Washington does not have a state income tax for individuals, however the state imposed a capital gains tax for gains above $250,000 realized after January 1, 2022, however this capital gains tax does not include gains subject to QSBS treatment.
Federal QSBS Exclusions and State Tax Implications
Allowing capital gains tax exclusions for Qualified Small Business Stocks (QSBS) encourages investment in US small business. QSBS laws help provide capital for these businesses while offering a savvy tax strategy for investors who want to minimize capital gains taxes.
Investors who hold qualified small business stock for at least 5 years can exclude up to $10,000,000 or more of their recognized capital gains from their taxable income if certain criteria are met.
Each state has its own treatment of QSBS gains at the state income tax level. There are three ways in which states typically address the exclusion.
- Some states fully conform to the Federal QSBS guidelines, and therefore allow a full exemption if the stock meets the Section 1202 QSBS criteria. States conform to the federal tax code on either a static or rolling basis. “Static” conformity means the state starts conforming to the Internal Revenue Code as of a specific date. “Rolling” conformity means that the state adopts IRC changes as they occur. Alternatively, certain states do not have state income taxes and therefore there is no QSBS implication at the state level.
- Some states partially conform to the Federal QSBS guidelines, whereby the capital gains from QSBS are exempt if additional criteria beyond the Federal guidelines are met, such as only allowing exemptions if the QSBS gains were from a company doing business in that state.
- Lastly, certain states do not allow any capital gains exclusions for QSBS.
Washington State and QSBS
Washington does not have a state income tax for individuals, and before Senate Bill 5096 was passed, there was no state tax on capital gains either.
Passed by the 2021 Washington State Legislature, ESSB 5096 (RCW 82.87) created a 7% tax on any gain in excess of $250,000 in a calendar year from the sale or exchange of certain long-term capital assets such as stocks, bonds, business interests, or other investments and tangible assets. The tax took effect on Jan. 1, 2022.
According to the Washington State Department of Revenue,
“The 2021 Washington State Legislature recently passed ESSB 5096 which creates a 7% tax on the sale or exchange of long-term capital assets (stocks, bonds, business interests, or other investments, and many tangible assets) if the profits exceed $250,000 annually. This tax applies to individuals only, though individuals can be liable for the tax as a result of their ownership interest in an entity that sells or exchanges long-term capital assets. It is only applicable to gains allocated to Washington state. The tax takes effect on Jan. 1, 2022, and the first payments are due on or before April 17, 2023.”
How are QSBS gains treated? As pointed out in this article, the Washington state capital gains tax calculation begins with “Federal net long-term capital gains/losses” which includes any federal adjustments for QSBS gains. Certain additional adjustments are then made to deduct or add back particular types of gains or losses to determine the Washington state tax.
In addition, RCW 82.87 includes a deduction for gains from Qualified Family-Owned Small Businesses (with revenues less than $10M during the 12-month period preceding the gain and generally for a founder and/or active member of management owning at least 30%). There are various additional criteria for such businesses to qualify which are distinct from the IRC Section 1202 federal criteria for Qualified Small Businesses.
See this Washington Dept. of Revenue page for further details.
Entrepreneurship in Washington
Ideagist has a comprehensive list of startup accelerators and incubators in the state of Washington.
StartupWashington believes that, “the economy runs on the ideas and innovations of bold new explorers who want to create something breathtakingly new,” and offers a range of resources that help entrepreneurs access training, organizations, and capital.
Among other industries, the following industries in particular thrive in the state:
- Agriculture and Food Manufacturing
- Clean Technology
- Forest Products
- Information and Communications Technology
- Life Science / Global Health
- Military and Defense
Washington Opportunity Zones
Washington is home to approximately 139 Opportunity Zones.
Opportunity Zones (OZ) were created to help economically distressed areas by giving investors preferential tax treatment with new investments in these “specified” areas. Similar to QSBS, if the investment meets eligibility criteria and is held for at least 5 years, the investor can defer or be exempted from capital gains taxes (i.e. if held for at least 5 years, the taxpayer can exclude 10% of the gain and the percentage increases (or “steps up”) to 15% after 7 years).
Opportunity Zone investments can be in the stock of an OZ Qualified Business, an OZ partnership interest or an OZ business property.
To be a Qualified Opportunity Zone Business, the business must meet requirements such as at least 50% of the business’s total gross income being derived from within the Opportunity Zone. To learn more about Opportunity Zone qualifications, please refer to the Opportunity Zones and QSBS article.
Under the Tax Cuts and Jobs Act of 2017, 26 USC 1400Z-2, Washington made Opportunity Zones, is also home to the associated tax relief incentives that accompany these zones which are effective for tax years beginning on or after December 31, 2017. Refer to this mapfor the Opportunity Zones in the state and here for all Opportunity Zones in the United States.
Some Examples of Opportunity Zone Funds in Washington include:
- Fundrise Opportunity Fund (Commercial, Mixed-Use, Residential)
- Galena Opportunity Fund (Residential)
- Papillon Opportunity Fund (Hotel, Mixed-Use, Office, Parking)
See more at the Opportunity Zone Database.
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This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.