The first tax return won’t be due until 2029. But if you’re affected by the new tax? You want to understand mechanically how it works now. The formula varies from the federal tax formula. And you do have some planning options.

How New Washington Millionaire’s Tax Works

At first glance, many people assume this state income tax works like a traditional income tax system—with brackets, marginal rates, and complexity layered on top. But that mental model misleads. A better way to understand the tax? This is a flat tax with a one-size-fits-all deduction.

Conceptually, the tax formula works like this:

Step 1: Start with a taxpayer’s federal adjusted gross income (AGI)
Step 2: Make a handful of Washington-specific adjustments
Step 3: Subtract a $1,000,000 deduction
Step 4: Tax any positive remainder at a 9.9% flat tax rate

Two quick notes: First, that $1,000,000 standard deduction is per household and adjusted for inflation every other year. Second, the $1,000,000 Washington deduction essentially replaces the federal tax return’s standard deduction or itemized deductions total.

A Quick Example of How New Flat Tax Works

Let’s look at a quick example in the case where a taxpayer earns $2,000,000 of income:
• AGI: $2,000,000
• Less deduction: $1,000,000
• Taxable amount: $1,000,000
• Tax: $99,000

That’s all straightforward. But this flat tax gets more complicated as you dig into the details.

Step 2 Is Where Things Get Interesting

As noted, the Washington state millionaire’s tax starts with federal AGI. (See that list of steps above.) But Washington does not simply adopt that number. Instead, the statute requires a series of adjustments (again, step 2 above) to create what it calls:

“Washington base income” and ultimately “Washington taxable income.”

These adjustments complicate the tax. (That is bad.) And they also create planning opportunities. (Which is good.)

Here are the key modifications in plain English.

1. Long-Term Capital Gains Are Adjusted (But Separately Taxed)

Washington removes federal long-term capital gains from AGI and then mostly adds back Washington capital gains taxed under its separate capital gains tax system.

Translation:
• Federal capital gains don’t flow through directly
• They’re re-measured and tweaked under Washington’s capital gains rules
This keeps the two tax systems coordinated and avoids double taxation. (This also affects the taxation of residential property and small business sales, as discussed later.)

2. Tax-Exempt State and Municipal Bond Interest Gets Added Back

The formula adds-back interest excluded from federal AGI (like out-of-state municipal bond interest).

Example: $200,000 municipal bond interest (federally tax-exempt) isn’t typically included in the federal AGI. However, that amount may still be taxable in Washington. Thus, the formula adds-back that interest.

This is a classic “state decoupling” move.

3. State Taxes Deducted Federally Get Added Back

If you deducted certain taxes in computing federal AGI, Washington adds them back.

The add-backs for taxes include state income taxes (if applicable), Washington B&O taxes and pass-through entity (PTE) tax payments.

The logic here? Washington prevents you from reducing its tax base using deductions tied to other taxes.

4. Pre-2028 Net Operating Losses Are Disallowed

Net operating losses (NOLs) from before January 1, 2028 are added back to the federal AGI and, thus, not allowed to reduce Washington income. Only post-2028 losses get partial recognition. This is a major “reset” feature in the statute.

5. Interest on U.S. Government Obligations Is Subtracted

The formula subtracts interest from U.S. Treasury bonds, federal notes and similar federal obligations from Washington income. This follows long-standing constitutional principles limiting state taxation of federal obligations.

6. Wagering Losses Get Partial Relief

Washington allows a deduction for wagering losses: Up to 90% of losses (limited to wagering income). This matches the federal rules for 2026 and future years.

7. Cannabis Businesses Get a Special Deduction

Normally, businesses don’t get to deduct the expenses of operating an illegal or criminal enterprise because of IRC §280E. Washington state cannabis businesses, for example, cannot deduct ordinary expenses on the federal income tax return.

Washington reverses that result, however. It makes those disallowed expenses deductible for Washington purposes. This is a significant taxpayer-friendly adjustment for that industry.

8. A Few Niche Adjustments (Most Taxpayers Won’t Encounter)

The statute also includes several specialized rules:
• Incomplete nongrantor trusts: income may be pulled back into the individual’s tax base
• Tribal income: certain income is exempt
• Capital construction funds (vessel industry): deposits may be deductible.

For most taxpayers, these won’t matter—but they reflect how comprehensive the statute is. (And point, I guess, to why you want a well-connected lobbyist.)

Credits Matter Too

The Millionaire’s tax provides credits, too. (A $1000 credit reduces the state income tax amount by $1000.)

For example, Washington state gives you credit for business and occupation taxes it already levied against business income it wants to tax again. It also gives you credit for any Washington state capital gains it wants to tax again. (In effect with these credits, you pay tax once on income. Not twice.)

Washington state also gives you credit for income taxes you’ve paid other states. In the case where, for example, you’ve already paid another state (Arizona) income taxes on a $1,000,000 chunk of business income? Washington lets you reduce the amount of Washington state millionaires tax you owe on that same $1,000,000 for the other state’s (Arizona’s) taxes you’ve already paid.

Non-resident Millionaires Earning Income in Washington State Get Taxed

Non-resident millionaires with Washington state income get taxed too. And the flat tax works proportionally.

For example, a resident earning $2,000,000 AGI would pay about $99,000 in millionaires’ tax. (This is the example we used above.)

However, a nonresident earning $2 million total—two-thirds outside Washington and one-third inside—would pay roughly $33,000 of Washington millionaire’s tax, because both the income and the $1,000,000 deduction are prorated based on the share of income earned in Washington.

