Washington State Budget Triggers Higher Business, Capital Gains And Estate Taxes In 2025

Highlights

• Thanks to three primary revenue bills that were signed into law earlier this year, taxes are going up in the state of Washington, in particular for large service businesses, estates and individuals earning capital gains.
• Among the changes, Washington will impose an expanded definition of "retail sale" starting on Oct. 1, 2025 that expands the sales and use tax to a new group of seven specified services. Consumers who do not pay the sales tax will be subject to use tax on the service value.
• This Holland & Knight alert discusses several key provisions and the effects that the tax expansion will have on many Washington service businesses and their customers.

Starting in 2025, taxes are going up in the state of Washington. This is particularly true for large service businesses, estates and individuals earning capital gains. There is also an important change to the tax classification for certain service providers, including businesses engaged in custom software, web design and advertising that will require sales tax collection and reporting starting in October 2025.

All of these changes are part of Washington's two-year operating budget for 2025 to 2027.

These changes come from three primary revenue bills that were signed into law on May 20, 2025: Engrossed Substitute Senate Bill (ESSB) 5814 expanded the sales and use tax to specified services, ESSB 5813 updated the capital gains and estate tax, and Engrossed Substitute House Bill (ESHB) 2081 made modifications to the business and occupation tax.

ESSB 5814: Expansion of Sales and Use Tax to 7 New Service Categories

Starting Oct. 1, 2025, Washington will impose an expanded definition of "retail sale" that will require many service businesses to start collecting sales tax on their Washington transactions. Consumers who do not pay the sales tax will be subject to use tax on the service value.

Washington has long imposed a 6.5 percent sales and use tax¹ on a selected group service transactions – including construction, extended warranties and digital automated services, to name a few. The new law expands sales and use tax to a new group of specified services comprising the following: 1) information technology services, 2) custom website development services, 3) investigation, security and armored car services, 4) temporary staffing services, 5) advertising services, 6) live presentations, and 7) sales of custom software and customization of prewritten software.

The new sales and use tax expansion will have a significant effect on many service businesses with nexus in Washington and their customers. Below are several key points:

• Definitional Issues Will Be Critical. Applying each of the categories above to actual business fact patterns will not be easy. For example, the "live presentation" category, as drafted, could be interpreted to apply sales tax to all education costs, including tuition, whether in person or online. On June 9, 2025, the Department of Revenue issued an Interim Statement to indicate that a "live presentation" does not include 1) courses offered by public and private elementary and secondary schools, whether or not they are accredited, and 2) courses offered by institutions of higher education but only when such courses are "encompassed within the institution's accreditation." Otherwise, according to the Department, other forms of education and training for a fee will be subject to the new sales tax regime. Similar definitional issues will arise for companies providing technology consulting, software development and advertising-related services. A significant shift is that the new law eliminates a prior exemption category for many custom services – i.e., services that "primarily involve the application of human effort by the seller." ESSB 5814 now requires service businesses that create custom work products for their clients that fall within the new specified service categories – web design, online advertising, software development and tech services – to change course and charge and remit sales tax on those services.
• A Particular Risk for Out-of-State Service Businesses. Washington imposes economic nexus on out-of-state businesses once they record more than $100,000 in annual combined gross receipts sourced or attributed to Washington. Under the new law change, many non-resident providers of custom software, online training, information technology services, advertising and other specified services will suddenly be required to register to pay the business and occupation (B&O) tax in Washington and also to collect Washington sales tax.
• Use Tax Risk Grows. Use tax is due on the value of any specified service if the sales tax has not been paid. Thus, many Washington businesses will need to change course and start self-reporting use tax for many online and administrative services, including training and customization of software.

ESSB 5813: Increases in Capital Gains Tax from 7 Percent to 9.9 Percent Retroactive to Jan. 1, 2025

Since Jan. 1, 2022, Washington's capital gains tax rate has been 7 percent on the amount of an individual's Washington capital gains, less a standard deduction of $270,000 for all filers, adjusted annually for inflation. The Washington capital gains tax applies only to individuals, including on a pass-through basis for beneficial owners of S-corporations, partnerships and certain trusts. A taxpayer computes the amount of Washington capital gains by making certain adjustments to federal net long-term capital gains from IRS Form 1040. The tax does not apply to the sale or exchange of real estate or assets held in certain retirement accounts, among other exemptions.

The new law introduces an additional 2.9 percent excise tax on long-term capital gains exceeding $1 million, with a retroactive effective date of Jan. 1, 2025. The new 2.9 percent add-on tax is incremental and, therefore, creates a graduated rate structure. The rate is 7 percent on taxable gains up to $1 million and 9.9 percent for amounts over $1 million. Neither threshold is indexed for inflation.

Below are a few potential impacts:

• Additional Tax Cost for M&A Exit Deals. For equity investors and closely held businesses, Washington has moved from a state offering very low taxes (i.e., zero capital gains tax prior to 2022) to one of the higher taxing states in a manner of a few years. Thus, for gains above $1 million, the effective federal plus state tax rate on capital gains for a Washington resident seller is now about 30 percent (i.e., 20 percent federal rate plus 9.9 percent Washington rate). Washington no longer offers a significant tax rate advantage relative to exit sale transactions in California and Oregon.
• Equity Compensation Effect. The new 9.9 percent rate also has an effect on hiring and attracting talent. Washington-based employees who hold founder stock, option stock and profit units in limited liability companies (LLCs) and partnerships now face material state-level capital gain taxes when those investments are liquidated, either on an exit sale or upon termination of employment. Washington does not have a personal income tax, and retains some advantage in the area of compensation over California and Oregon. But the increased capital gains tax chips away some of the incentive effect and, over time, may result in either a need for larger equity grants to employees or a shift to non-capital gain instruments, such as deferred compensation and incentive bonus arrangements.
• The Importance of Planning. There will be a renewed focus on the use of permitted tax exemptions and deductions. For example, Washington recognizes the federal exclusion from capital gains on Qualified Small Business Stock² that creates an opportunity to structure startups as C-corporations to exclude both federal and state taxes on a future sale. A second key exemption is the qualified family-owned small business deduction³ that permits certain closely held companies with less than $10.79 million in trailing 12-month gross revenue to avoid all Washington capital gains tax.⁴ Installment sales can also be used to take advantage of the annual exclusion amount and lower marginal rates. Finally, with careful planning, it is possible to change one's domicile to a different state.⁵

