Washington’s capital gains excise tax continues to raise questions for founders preparing for an exit—especially those with stock eligible for the federal Qualified Small Business Stock (QSBS) exclusion under IRC §1202. The core issue comes down to how Washington defines “Washington capital gains” and why QSBS-excluded gains drop out of the state tax base entirely.
This post walks through the rule in plain terms.
Washington starts with federal taxable long-term capital gain
Under RCW 82.87.020, Washington defines its tax base as an individual’s “federal net long-term capital gain”—the amount that is subject to federal income tax.
If federal law excludes the gain from tax (as §1202 does for eligible QSBS), then there is no gain to bring into Washington’s starting point. Federal net long-term capital gain is simply zero for that transaction.
This alone eliminates QSBS-excluded gain from Washington’s excise tax.
The statute explicitly acknowledges QSBS-excluded gain
When SB 5096 was enacted, the Legislature specifically noted that certain transactions “do not give rise to long-term capital gains that are subject to federal income tax,” including gains excluded under IRC §1202.
That legislative statement confirms what the statutory framework already implies.
The WAC rules tell the same story
Washington’s implementing rule, WAC 458-20-301, allows you to subtract:
- “Any amount of long-term capital gain from a sale or exchange that is exempt under chapter 82.87 RCW.”
QSBS-excluded gain is exempt because it is not included in federal net long-term capital gain in the first place.
The takeaway for founders and early shareholders
If you sell QSBS-qualified stock and properly claim the §1202 exclusion:
- Your federal taxable long-term capital gain is zero (up to the exclusion limit).
- Your Washington taxable long-term capital gain is also zero because it starts with the federal number.
- Only non-QSBS long-term capital gain, if any, flows into the Washington tax calculation.
The key is making sure the stock actually qualifies under §1202’s requirements—entity type, active business rules, qualified trade or business, original issuance, the $50 million gross-assets test, and the five-year holding period. A misstep on these points can turn what should be excluded gain into fully taxable gain at the federal and state levels.
Need help confirming eligibility?
If you’re planning a sale or want to verify that your stock qualifies for the federal QSBS exclusion—and therefore avoids Washington’s capital gains excise tax—feel free to reach out. A small amount of planning on the front end can prevent a very large tax bill on the back end.