Note that the $33,000 is one third of the $99,000 millionaire’s tax a resident would pay.

Two Final Qualifications

The statute’s preamble suggests that sales of residential real estate and qualified family-owned businesses won’t be taxed—and importantly, that treatment does appear in the operative law.

But the mechanism is indirect: Washington removes federal long-term capital gains from income and then adds back only “Washington capital gains,” as defined under the state’s existing capital gains tax. Because that system already excludes real estate and provides a deduction for qualified family-owned businesses, those exclusions effectively carry over into the new millionaire’s tax. The result is that, while not stated in a single clean sentence in the statute, the intended treatment is largely implemented through cross-reference.

Other Resources

Washington State Millionaires’ Tax Residency Rules
Changing Your Washington State Residency
Qualified Family-Owned Business Deduction

The post The New Washington Millionaires Tax appeared first on Evergreen Small Business.

But let me explain how this simple technique works. And then illustrate why it’s so powerful using our tax-inclusive gift tax calculator (which appears below).

A $10,000,000 Gift Shows Mechanics

To set this up, assume your estate will be subject to the 40% federal estate or gift tax as well as the top state estate tax (currently 35%.)

Note: For the record, few families need to worry about federal estate taxes. But Washington state estate taxes kick in when an estate exceeds roughly $3,000,000. (More information: here.)

If you gift $10,000,000 in this situation, you pay a 40% gift tax or $4,000,000. That sounds terrible. But in effect, in a best-case scenario, you may be moving $14,000,000 out of your estate. Thus, one way to look at this is you’re paying $4,000,000 to move $14,000,000 out of your estate. And that amounts to a 29%-ish federal “estate and gift tax.” (Okay, maybe that still sounds like a lot. But 29% is less than 40%.)

Further, in the best case scenario, that $14,000,000 transfer zeros out Washington state estate taxes on $14,000,000 of your estate. That would save $4,900,000 in state estate taxes.

The Gift Tax Addback

But there’s a wrinkle here. If you die within three years of gifting, the gift tax you paid? It gets added back to the estate on which you pay federal and state estate taxes. In other words, that $4,000,000 in the earlier example? Your estate pays federal and state estate taxes on that money if you die within three years of the gift.

You still save taxes in this scenario. But the math gets tricky. Thus, the calculator below.

Using Tax-Inclusive Gift Strategy Calculator

The initial inputs show a $10,000,000 gift and set the federal estate or gift tax percent to 40% and the state estate tax to 35%. You can enter some other gift amount. Or change the estate and gift tax percentages. The calculator recalculates as you make changes.

Note: On July 1, 2025, the Washington state estate tax jumped from 20% to 35%. As I’m writing this, however, the state legislature is in process of enacting a bill that may return the top estate tax rate to 20% as of April 1, 2026.

Understanding the Tax-Inclusive Gift Strategy

A quick overview of the two potential savings that flow from a tax-inclusive gift:

First, if you gift, pay the gift tax, but then your estate avoids the gift tax addback? That means you only paid federal taxes on only a portion of the money you’re effectively moving out of your estate. (With the default inputs, this is the best case “all you pay is $4,000,000 of gift tax” scenario.)

Second, if you gift but your estate later does the addback? Then you lose some of the savings. Roughly half in fact with the default inputs. What’s happening here is, your estate pays state and federal estate taxes on the gift tax you paid to the IRS.

Third, if you do nothing? That’s the worst-case scenario modeled here. That worst case “pay state and then federal estate taxes” scenario means you first pay the Washington state estate tax on your $14,000,000 (or whatever). And then, after that, you pay the federal estate tax on the leftover.

In the area under the input boxes, the calculator shows the range of estimated tax savings a tax-inclusive gift generates for a specified gift amount.

Some Caveats

You need to think carefully about the tax-inclusive gifts. And probably you want the help of your tax and legal advisors. But some things to ponder:

You obviously are moving assets out of your estate. So that impacts your income and lifestyle potentially.

Related to this point, for good or bad, you also move income out of your estate and into your heirs. If you did move $10,000,000 from your investment account to your daughters and you paid a $4,000,000 gift tax, every year you would have held that money is a year you don’t earn income on the $14,000,000. But, of course, every year your daughters do earn income on $10,000,000. That’s something to consider.

If you gift appreciated assets you lose the Section 1014 adjustment (aka “step-up basis” adjustment). Probably, then, you would not want to gift appreciated assets.

Finally, whether this tactic makes sense and optimizes depends on your alternatives. Your estate planning attorneys have lots of other options which will potentially work well in scenarios where you’re not paying gift taxes.

Some Other Resources

Another high impact option for avoiding Washington state estate taxes (or income taxes) is changing domicile. We talked about that in a recent blog posts here: Washington State Millionaires Tax Residency Rules and here: Changing Your Washington State Residency.

If you’re interested in reading the actual law that creates the gift tax addback, that appears here: Section 2035.

The post The Tax-Inclusive Gift Strategy Calculator appeared first on Evergreen Small Business.

In effect—and this is intentionally a rough description—a resident pays the millionaires’ tax on their Washington taxable income in excess of $1,000,000. (The actual law as currently proposed is significantly more complicated; this description is only meant to orient the reader.)

A Term to Know Before You Look at Residency Rules

Before looking at the residency rules, you need to understand one term: domicile.

