QSBS and Washington's New Millionaire Tax

If you're a founder or early-stage investor in a Washington startup, you've likely heard the buzz about Washington's new income tax. In 2026, Washington enacted ESSB 6346—a 9.9% tax on income above $1 million per household, scheduled to take effect on January 1, 2028. If you've also been fortunate enough to hold Qualifying Small Business Stock (QSBS) under Section 1202 of the tax code, you're probably wondering whether your gains will be subject to this tax when you eventually sell.

For the full analysis of ESSB 6346 — including the tax stack, marriage penalty, and residency rules — see Washington's New Income Tax: What Founders, Investors, Athletes, and High Earners Need to Know.

For the planning side — what to actually do before 2028 — see our Washington income tax action guide.

The short answer, for now, is no. Your federally excluded QSBS gains won't enter Washington's tax base in January 2028. But that's not the whole story—and the risk of future change makes this a critical planning issue for founders expecting a liquidity event.

This post is part of our Complete Guide to Washington's New Income Tax.

Understanding ESSB 6346: Washington's New Income Tax

Let's start with the basics. Washington has historically had no state income tax—a significant advantage for high earners compared to California or New York. That changed with ESSB 6346, which imposes a 9.9% tax on the Washington share of federal adjusted gross income (AGI) above a $1 million standard deduction. Note the structure: the $1 million is per individual, but married couples share a single $1 million deduction—not $2 million—so the statute builds in a marriage penalty.

The law defines "Washington's share" as income earned by Washington residents or allocated to Washington under state apportionment rules. For most founders selling their company, this means Washington-source income from the sale will be included.

The effective date is January 1, 2028. If you're contemplating a liquidity event before that date, the gain entirely avoids Washington's new income tax. If you're timing a sale for after 2028, the income tax will apply—unless, of course, your gains are excluded from federal taxable income under Section 1202.

How Federal QSBS Exclusions Interact with Washington Taxation

Here's where QSBS becomes important. Section 1202 of the Internal Revenue Code allows shareholders to exclude 100% of the gain on qualified small business stock held for at least five years, up to a cap of $10 million per taxpayer per issuer (or ten times adjusted basis, whichever is greater). Note: the One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, increased this cap to $15 million for stock acquired after enactment. Some of the highest-bracket shareholders can exclude up to 100% of their QSBS gains from federal income tax.

Washington's income tax is tied to federal AGI. AGI is calculated at the federal level and then applied to Washington's tax formula. When you exclude QSBS gains from federal taxable income, those gains don't appear on your federal return, so they don't enter Washington's AGI calculation either.

In practical terms: if you sell your QSBS for a $5 million gain and exclude all of it under Section 1202, your federal AGI remains unchanged (as if the sale never happened for income tax purposes). Since Washington's income tax is piggybacked on federal AGI, that $5 million exclusion means you're not subject to Washington's income tax on those gains.

So the current answer is straightforward. Federally excluded QSBS gains do not trigger Washington's new millionaire tax. You can sell, realize the gain, and keep the entire proceeds without the 9.9% state hit.

The Decoupling Risk: Learning from Oregon

But there's a caveat worth understanding, especially if you're planning around a longer timeline. While Washington currently conforms to federal QSBS exclusions, state legislatures can and do deviate from federal tax treatment.

Oregon offers the cautionary tale. Oregon, which had previously conformed to Section 1202, recently moved to decouple from the federal exclusion, so that Oregon-source QSBS gains can be fully taxable under Oregon's personal income tax even when they're excluded federally.Proposals to add excluded QSBS back into the Washington tax base have been floated in the legislature but have not become law. Founders and investors with Oregon-source QSBS gains face a state-level tax that wipes out the federal benefit on those gains.

Could Washington do the same? Technically, yes. The legislature could amend the tax law to decouple and make QSBS gains taxable at the state level, even if they're excluded federally. Would they? That depends on future revenue needs, political will, and how the income tax revenue streams evolve. But it's a real risk—especially if Washington's income tax brings in less revenue than projected or if there's political appetite to broaden the tax base.

If you're holding QSBS and banking on a sale after 2028, you should be aware that a decoupling change is possible (if unlikely in the near term). It shouldn't necessarily change your strategy, but it should inform your risk assessment.

The Partial Exclusion Scenario: When Not All Gains Are Excluded

Not all QSBS qualifies for the full 100% exclusion. This is where things get complicated for founders and their advisors.

