Washington State Implements Tiered Capital Gains Tax Increase Affecting High-Net-Worth Investors

Washington State Enacts Enhanced Capital Gains Tax Framework

U.S. equities remain sensitive to policy shifts, and a significant change has emerged from Washington State, which has implemented a notable increase in its capital gains tax structure. The state, which previously had no capital gains tax, has incrementally raised the rate to a top-tier of 9.9% for gains exceeding $1 million, a development poised to influence wealth management and investment strategies for high-net-worth residents.

Detailing the Legislative Changes and Tax Structure

Washington State's journey to its current capital gains tax regime began with the enactment of ESSB 5096 on May 4, 2021, which introduced a 7% tax on long-term capital gains above an inflation-adjusted deduction, initially $250,000 and set at $270,000 for 2025. This tax, applying to profits from the sale of stocks, bonds, and other investments held for over one year (excluding real estate, retirement accounts, and certain family-owned small businesses), became active on January 1, 2022.

The initial 7% tax faced legal challenges, with the Douglas County Superior Court ruling it unconstitutional in March 2022. However, the Washington State Supreme Court subsequently upheld the tax in a 7-2 ruling in March 2023, classifying it as an excise tax rather than an income tax. Further efforts to repeal the tax through Initiative 2109 failed on the November 2024 ballot, cementing its permanence.

The most recent development, Senate Bill 5813, signed by Governor Bob Ferguson on May 20, 2025, introduced an additional 2.9% surcharge on capital gains exceeding $1 million. This brings the total rate for these excess amounts to 9.9%, effective retroactively from January 1, 2025. This tiered structure means gains up to $1 million continue to be taxed at 7%, while amounts above this threshold incur the 9.9% rate. For example, a founder selling $4 million of company stock in mid-2025 would see the first $1 million taxed at 7%, and the remaining $3 million taxed at 9.9%.

Market Reaction and Strategic Adjustments

The implementation of a 9.9% top capital gains tax has introduced a degree of uncertainty, particularly among high-net-worth investors and entrepreneurs in Washington State. Financial advisors are actively counseling clients on various strategies to manage this increased tax exposure. Firms like J.P. Morgan Private Bank are recommending approaches that include considering relocation to lower-tax jurisdictions and utilizing sophisticated tax deferral mechanisms.

Specifically, Private Placement Variable Annuities (PPVAs) are being highlighted as a tool for individuals intending to hold tax-inefficient investments, enabling tax deferral on a selection of assets, including alternative investments not typically found in standard annuities. While withdrawals from PPVAs are taxed as ordinary income and may incur penalties if taken before age 59½, they offer a means to manage "tax drag" and preserve wealth in complex tax environments.

For startup founders, these changes significantly impact exit strategies and long-term wealth planning. Planning around the timing of liquidity events, charitable contributions, and installment or multi-year sales of business interests are becoming critical considerations to mitigate tax exposure.

Broader Context and Economic Implications

Washington State's move to a tiered capital gains tax represents a progressive shift in its tax system, which notably lacks a state income tax. The revenue generated from this tax is primarily allocated to support public services, including "The Fair Start For Kids Act," schools, early learning, childcare programs, and school construction. Proponents of the tax argue it is designed to target the state's highest earners, with projections indicating fewer than 8,200 households will be directly affected.

With its new 9.9% top capital gains rate, Washington now aligns with Oregon and is positioned below California (13.3%) and Hawaii (11%), according to the Tax Foundation. The state's high exemption threshold means a smaller percentage of residents are subject to the tax compared to these other states.

Concerns about capital flight—the exodus of wealthy individuals due to increased taxation—have been a recurring theme in public discourse. However, recent data from the Institute for Policy Studies and the State Revenue Alliance suggest a more nuanced reality. Studies indicate that the annual millionaire migration rate (2.4%) is lower than the general population's migration rate (2.9%) and significantly lower than that of low-income individuals (4.5%). In fact, both Massachusetts and Washington State have seen substantial growth in the number of millionaires and their wealth after raising taxes on higher earners, with Washington experiencing a 46.9% increase in its millionaire class between 2022 and 2024, and their wealth growing by $748 billion.

Complementing the capital gains tax changes, Washington's estate tax is also undergoing revisions. Effective July 1, 2025, the estate tax exemption will rise to $3 million (indexed for inflation), but concurrently, the top marginal rate climbs to 35% for taxable estates exceeding $9 million, making it one of the highest state estate tax rates nationally. These changes are for decedents dying on or after July 1, 2025.

Expert Commentary and Future Outlook

Leading financial experts emphasize the critical importance of proactive financial and estate planning in light of these legislative changes. Advisors recommend revisiting existing strategies to potentially include charitable giving through structured organizations, making gifts to family members using annual exclusions, and establishing trusts to align with long-term personal and philanthropic goals while mitigating tax liabilities. The need for coordinated efforts with a financial advisor, CPA, and estate planning attorney is underscored.

Looking ahead, the market anticipates continued demand for sophisticated wealth management solutions that can adapt to evolving tax regulations. The interplay between state tax policies and investor behavior, particularly among high-net-worth individuals, will remain a key area of focus, potentially leading to ongoing shifts in capital allocation and economic activity across different tax jurisdictions. Affected taxpayers will need to factor the retroactively effective increased rates into their 2025 tax filings in April 2026.