Domicile means the primary place you live and intend to live. If you work in Washington state, rent or own a home you live in, plug into the local community here, have children in school here, and generally organize your life around Washington, you are likely domiciled in Washington state. If you always plan to return to Washington state, you are likely domiciled in Washington state.

If you spend time in Washington state and also spend time in another state (for example, Florida or Arizona), your domicile is generally the state where you have the deepest roots and strongest connections. This determination is inherently fuzzy and fact‑specific. (Hopefully, the legislature will provide a clearer definition in the final bill.)

Here is the key takeaway: If you are domiciled in Washington state, you will usually pay the millionaires’ income tax. But domicile alone does not determine whether you pay the tax. The statute separately defines who is treated as a resident for millionaires‑tax purposes, and those residency rules can override domicile in limited circumstances.

The 30‑Day Residency Rule

The first residency concept to understand is the so‑called “30‑day rule.” The proposed statute provides that a “resident” includes an individual:

(i) Who is domiciled in this state during the taxable year, unless the individual (A) maintained no permanent place of abode in this state during the entire taxable year, (B) maintained a permanent place of abode outside of this state during the entire taxable year, and (C) spent in the aggregate not more than 30 days of the taxable year in this state.

This provision is easy to misread. The 30‑day rule is not what makes someone a resident. It is an exception that allows a Washington domiciliary to avoid being treated as a resident—but only if all three conditions are satisfied for the entire year.

Under this rule, even if you are domiciled in Washington state, you are not treated as a resident for millionaires‑tax purposes if:

• You did not maintain any permanent place of abode in Washington state at any point during the taxable year;
• You did maintain a permanent place of abode outside Washington state for the entire taxable year; and
• You were physically present in Washington state for 30 days or less during the year.

Think of this as a narrow “de minimis presence” exception. If you truly live somewhere else, have no place to live in Washington, and are only in the state briefly, the statute treats you as a nonresident—even if domicile might otherwise be arguable.

Important note: Nonresidents may still be subject to the millionaires’ tax on Washington‑source income. For example, a high‑income California resident who owns rental property located in Washington or an interest in a pass‑through business operating in Washington may owe millionaires’ tax on that Washington‑source income. But they would not be taxed on all of their income.

The 183‑Day Residency Rule

For individuals who are not domiciled in Washington state, a different residency rule applies: the 183‑day rule. The statute provides that a resident also includes an individual:

(ii) Who is not domiciled in this state during the taxable year, but maintained a place of abode and was physically present in this state for more than 183 days during the taxable year.

This rule generally targets seasonal or extended‑stay visitors. If someone is not domiciled in Washington but maintains a place of abode here and spends more than half the year in the state, the statute treats them as a resident for millionaires‑tax purposes.

Both elements matter. Physical presence alone is not enough. The individual must also maintain a place of abode in Washington during the year.

Clarification #1: Partial Days Count as Full Days

The statute includes an important clarification regarding day counting:

For purposes of this subsection, “day” means a calendar day or any portion of a calendar day.

This means partial days count as full days when applying both the 30‑day rule and the 183‑day rule. Days can add up faster than many people expect. For example, entering Washington late on a Friday and leaving early Monday morning can count as four days, even if you were physically present for less than 48 hours.

Clarification #2: Partial‑Year Residency

The statute also addresses how residency applies when a person is classified as a resident for only part of the year. It provides:

An individual who is a resident under subsection (a) is a resident for that portion of the taxable year in which the individual was domiciled in this state or maintained a place of abode in this state.

This rule does not change who is a resident. Instead, it limits how much of the year is treated as resident once residency is established.

For example:

• If a Washington domiciliary fails the 30‑day exception (for example, by spending more than 30 days in the state), the individual is treated as a resident only for the portion of the year during which they were domiciled in Washington or maintained a Washington place of abode.

• If a non‑domiciliary is classified as a resident under the 183‑day rule, they are treated as a resident only for the portion of the year during which they maintained a Washington place of abode.

This partial‑year rule provides a measure of fairness by preventing the statute from automatically treating someone as a resident for an entire year when their connection to Washington exists only for part of that year.

Additional Resources

Changing Your Washington State Residency or Domicile

Text of Proposed Washington State Income Tax Bill (as of February 10, 2026)

The post Washington State Millionaires Tax Residency Rules appeared first on Evergreen Small Business.

But if you can’t move to another state—and most people can’t—another option possibly exits: You can move some assets to another state.

To begin this discussion, let me start with a quick example of how the state’s estate tax formula works. (I’m going to use the estate tax formula for 2025 because that makes for rounder numbers.) And then I’ll get into the exporting assets thing.

Quick Review of How Washington State’s Estate Tax Formula Works

In 2025, a decedent dying in the last half of the year pays zero estate taxes on the first $3,000,000 of their net worth. (The amount inflates in subsequent years. For 2026, for example, that nice round $3,000,000 ratchets up to $3,076,000.)

On the next $9,000,000, they pay an estate tax rate that starts at 10% but quickly escalates to 35%. In total, though, on that $9,000,000 “band”, they pay $1,930,000 of estate tax.

On the rest of their net worth, they pay a flat 35% estate tax.

Thus, for example, the estate (or really the heirs) of someone who dies with $22,000,000 in late 2025 pays $5,430,000 in estate taxes.

How Out of State Assets Affect the Taxes

But here’s something else to note: Washington state doesn’t “estate tax” residents on out of state tangible property.

For example, while a Washington state resident who died in late 2025 with a $22,000,000 of net worth pays $5,430,000 if the assets are all located in Washington state? If a taxpayer stored or situated half of their assets, or $11,000,000 of their $22,000,000, out of state? That allocation halves the estate tax bill.