First, Section 1202 has an aggregate gains cap: the maximum excluded gain per taxpayer per issuer is $10 million (or ten times your adjusted basis, whichever is greater) for pre-OBBBA stock, and $15 million for stock issued after July 4, 2025. If your co-founders and you have a $1 million basis and the company sells for $25 million—a $24 million gain—the excluded gain is capped at $10 million, and the remaining $14 million is fully taxable.

Second, OBBBA—the One Big Beautiful Bill Act—changed the holding-period rules, but only for stock issued after July 4, 2025. For that post-OBBBA stock, the exclusion is tiered by holding period: 50% at three years, 75% at four years, and 100% at five. For stock issued on or before July 4, 2025—which is most founders selling around 2028—the older rule still governs: no exclusion until you've held more than five years, then 100%. So the partial 50%/75% steps exist only on post-July-2025 stock; on older stock it's all-or-nothing at five years.

Here's the crucial point: the portion of your QSBS gain that is not excluded under Section 1202 is included in your federal AGI. And if it's included in federal AGI, it flows through to Washington's income tax calculation.

Here's a concrete example. Suppose you hold QSBS from a company that qualifies for the OBBBA rules, and you sell it after holding for exactly four years. You have a $5 million gain. Under QSBS, 75% is excluded ($3.75 million), but 25% is taxable ($1.25 million). That $1.25 million enters your federal AGI and, therefore, your Washington taxable income. If you also have salary or other income that brings your total AGI over $1 million, the combination could trigger Washington's 9.9% tax.

This matters more than you might think. A $5 million partially-excluded QSBS gain combined with ordinary income could push a founder well over the $1 million AGI threshold, triggering the tax on the cumulative amount subject to tax.

The $1 Million Threshold and Cumulative Income Planning

Let's talk about the AGI floor itself. The 9.9% income tax applies to income above $1 million. If your federal AGI is $999,999, you owe no Washington income tax. If it's $1,000,001, you owe 9.9% on the $1 of excess—about a dime. The tax only bites as income climbs meaningfully above the line.

For high-earning founders, the threshold is often already exceeded from salary, dividends, capital gains on other investments, and so forth. But for bootstrapped founders who are income-light until their company exits, the threshold can be the difference between owing tax and owing nothing.

Here's where partial QSBS exclusions become relevant. If you have partially-taxable QSBS gains and you're planning your exit, the non-excluded portion could be the marginal dollars that push you over the $1 million line. Once you're over, the 9.9% applies to all income above that threshold—so the marginal dollars are actually very expensive.

Conversely, if you're below $1 million AGI, keeping your gain below the threshold through timing or structure could save significant taxes.

The Capital Gains Tax Interaction

Many founders also forget that Washington has an existing tiered capital gains tax (7% above the standard deduction, rising to 9.9% on gain above $1M) on long-term gains from the sale of stocks, bonds, business interests, and other capital assets, effective since 2022. Real estate is exempt—when an interest in a business that owns real estate is sold, only the non-real-estate portion is reached. Unlike the new income tax, this tax has no $1 million AGI threshold; it applies to long-term gain above the standard deduction regardless of your total income.

Here's the part founders most often get backwards: federally-excluded QSBS gain also escapes Washington's capital gains tax. The capital gains tax starts from your federal net long-term capital gain, and Section 1202–excluded gain never reaches your federal return—so the Department of Revenue's own guidance confirms the tax doesn't apply to gain excluded under §1202(c). Proposals to add excluded QSBS back into the Washington tax base have been floated in the legislature but have not become law. So under current law, fully-excluded QSBS escapes both the income tax and the capital gains tax. What the capital gains tax does reach is the non-excluded portion of your gain—7% above the standard deduction (around $270K, indexed annually) and 9.9% above $1 million.

Exit Timing: Should You Sell Before 2028?

A common question I hear is: should we accelerate our exit to avoid the 2028 income tax?

Start by splitting your gain into the part that's fully excluded and the part that isn't. If your QSBS is fully excluded under Section 1202, the 2028 date is a non-event: excluded gain never enters your federal AGI, so the income tax can't reach it whether you sell in 2027 or 2032—and, as covered above, neither can the capital gains tax. On a fully-excluded $10 million gain, accelerating saves you nothing, because Washington was never going to tax it. Acceleration only changes the math for gain you can't fully exclude—gain over the Section 1202 cap, stock you haven't held long enough, or ordinary income in the sale year—and for the long-term-capital-gain slice of that, Washington's capital gains tax already applies today, so the 2028 income tax bites hardest on ordinary income and short-term gain.

