of SB 6346 — a 9.9% income tax on household income above $1 million — has dominated the conversation, and its implications for high earners in this state are real. But something important has gotten lost in that noise: Washington's treatment of Qualified Small Business Stock (QSBS) under Section 1202 of the Internal Revenue Code is as favorable as it has ever been — and thanks to major federal legislation enacted last year, it just got dramatically better.
Key takeaway: QSBS gains remain untaxed in Washington today. A bill to change that did not pass. And the federal exclusion just got significantly more powerful.
Who This Matters For
- Founders receiving stock in a C-corporation
- Early employees exercising stock options
- Angel investors writing checks
What Happened in Washington
Early in the 2026 legislative session, a bill called SB 6229 was introduced that would have dealt a serious blow to QSBS in Washington. It would have required founders and investors to add back federally excluded QSBS gains to their income for purposes of Washington's capital gains tax — meaning gains fully exempt from federal tax could have been taxed at 7% or 9.9% at the state level.
That bill did not pass. The legislative deadline came and went without SB 6229 moving forward.
The result: because Washington's capital gains tax starts with federal net capital gain, gains excluded under Section 1202 are not currently subject to Washington's capital gains tax. You owe Washington capital gains tax only on the portion of your gain that is not excluded federally.
This matters because Washington is in a better position than several other states. California, Pennsylvania, Alabama, and Mississippi do not recognize the federal QSBS exclusion — meaning a founder or investor in those states can face substantial state tax even on gains that are federally tax-free. Washington has no such problem today.
What Congress Did — the 2025 Tax Legislation
At the federal level, the One Big Beautiful Bill Act, signed on July 4, 2025, made the most significant changes to Section 1202 in more than a decade. Here is what changed for stock issued after July 4, 2025:
The per-issuer exclusion cap increased from $10 million to $15 million. This cap will be indexed for inflation beginning in 2027. The old $10 million limit still applies to stock issued before July 5, 2025.
Tiered holding periods are now available. Previously, you had to hold QSBS for more than five years to receive any exclusion — all or nothing. Under the 2025 legislation, partial exclusions are now available sooner:
- Hold for at least 3 years: 50% of gain excluded
- Hold for at least 4 years: 75% of gain excluded
- Hold for at least 5 years: 100% of gain excluded
This is meaningful for investors who need liquidity before five years, or who face an acquisition on someone else's timeline.
The gross asset threshold increased from $50 million to $75 million. This is the cap on the issuing company's aggregate gross assets at the time of stock issuance. More companies can now issue qualifying QSBS. This threshold will also be indexed for inflation beginning in 2027.
One important note: these improvements apply only to stock issued after July 4, 2025. If you hold QSBS issued before that date, the prior rules continue to apply — including the $10 million cap and the five-year all-or-nothing holding period.
Do You Qualify? A Quick Checklist
To qualify for the Section 1202 exclusion, both the company and the stockholder must meet several requirements. For a comprehensive overview, see our Complete Guide to QSBS & Section 1202.
Company-level requirements:
- Domestic C-corporation (not an LLC, S-corp, or partnership)
- Aggregate gross assets of $75 million or less at and immediately after the time of stock issuance (for post-July 4, 2025 stock; $50 million for earlier stock)
- Actively engaged in a qualified trade or business (professional services firms, financial services companies, and several other categories do not qualify)
Stockholder-level requirements:
- Stock must be acquired at original issuance, directly from the corporation, in exchange for money, property, or services
- Stockholder must be a non-corporate taxpayer (individuals, certain trusts and estates)
- Holding period requirement: more than 3, 4, or 5 years for tiered exclusions (post-July 4, 2025 stock); more than 5 years for pre-July 5, 2025 stock
How the Pieces Fit Together in Washington
Washington's capital gains tax. Washington imposes a 7% tax on capital gains above the inflation-adjusted standard deduction, and a 9.9% rate on gains above $1 million. Because Washington's capital gains tax is calculated starting from federal net capital gain, QSBS gains excluded under Section 1202 are not subject to this tax.