Thus this idea to export assets…

How Would Someone Export Assets?

To make this illustration easy, I want to use some big round numbers. So, let’s say two Washington state residents, Tom and Pete, each have $22,000,000. Both own a $10,000,000 retirement account, a $10,000,000 rental income property, a $1,000,000 rare coins collection, and a $1,000,000 condominium where they reside.

I also need to tell you something else here. Washington state sources intangible assets to the state of domicile. Thus, that giant retirement account holding $10,000,000? That’s an intangible asset. No matter what, for both Tom and Pete, Washington state treats it as located in Washington state. (This bit becomes important in a minute.)

But the tangible stuff? So, the $10,000,000 rental property and the $1,000,000 rare coins collection and the $1,000,000 condo? State law sources those to the state where the property is.

If Tom’s rental property, coin collection and condo are all in Washinton state? All $22,000,000 of his stuff sits in Washington state. And he pays the estate tax on the full $22,000,000. So, $5,430,000.

If Pete’s condo is in Washington state but the rental property and coin collection are in Nevada? Yeah, in that case, $11,000,000 of his $22,000,000 estate is tangible property outside of Washington. And therefore, his estate only pays Washington state estate taxes on half of his estate, so $2,715,000.

The obvious maneuver then: If Tom moves his coin collection to another state and exchanges his Washington rental property for one in some other state, voila.  He halves the estate taxes his heirs effectively pay.

Three Wrinkles Related to Exporting Assets

You want to know three other things as you think about this strategy of exporting assets. The first one? You want to export assets to a state with no estate tax. (That should be pretty easy. Most states don’t levy estate taxes. And none levies an estate tax as high as Washington’s 35% rate.)

The second thing to know: If you invest in tangible property through a limited liability company, Washington state sees that as intangible property. Not tangible property. Intangible property, as noted earlier, gets sourced to the state of domicile. Thus, you need to directly own the property. Tom then, in the example above, needs to exchange his $10,000,000 rental property in Washington state for a $10,000,000 rental property in Nevada. Not for a Nevada LLC that owns a $10,000,000 rental property in Nevada. (The Washington Department of Revenue explains and confirms this treatment here.)

A third thing to know and this is common sensed: A person needs to move tangible assets out of the state before they die. This “exporting assets” tactic isn’t something an executor or personal representative does while administering the estate.

Other Resource

Our Washington State Estate Tax Calculator

How Washington State “Estate Taxes” Income in Respect of a Decedent

Powerball Estate Tax Planning

The post Exporting Assets Avoids Washington State’s 35% Estate Tax appeared first on Evergreen Small Business.

For purposes of this blog post, I’m going to talk in terms of the recent, late December 2025 $1,500,000,000 Powerball. That drawing gave the winner an option. Receive $50,000,000 annually for three decades. Or, alternatively, take a roughly $700,000,000 lump sum.

And that choice—annuity vs lump sum—is the part I want to focus on…

The TLDR Summary: Take the Lump Sum

To cut to the chase, with large Powerball lottery winnings, the safe tax plan is probably to take the lump sum. This advice appears to be the opposite of what I saw reported in the media. Most experts appeared to think $50 million a year for thirty years makes more sense. And just superficially? That advice sounds right.

But seriously you really don’t want to burden heirs with the catastrophic estate tax risks of an annuity. And a quick illustration explains why.

Say you were confronted with the exhilarating choice of either $50 million a year for three decades versus a lump sum $700 million. And then (sorry) say you died the day after you won.

In this situation, your estate owes about $427,000,000 in estate taxes if you domicile in Washington state. (The state’s new 35% estate tax will amount to about $245 million. The federal 40% estate tax would account for the other $182 million.)

And the problem here? Your estate and heirs only “have” enough cash to pay the $427 million of estate taxes due a few months after your death if you took the $700 million lump sum.

Paying the Estate Taxes Off Over Time

In other words, in the tragically absurd scenario where you took the annuity and then died, your heirs will find themselves paying off the $427,000,000 estate tax liablity using the $50,000,000 annual annuity.

That sounds workable. But let me step you though the details so you see it’s a terrible outcome.

First of all, the federal and state income taxes on the $50 million might run about $18 million for a Washingtonian if the state’s new 10% millionaire’s tax has become law. So you don’t have $50 million each to grind down the debt. You have about $32 million after income taxes.

But because you owe the state and the federal government several hundred million dollars in taxes? Your estate accrues, one way or another, interest on the hundreds of millions of dollars of tax debt. Close to $24 million the first year, roughly $23 million in years two and three, and then ever smaller amounts as the “loan balance” shrinks.

Now, yes, your heirs will slowly be able to pay off the estate tax lability loan using the leftover money: $8 million of principal the first year, $9 million the second year, and increasingly large amounts each future year. But the paydown process will take decades. (I did a little Excel spreadsheet that amortizes the pay down and it takes the first 24 annual payments to extinguish the debt if the interest rate is 6%.)

And that’s the surprise here. Taxes not only reduce the net winnings (by more than 80%.) Taxes also delay when heirs receive their inheritances. And worse than that , some heir will find him or herself jungling estate finances over decades to pay off the $400,000,000-ish estate tax bill.

Thus my advice: If you ever do win a big state lottery? Yeah, absolutely take the lump sum.

Closing Comments and Caveats

Let me share three other comments, too, before I close.