But several factors complicate this analysis. First, the company's value may grow over that time, making delay more profitable than acceleration. Second, if you haven't held your QSBS for five years yet, accelerating the sale means missing out on full Section 1202 exclusion—a federal tax that dwarfs the state tax. Third, bringing a deal to market takes time and depends on buyer appetite.

My general advice: don't let the 2028 date alone dictate your exit strategy. For fully-excluded QSBS, the date is irrelevant—sell when the business and the market say it's time, not to beat a state tax that will never touch excluded gain. The January 1, 2028 trigger is worth marking on your calendar only to the extent you expect non-excluded gain or ordinary income in the year you sell; that's the slice the new income tax can actually reach.

Planning Strategies for Founders Expecting a Liquidity Event

So what should you actually do? Here are some strategies I discuss with founders holding QSBS:

First, understand your QSBS position. Are the shares actually qualified small business stock under Section 1202? Have you held them long enough? This isn't always obvious. QSBS requires that the corporation be a C corporation (not an S corp or LLC), that its gross assets were under $50 million when you acquired the shares (raised to $75 million for stock issued after July 4, 2025 under OBBBA), and that substantially all assets be used in an active business. Many startups meet these requirements, but not all. If you're unsure, get clarification from your tax advisor.

Second, model the partial exclusion scenarios. If you don't yet have five years of holding, what's your actual excluded and taxable gain? Be careful here: the partial steps—50% at three years, 75% at four—exist only for stock issued after July 4, 2025. Stock issued on or before that date gets no exclusion until five years, then 100%. If your stock is post-July-2025, running the numbers on holding to the next step can be the difference between owing Washington tax and avoiding it.

Third, keep the 2028 date in perspective. For fully-excluded QSBS, January 1, 2028 changes nothing: the income tax never reaches excluded gain, so closing before or after that date produces the same zero Washington income tax. The date is a genuine inflection point only for gain you can't fully exclude, or for ordinary income realized in the sale year—and even then it shouldn't outweigh valuation or business timing.

Fourth, watch for decoupling risk. If you're contemplating a sale after 2030 or 2035, and Oregon's QSBS decoupling is a concern, stay informed about Washington legislative proposals. If a decoupling bill emerges, the calculus changes. For now, it's not an immediate risk, but it's worth monitoring.

Fifth, mind the capital gains tax on any non-excluded gain. Fully-excluded QSBS escapes Washington's capital gains tax too—it never enters the federal base the tax starts from—but the portion of your gain that isn't excluded (gain over the cap, or stock held too briefly) is subject to it: 7% above the standard deduction (around $270K) and 9.9% above $1 million. Model the excluded and non-excluded slices separately, and work with your advisor on timing, entity, or buyer structure to manage the taxable piece.

What If Your QSBS Doesn't Fully Qualify?

Finally, let's address the scenario where your QSBS doesn't fully qualify—either because the company's assets exceeded $50 million when you invested, because the gain exceeds the $10 million cap, or because you haven't held long enough to hit the highest exclusion tier.

In these cases, your non-excluded gain is taxable at the federal level and will flow through to Washington's income tax. The calculation is straightforward: add the taxable portion of your QSBS gain to all other income, and if the total exceeds $1 million, the Washington 9.9% tax applies to the amount over the threshold.

The good news: if you're expecting a multi-million-dollar QSBS sale and you're already over the $1 million AGI threshold from other income, the marginal impact of additional taxable QSBS gain is "just" 9.9% (plus federal and capital gains taxes). The bad news: there's no planning around it. The tax applies. Your strategy should focus on maximizing the excluded portion (by hitting the five-year mark if possible) and understanding the true after-tax proceeds.

Bottom Line

Washington's new 9.9% income tax doesn't currently reach federally excluded QSBS gains. But your exit strategy shouldn't be built on that assumption alone. There are multiple moving parts: the five-year holding requirement, the partial exclusion scenarios, the $1 million AGI threshold, the existing 7% capital gains tax, and the risk of future decoupling.

If you're a founder or investor expecting a significant QSBS liquidity event, now is the time to map out your position with your tax advisor. Understand which gains are fully excluded, which are partially taxable, and how the timing of your sale interacts with both the 2028 effective date and your current AGI. That kind of planning can save you hundreds of thousands of dollars.

Questions about your own QSBS or Washington tax position? Let's talk. I help founders and investors navigate the intersection of federal and state tax planning, and QSBS is one of my favorite topics to dig into.

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This post is for educational purposes only and is not legal or tax advice. Consult a qualified attorney about your specific situation.