Washington State Millionaire Tax Demands Tax Advisers’ Attention

Washington state’s new 9.9% “millionaire tax” would bring several noteworthy tax consequences, if it’s allowed to take effect in 2028.

The levy is now the subject of a lawsuit by a group of citizens and business groups alleging it’s an illegal tax on property. Another legal challenge to put the tax before voters is pending before the Washington Supreme Court.

Despite the legal pushback, the law remains on the books, so tax professionals should review how the tax would impact their clients and prepare accordingly.

Does Leaving Help?

High-net-worth individuals who are tempted to exit Washington state may be affected differently depending on their specific income class and whether they leave the state full-time.

A person who successfully terminates residency, but who may continue to work in the state for more than five days per year, would need to allocate a portion of that compensation income back to Washington and then apply the new tax to the allocated amount.

In such a case, many nonresidents would end up paying the new tax on a piece of their wage income because they wouldn’t be eligible for the full $1 million standard deduction that applies to residents. Instead, they would receive a fractionalized portion.

Consider this example: Jim terminates his Washington residency, but in the next year, he still works for 10 days out of 260 working days of the year in Washington. His total compensation is $1 million. His other non-Washington income is $500,000.

Jim’s Washington-allocated wage income is $38,461. And as a nonresident, the $1 million deduction is reduced by the ratio of Jim’s Washington base income over his total adjusted gross would end up owing the 9.9% tax on Washington base income of $12,820 ($38,461 Washington income less a fractionalized standard deduction).

The statute includes also allocation and apportionment rules for nonresidents. These rules would source many categories of income to Washington—including business income, rents and royalties—if the underlying business has Washington sales or customers, or if the underlying property is located or used in the state.

Washington would use a single receipts factor to allocate income between multiple states. Nonresidents, including former residents who succeed in terminating their residency, would potentially owe the 9.9% tax on the portion of their business income that is allocated to Washington state.

Handling Tax Distributions

The new tax would apply to the pass-through income of individual owners of S corporations, limited liability companies, and partnerships. This would create a broad need to review and modify tax distribution terms.

Consider, for example, a Washington LLC or S corporation that has historically paid out quarterly tax distributions based on the highest federal tax rate, with no adjustment for state taxes. This is a common fact pattern in Washington because the state has never had an individual income tax.

Flow-through entities are required to allocate 100% of their income to the owners each year. The owners must pay tax on these “phantom income” allocations regardless of whether cash distributions are paid. One can expect that higher income owners who now face the 9.9% Washington state tax would lobby for preferred tax distributions to help cover their new tax charge.

Lenders and preferred equity holders also have a stake in any major change to tax distributions. Loan covenants for Washington-based companies may prohibit or limit additional tax distributions to cover the new 9.9% tax or may require an amendment to permit them.

In complex partnerships, preferred equity holders often have special terms that permit tax distributions without counting those distributions against part or all their future economic return in the distribution waterfall. In those situations, preferred equity holders may be able to obtain an additional 9.9% tax distribution without harming their future returns.

Pass-Through Entity Risks

Pass-through entities that are cash-flow poor, or heavily leveraged, may find it impossible to pay out cash distributions to cover the new 9.9% tax without renegotiating bank loan covenants, crimping salaries or raising prices.

Distressed pass-throughs face a real risk that a loan modification or default could trigger cancellation of debt income for the owners, triggering both federal and Washington state tax. Making matters worse, the new statute doesn’t allow the use of carryover losses that pre-date 2028. This could lead to situations where a cancellation of debt occurs after 2028, creating a large slug of income, where pre-2028 losses wouldn’t be available as a carryforward to offset the income.

Let’s say, for example, a distressed pass-through entity needs to pay the millionaire tax starting in tax year 2028. Its members have large net operating loss balances from that entity from pre-2028 years and the entity defaults on its debts in 2029, creating a large cancellation of debt income inclusion in 2029.

Under the statute, these members wouldn’t be able to apply their pre-2028 net operating losses to offset the 2029 cancellation of debt income. At the federal level, they would enjoy a partial offset.

What’s Next

The state is assembling a 17-member advisory group that would provide guidance on a pass-through entity election. The state Department of Revenue would need to hire and train a new staff of income tax employees. The statute requires the department to produce an initial report on the implementation of this tax by Dec. 15, 2026.

In the meantime, tax professionals can help their clients in two ways.

First, advisers should recognize that Washington law regarding termination of residency isn’t very developed and therefore remains uncertain. Thus, caution should be the watchword for clients who are seeking to change their state of residency, particularly those who would retain contacts with Washington.

Second, for pass-through clients, advisers can help by reviewing their recent tax distribution history, and possibly making changes to governing documents, or renegotiating credit agreements, to accommodate higher tax distributions starting in 2028.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Christopher S. Brown is a tax partner in Holland & Knight’s Seattle office.

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