First, comment: I was a little rough in my accounting. The federal tax rate for example isn’t exactly 40%. Rather, it’s 37% for the federal income tax and then 3.8% for the net investment income tax so a total of 40.8%. The federal estate tax is a flat 40% but only after any state estate tax is paid and only above $15 million (roughly). The new 35% Washington state tax applies only above $3 million and uses a $9 million phase in range where the rate starts at 10% and then rises to 35%. Finally, I assume that both federal income taxes and state income taxes calculations allow a deduction for the estate taxes paid. Federal rates do work that way. But we don’t know how a new Washington state millionaires tax might work.

Second comment: The fundamental, structural problem here is the estate needs to pay taxes on illiquid assets not easily converted to cash. And note this isn’t only a problem with something like a lottery annuity. Illiquid business and investment interests may create a similar timing problem for families.

Third comment: A change in domicile can fix or address a state estate tax problem as well as reduce a state income tax burden. Moving from Washington state to Nevada, for example, potentially zeros out your Washington state estate and income taxes. (If you really did win a Powerball lottery and you currently reside in Washington state? You’d probably want to seriously look at a domicile change.) You can’t however do something similar with federal estate and income taxes. Thus, moving from Washington state to, say, Luxemburg does not zero out your federal estate and income taxes.

Additional Resources

Washington State Estate Tax Calculator

Planning for the 35% Washington Estate Tax

Changing Your Washington State Residency (or Domicile)

The post Powerball Lottery Tax Planning appeared first on Evergreen Small Business.

In most cases, taxpayers need to pass one of the seven material participation tests — commonly by working more than 100 hours, and no one else works more; or more than 500 hours during the year. (We’ve got a complete list of the seven tests here: Counting and Grouping Material Participation Hours.)

If you meet one of these tests, you materially participate. If you don’t, the activity is passive — and passive losses often get suspended.

A Simple Example Makes This Clear

Let’s look at a simple example. Say Tom and Dick each start new businesses in 2025. Both generate a $100,000 loss.

• Tom materially participates → he can probably deduct the loss.

• Dick does not materially participate → his loss is likely suspended under the passive activity rules.

So far, nothing surprising. But buried inside this area of the law is a question many professionals get wrong: When do you start counting hours toward material participation?

Let’s walk through the wrong answer and then share the right answer from the Treasury Regulations—which most practitioners never quote.

The Wrong Answer: “You start counting when the business starts.”

This is the conventional wisdom, and it sounds reasonable:

• For a rental property: you start counting when the property is placed into service.

• For a restaurant: when you open the doors.

• For a consulting firm you purchased: when you take over operations.

IRS auditors say this. Many CPAs say this. Even tax attorneys say this.

But the regulations do not say this.

And in many cases, this answer causes taxpayers to incorrectly conclude they cannot materially participate in the first year of operation — when in fact they can.

What the Regulations Actually Say

Treas. Reg. §1.469-4(b)(1) defines what counts as an activity for purposes of material participation. And it includes three categories of work:

1. Conduct of the trade or business

This is the obvious one: the hours you work after the business is up and running.

This covers:

• Tenant communication in a rental activity

• Hosting guests in a short-term rental

• Serving customers in a restaurant

• Producing goods or services in an operating business

Nothing controversial here.

2. Work performed in anticipation of the activity beginning

This is the critical, widely misunderstood part. The regulation explicitly includes activities “conducted in anticipation of the commencement of a trade or business.”

In plain English: Pre-launch work counts.

Hours spent on:

• Market research

• Property searches

• Drafting a business plan

• Negotiating leases

• Meeting with lenders

• Designing a service offering

• Sourcing suppliers

• Setting up software and systems

• Preparing for launch

… all count toward material participation, as long as they occur in the same taxable year as the business’s commencement (and none of the “throw-out rules” apply which I’ll talk about in a few paragraphs).

This is enormously important for taxpayers launching new ventures or buying real estate. (In many cases, it would not be possible to safely and intelligently start a new business without spending at least a 100 hours.)

3. Research and experimental activities under Section 174

If your business begins with:

• software development

• product research

• formulation work

• feasibility studies

• experimentation

…those hours also count toward material participation.

This can matter a great deal for tech startups or any venture where the “R&D phase” consumes the majority of the first year.

Does This Apply to Rental Activities? Yes.

A technical point for tax accountants reading this and who have read the regulations. Many people assume rentals are different because the regulations define “rental activities” separately.

But Treas. Reg. §1.469-4(b)(2) simply cross-references the rental activity definition. It does not carve rentals out of the rule allowing:

• pre-operation hours

• hours in anticipation

• research or planning hours

If you’re starting a short-term rental business and spend 200 hours in the spring:

• touring properties

• running revenue projections

• negotiating with sellers

• learning STR software

• analyzing cleaning and maintenance options

… and then place the property into service later that year?

Those 200 hours count.

This can easily push a taxpayer over the 100-hour or even 500-hour thresholds.

Why This Matters So Much in First-Year Loss Situations

Many first-year businesses — including rentals — generate meaningful startup costs, depreciation, and operating losses.

Taxpayers and sometimes even preparers often assume:

“Well, I didn’t start operating until September, and I only have 60 hours over those last four months of year. I guess I can’t materially participate.”

But that assumption is almost always wrong.

If you spent substantial time preparing the business earlier in the year, those hours often count.