Estate Tax: Relief for Smaller Estates, but Higher Taxes on Estates Over $9 Million

Prior to the 2025 law change, Washington imposed a 10 percent to 20 percent estate tax for estate value in excess of an exclusion amount of $2.193 million. The new law increases the estate tax exclusion amount to $3 million for deaths occurring on or after July 1, 2025, and now indexes this amount for inflation. At the same time, it increases the estate tax rate structure. For deaths after July 1, 2025, the rates are increased for taxable estate value in excess of $1 million, with a top marginal rate of 35 percent for taxable estate value exceeding $9 million. The combination of the $3 million exclusion amount, plus the higher rate brackets, means that the increased estate taxes will fall most heavily on larger estates with taxable value above $9 million. Additional changes include updates to deductions for qualified family-owned business interests and farmland, with increased deduction thresholds and new compliance requirements for heirs.

The new rate structure is shown in the table below:

ESHB 2081: Increases B&O Tax for Narrow Group of Washington Businesses

Washington State does not impose a net income tax on businesses, but instead applies a gross receipts tax, known as the B&O tax, on gross business income. The taxable base is calculated without deduction for operating costs. Under current law, the B&O tax rate was:

• 471 percent for retailing activities
• 484 percent for manufacturing, wholesaling and extracting business activities
• 5 percent for service and other activities up to $1 million in prior year gross income
• 75 percent for service and other activities over $1 million of gross income in the prior year

Cities often impose a local B&O tax in addition.

Washington also levies several B&O surcharge taxes to the normal rates. Thus, specified financial institutions⁶ pay an additional 1.2 percent as a B&O surcharge on all of their service income, and select advanced computing businesses⁷ pay an additional 1.22 percent surcharge for a workforce education fund (capped at $9 million per year for each affiliated group).

Starting Oct. 1, 2025, the new law imposes higher B&O tax costs on service businesses with annual gross income over $5 million. The B&O tax rate for this category will increase from 1.75 percent to 2.1 percent.

The new law also imposed a significant increase on B&O tax surcharge rates, as shown in the table below:

Key Takeaways

For Washington companies and shareholders who are considering a future exit transaction, the new 2025 taxes will increase B&O taxes for many service businesses and also increase transaction costs, at the shareholder level, due to higher capital gains tax. In addition, the expansion of sales tax to new service categories will create potential due diligence problems for companies that fail to implement the new law. It is prudent to examine early the possibility of tax planning and tax compliance systems to address all of these issues.

Companies not expecting a future exit sale should also pay careful attention to the change in B&O tax rates and new sales and use tax expansion for specified services. Companies that are consumers of custom software, training and other online systems will end up paying more for these services in the form of new sales or use tax.

Footnotes

1. 6.5 percent is the state rate. Adding in local sales taxes, the combined sales and use tax rate in Washington ranges from 7.7 to 10.35 percent, depending on the location of the sale or use.

2. Both the Revised Code of Washington (RCW) and the Washington Administrative Code (WAC) are silent on any exemption from Washington capital gains tax related to the sale of qualified small business stock under Internal Revenue Code (IRC) Section 1202. However, Section 1202 gains are in fact excluded from federal long-term capital gains, which is the basis for calculating the Washington capital gains tax. The Washington Department of Revenue website states that the capital gains tax does not apply to federal long-term capital gains excluded under Internal Revenue Code Section 1202(c). In contrast, both the RCW and WAC disallow the federal capital gains exemption for gains related to Opportunity Zones under IRC Section 1400A-2. See WAC 458-20-301, Section 3(a)(Example 7).

3. RCW 82.87.070.

4. The 12-month gross revenue threshold was originally set at $10 million in 2022 and is indexed for inflation. The $10.79 million is from 2024. The 2025 figure was not yet released at the time this Holland & Knight alert was finalized.

5. See, e.g., WAC 458-20-301, Sections (2) and 6(c) (stating the definition of "domicile," "permanent place of abode" and "resident," for capital gains tax purposes, including a list of facts taken into account to determine domicile). There is uncertainty in applying Washington's tax rules on residency and domicile because they are new and not yet accompanied by published rulings and court cases.

6. In general, a "specified financial institution" means a financial institution that is a member of a consolidated financial group reporting on its consolidated financial statement for the previous calendar year annual net income of at least $1 billion. RCW 82.04.29004(d) and (e).

7. In general, a "specified financial institution" means a financial institution that is a member of a consolidated financial group reporting on its consolidated financial statement for the previous calendar year annual net income of at least $1 billion. RCW 82.04.29004(d) and (e).

8. Not all companies with over $250 million of gross receipts will be subject to this tax due to various exclusions in calculating the $250 million revenue threshold, including these: 1) manufacturing income, 2) wholesale or retail income derived from products manufactured by the taxpayer, 3) retail sales of food, food products and prescription drugs, 4) timber business income, and 5) certain petroleum sale income. Section 201, Paragraph 3 of ESHB 2081.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.