SB 6346 — the new income tax. SB 6346 imposes a 9.9% tax on household income above $1 million. It is currently scheduled to take effect for tax years beginning in 2028, though its effective date and constitutionality are subjects of ongoing legal and legislative discussion. For a detailed analysis of SB 6346, see our Washington Income Tax Guide.
Because Section 1202 excludes qualifying gains from federal gross income, those gains do not enter federal AGI. Whether SB 6346 reaches such excluded gains will depend on how the statute is interpreted and applied. That issue has not yet been fully resolved. If you have a significant QSBS position, discuss the SB 6346 interaction with your tax advisor.
Risk snapshot: What to watch
No explicit add-back today. Washington's capital gains tax does not currently reach federally excluded QSBS gains.
The legislature has considered one. SB 6229, which would have added QSBS gains back into the capital gains tax base, was introduced in 2026 but did not pass.
Future change risk is real. The bill had sponsors and the state faces ongoing budget pressure. Washington's favorable treatment of QSBS is not guaranteed to persist. Plan accordingly.
What This Looks Like With Real Numbers
Scenario 1: An Angel Investor
You invest $250,000 in a Washington-based startup in August 2025. The company qualifies to issue QSBS at the time of your investment. The company is acquired in October 2030 — more than five years later — and your shares are worth $8 million. Your gain is $7.75 million.
Federal tax: Your $7.75 million gain is fully excluded under Section 1202. You are under the $15 million cap, you've held for over five years, and the company issued qualifying stock after the new rules took effect. Federal tax: $0.
Washington capital gains tax: Because the gain is federally excluded, it does not enter Washington's capital gains tax base. Washington tax: $0.
Total tax on a $7.75 million gain: $0.
Without QSBS, that same gain would face approximately 23.8% in federal tax (20% long-term rate plus 3.8% NIIT) — roughly $1.85 million — plus Washington capital gains tax at the applicable rates. Total tax without QSBS: approximately $2.57 million.
Scenario 2: A Founder With a Larger Exit
You form a Washington C-corporation in August 2025 and receive founder stock qualifying as QSBS. In 2031, your company is acquired and your gain is $20 million (with a nominal basis).
Federal tax: The first $15 million of your gain is excluded under Section 1202. The remaining $5 million is subject to the 20% long-term capital gains rate plus 3.8% NIIT. Federal tax on $5 million: approximately $1.19 million.
Washington capital gains tax: The $15 million excluded federally is not subject to Washington's capital gains tax. The remaining $5 million is taxable at Washington's capital gains rates (7% up to $1 million in gains, 9.9% above that, with a small reduction for the inflation-adjusted standard deduction). Total Washington capital gains tax: approximately $446,500.
Total tax on a $20 million gain: approximately $1.64 million — an effective rate of about 8.2%.
Without QSBS, the same $20 million gain would face approximately $4.76 million in federal tax and approximately $1.93 million in Washington capital gains tax — a total of roughly $6.69 million, or about 33.5% effective rate.
QSBS saves this founder approximately $5.05 million.
The Bottom Line
Washington is in the middle of a serious conversation about its tax structure. Much of that conversation is focused on SB 6346 and its implications for high earners. That conversation is warranted.
But founders and angels in Washington have something worth recognizing clearly: Washington's capital gains tax does not apply to QSBS-excluded gains, the bill to change that did not pass, and the federal QSBS exclusion just became significantly more powerful.
For a founder or angel who structures their investment properly — in a qualifying C-corporation, with stock issued while the gross asset test is satisfied, held for the required period — Washington is one of the better states in the country to be holding early-stage equity. That's a story worth knowing.
If you're planning a sale before or after 2028, documenting QSBS eligibility early matters. We help founders and investors prepare QSBS confirmation letters and supporting analysis — the kind of documentation that substantiates your exclusion if the IRS ever looks.
This post is for general informational purposes and does not constitute legal or tax advice. The scenarios in this post are illustrative and do not account for all variables that may affect a particular taxpayer's situation. You should consult a qualified attorney and tax advisor about your specific circumstances.
Joe Wallin is a startup and tax attorney at Carney Badley Spellman in Seattle. He can be reached at jwallin@carneylaw.com.