This is especially relevant for:

• Short-term rentals (property acquisition is labor-intensive)

• Real estate flips

• New professional practices

• Restaurants and hospitality businesses

• Software development startups

• Any venture with heavy pre-launch planning

A Practical Example with a Short-term Rental

Let’s look at a really common example where bungling this bit of law occurs. Say Sarah decides in January to start a short-term rental business. She spends:

• 120 hours researching markets

• 80 hours touring properties

• 40 hours negotiating financing

• 60 hours setting up software, décor planning, onboarding cleaners

She closes on a property in August and begins renting it in September. Once renting, she spends another 60 hours in operations.

Sarah’s total hours for the year:
120 + 80 + 40 + 60 + 60 = 360 hours

She easily exceeds the 100-hour test and often the 500-hour test depending on further operating activity.

Yet many preparers would mistakenly tell her she only has ~60 hours of participation.

A Few Final Guidelines

To make this all work in practice, taxpayers must do two things:

1. Keep contemporaneous records

A simple log — even in Outlook, Google Calendar, or a notes app — works. But it needs dates, times, and descriptions. You want to track the owner’s hours and the owner’s spouse’s hours. You also want to track the hours spent by your vendors.

2. Avoid the “throw-out” categories

Reg. §1.469-5T(f) excludes:

• purely investor activities if not involved in daily operations

• hours not customarily performed by owners if only performed to qualify as materially participating

• capital acquisition work for someone who will not operate the business

These categories rarely apply to someone who will personally operate a short-term rental or a small business. But they matter for passive investors.

The Big Takeaway

The regulations make it clear: Material participation doesn’t start when the business starts. It starts when you start working on the business — so long as it’s in anticipation of beginning the activity.

For many taxpayers, this means more hours count than they realize. And it means first-year losses are more deductible than they thought, provided they meet one of the material participation tests.

And for short-term rental operators in particular, the hours spent searching for, analyzing, acquiring, furnishing, and preparing a property often form the majority of total participation hours.

That’s good news — as long as you keep good records.

Other Resources You May Find Useful

A Dozen Ways to Deduct Passive Losses

Short-term-rental Depreciation Deductions Calculator

The post When Material Participation Really Starts (It’s Earlier Than Most People Think) appeared first on Evergreen Small Business.

The Basic Idea

Bonus depreciation (IRC §168(k)) lets you immediately write off the cost of certain property with a recovery period of 20 years or less. You can think personal property, land improvements, and some interior improvements identified in a cost segregation study. (We talked about this in our last blog post: The Section 168(k) Bonus Depreciation Purchased Requirement.)

A 1031 exchange lets you defer gain when you swap one property for another of like kind. (We’ve also described how these work in past. For example, see Like Kind Exchange Rules Powerful But Tricky )

Here’s the twist: Treasury regulations say that when you exchange into a new property, the basis that carries over from the old property and any new money you invest can be eligible for bonus depreciation. The key cite is Reg. §1.168(k)-1(f)(5)(iii)(A). And the main thing to know: Combining these two laws can potentially result in gigantic tax savings.

A Simple Example

Let’s start with a practical but simple example. Suppose you:

1. Buy a $1,000,000 rental property. A cost segregation study finds $300,000 of 15-year improvements. You claim 100% bonus depreciation = $300,000 deduction in Year 1.

2. In Year 2, you exchange that property for a replacement worth $1,000,000. Basis carries over at $700,000.

3. Regulations let you treat that $700,000 as if newly placed in service for bonus depreciation purposes. Another cost seg shows $210,000 of short-life property — and you get another big deduction.

4. Do it again in Year 3, and the same mechanics apply (though the numbers shrink as the basis shrinks).

It’s a bit like a geometric series of deductions: $300K, then $210K, then $147K…

Obviously, transaction costs matter. The timing needs to work right. (You can’t both acquire and dispose of a property in the same year, for example, to point out one of the important requirements.)

But, wow, that’s surprising, right?  If you’re a high income real estate investor, you may want to exchange existing properties for new properties simply to trigger bonus depreciation. Further, if you’re a high income taxpayer looking for a way to really dial down your federal tax burden? Now would not be a crazy time to look into this investment category.

Who Benefits?

This isn’t for everyone. To make it work you need:

• The right timing (properties bought and exchanged while bonus depreciation is available).

• A cost segregation study on each property.

• Enough participation in the rental activity to avoid falling into the passive activity category. (The three most practical ways to avoid passive losses are described here: real estate professional status, short-term rentals, and self-rentals to a business you own.)

But for active real estate investors, especially those moving up in property size, this can be a powerful way to defer gain through §1031 while still accelerating deductions with bonus depreciation.

The Bottom Line

Most investors think they must choose between a 1031 exchange or a large depreciation deduction. The truth? Under the right circumstances, you can have both.

As always, details matter. Talk with your tax advisor before trying to apply this in your situation.

The post Bonus Depreciation and 1031 Exchanges: A Hidden Opportunity appeared first on Evergreen Small Business.

The date part of that? Easy. You can read a calendar.

The tangible property part? Mostly easy, too. The main rule is anything with a class life of 20 years or less? You can bonus depreciate.

But that “purchase” requirement? Trickier that you might guess.

The Technical Purchase Requirement

So, the Section 168(k) statute says we look to Section 179(d)(2) to determine what a purchase is. And that chunk of the law says this:

For purposes of paragraph (1), the term “purchase” means any acquisition of property, but only if—

(A) the property is not acquired from a person whose relationship to the person acquiring it would result in the disallowance of losses under section 267 or 707(b) (but, in applying section 267(b) and (c) for purposes of this section, paragraph (4) of section 267(c) shall be treated as providing that the family of an individual shall include only his spouse, ancestors, and lineal descendants),

(B) the property is not acquired by one component member of a controlled group from another component member of the same controlled group, and

(C) the basis of the property in the hands of the person acquiring it is not determined—

(i) in whole or in part by reference to the adjusted basis of such property in the hands of the person from whom acquired, or

(ii) under section 1014(a) (relating to property acquired from a decedent).

Which provides most but not all the rules you need… so let’s just step through this.

No Bonus Depreciation for Related Party Acquisitions

A first observation? Someone can’t purchase property from a related party.

That simple rule makes sense just from a loophole prevention context. Without that prohibition, families and family-owned businesses could manipulate bonus depreciation deductions at will.

No Bonus Depreciation for Purchaser Contributed Property

A more subtle requirement. If you purchase some property and then contribute it to a partnership or corporation? No bonus depreciation.

This wrinkle may matter more than you think. For example, if you and your spouse buy a short-term rental thinking you should be able to get giant bonus depreciation deductions? That may work, sure.

But then if you contribute that property to an LLC which you and your spouse both own and then treat that LLC as a partnership? Okay, now we got a problem. The reason? The bonus depreciation deduction would need to go on a partnership tax return. Except the partnership didn’t purchase. You and your spouse did.

No Bonus Depreciation on Inherited Property

Bonus depreciation doesn’t apply to inherited property someone acquires from a decedent and for which tax law (specifically Section 1014) resets the basis to the fair market value usually at time of death.

You can read this rule right in the statute I quoted above. But so you understand and so this makes sense, assume you and your spouse own property—maybe it’s an income rental—and you’ve already depreciated it fully. Maybe you bought the property for $200,000 decades ago and have long since deducted all the available depreciation meaning the adjusted for depreciation “cost basis” now seats at $50,000.

In a community property state, the death of one spouse resets the basis to the fair market value. If the above property at the date of death of the first spouse is now worth $1,000,000? The surviving spouse can again begin depreciating the property. And based on that new $1,000,000 basis. But he or she can’t use bonus depreciation. Rather, the surviving spouse uses regular old MACRS depreciation.

Note: Bonus depreciation would not apply to much of an income rental. Only the parts of the property that represents tangible personal property with of 20 years or less.

No Bonus Depreciation for Section 754 Elections

A sort of related issue: If someone buys into a partnership with tangible property or inherits an interest in a partnership with tangible property? Their purchase price or the Section 1014 basis adjustment can, if a Section 754 election has been made, cause the partnership to adjust the basis and depreciation numbers for that partner’s share of, say, the machinery.

However, the regulations for Section 168(k) specifically exclude taking bonus deprecation on this amount created via the Section 754 election. (Let me cite the actual regulation in case you’re a tax practitioner and want to read this: Reg 1.168(k)(f)(9).)

Yes Bonus Depreciation on Section 1031 Like-Kind Exchanges

So, you might guess that the statute quoted earlier prevents you from deducting bonus depreciation on a least some of the basis you count after a like-kind exchange. But that’s not exactly right. In general, if you want, you can take bonus depreciation on the new property you acquire via a like kind exchange.

Example: You trade land worth $1,000,000 but with a basis equal to $100,000 for a building worth $1,000,000. You can use Section 1031 to avoid paying taxes on the $900,000 realized gain. And the probably you can bonus depreciate the part of the new building that counts as tangible personal property. If 20% of the new building is tangible personal property and your basis is only that $100,000, probably you can deduct $20,000 of bonus depreciation.

If you trade the $1,000,000 piece of land and use a $2,000,000 mortgage to acquire a $3,000,000 building and 20% of that building counts as tangible personal property, you can probably bonus depreciate 20% of the $2,000,000 and the $100,000 so roughly a $420,000 bonus depreciation deduction.

Yes Bonus Depreciation on Section 1033 Involuntary Conversions

A quick final point: If you use Section 1033 to handle an involuntary conversion? Roughly, the accounting for a Section 1033 involuntary conversion works like the accounting for a Section 1031 like-kind exchange.

In other words, if the involuntary conversion causes you to lose one property (a vehicle, a building, or whatever) and you replace that property, you can potentially use bonus depreciation on the carryover basis and the new property’s excess basis.

A fire destroys equipment with basis $400,000 and FMV $1,000,000. The taxpayer receives $1,000,000 insurance and reinvests it all in similar equipment (qualifying under §1033). Basis in replacement equipment = $400,000 (carryover). Under the §168(k) regs, that $400,000 basis qualifies for bonus depreciation (since equipment has a recovery period <20 years)

The post The Section 168(k) Bonus Depreciation Purchased Requirement appeared first on Evergreen Small Business.

But if you’re curious about establishing residency in or changing your domicile to some new state? Maybe you want to avoid the Washington state capital gains tax? Or maybe you want your heirs to avoid the new higher Washington state estate taxes? (Click here to learn about the new higher tax.) Washington provides a useful form for thinking about these issues: Form 85-0045, the Affidavit Substantiating Decedent’s State of Domicile at Death.

The General Washington Residency Rule to Start

Let’s start with the general residency rule, though, which comes from the Revised Code of Washington (RCW 83.100.020), the Washington Administrative Code (WAC 458-57-105), and ironically from the Department of Revenues FAQ (click here).

Residents potentially owe estate and capital gains tax returns. And residents are people domiciled in Washington state.

So what is a person’s domicile? Quoting ChatGPT, “’Domicile’ means a person’s true, fixed, and permanent home and place of habitation. It is the place the person intends to return to whenever absent. A person can have only one domicile at a time”.

The state applies a facts and circumstances test and basically looks at all the common-sense stuff you would look at if your job was determining people’s domiciles. But you and I get a concrete sense of what matters from that Form 85-0045.

The actual form appears here: Affidavit Substantiating Decedent’s State of Domicile at Death. And for background, a personal representative, or executor, might fill out and provide this form to the state’s Department of Revenue if he or she needs help determining domicile.

But the other useful thing? The form helps you think concretely the mechanics of possibly changing your domicile.

Reviewing Form 85-0045

A first tip to start: Go ahead and grab the form and fill it out the way you’d want to be able to fill it out if you were arguing you’re not a Washington resident. Because you do not want to be subject to the state’s capital gains tax, say. Or because you do not want your estate or the estate of some family member to be subject to the state’s estate tax. Answering the form’s questions will help you understand the issues. (The form resembles a test where the questions signal the correct answers.)

But let me point to the key bits if you’re thinking about your own Washington state residency.

Primary Residence at Time of Death

The very first question of the affidavit asks for the decedent’s current primary residence, the mailing address, the time living at this location, and then whether there was any known intent to continue or change this residency. So that’s the big thing. And the significance: If you’re going to argue your residence or domicile isn’t in Washington state, you want or need to be able to point to a residence in some other different state. Makes sense, right?

A couple of other questions at the top of the form explore this issue in more detail. The second question, for example, asks if the decedent was residing in a nursing home at the date of death and how long he or she had been in the nursing home. The third question asks if the decedent owned a home and whether that home was or is rented or leased or available for rental or lease. (Obviously, you can’t argue you plan to return to your house in Las Vegas if you’re renting or leasing it to someone else.)

Washington State Real and Personal Property

Next point: A number of the Affidavit’s questions (specifically, questions 3, 4, 6, 8 and 13) ask about whether the decedent owned property in Washington state. Real property (like a home), personal property including cars, business interests and so on. The affidavit also asks about safe deposit boxes in Washington state. Those of course might store some of the most valuable personal property a person owns like jewelry and gold. (The form doesn’t ask if you’ve rented storage units or lockers in Washington state. But those should probably be considered in the same manner as safe deposit boxes.)

Pretty obviously if you want to strongly claim another state for your residency or domicile, property located in Washington state matters. A lot.

Also this comment and reminder: If you have any real property located in or personal property stored in Washington state, your estate needs to file a Washington state estate tax return if the estate crosses the filing threshold.

Example: A decedent domiciled in Nevada dies during the last half of 2025 when the filing threshold equals $3,000,000. The total estate includes only two items: A $3,000,000 IRA and then also a small undeveloped parcel located in Kitsap County worth $100,000. The Nevadan’s estate needs to file a Washington state estate tax return because the gross estate value exceeds $3,000,000. Note that the estate will pay only a tiny amount of tax. (About $300 in this situation.)

Washington State Activity Within Prior Five Years

The affidavit also asks questions about any in-state business or personal activities within the last five years. The fifth question for example asks whether the decedent was employed in Washington state any time in the prior five years. The sixth question asks if the decedent owned or operated a business in Washington state during the prior five years. The twelfth question asks about memberships in Washington state community or religious organizations, clubs or societies in the last five years. The fourteenth question asks for a complete list of trips (including location visited, travel dates, and reasons for travel) during the prior five years.

You can see what the Department of Revenue is trying to glean here: How connected are you to Washington state? Close, tight connections weaken an argument that you’re domiciled in some other state. And the lookback period? The prior five years.

Official Government Documentation Connected to Location

A final observation about the affidavit—which works as a good reminder too. The affidavit asks a number of questions that can be easily verified by looking at a government document. For example, the seventh question asks which IRS service center the decedent used to file tax returns. And for the address shown on the federal tax return.

The ninth question asks where the decedent was or is registered to vote.

The tenth question asks if the decedent held a driver’s license and if so from which state.

The eleventh question asks whether the decedent held any licenses or permits at the time of death. These might be recreational permits (fishing or hunting licenses) or professional licenses (like a CPA license or state bar membership).

Finally, the fifteenth question asks if the decedent declared a state of residence near the time of death. If so, it asks to whom the declaration was made and when.

The obvious observations here: All the federal and state government documents you file should match the story of your residency. The tax returns you file, for example, should logically match the residency or domicile you’re claiming. And if you’re domiciled in, say, Texas, the majority or maybe even all your licenses and permits should match that state.

Wrapping Up Comments

Form 85-0045 seems insightful to me if you’re starting to think about residency and domicile and maybe moving to some new state. You get a good picture of the changes to make if you did decide to move.

And just to summarize all this, you ideally want to avoid having any property in Washington state—at least if you’re worried about filing an estate tax return. That property—even if only miniscule—triggers a requirement to file an estate tax return if you’re over the reporting threshold. Reporting obviously puts you on the Department of Revenue radar screen whether you deserve to be or not.

You need a home someplace else. And with that, a mailing address along with things like a drivers’ license, voter registration, and then state and local licenses and permits as appropriate for a resident. Ideally, your profile would resemble a local Floridian, Texan or Nevadan if you decide to reside in Florida, Texas or Nevada.

Do make strong connections to your new location. And then limit or intentionally weaken connections your former state of residence.

Finally, think about how much time you spend you spend in Washington state. Less is better. You may even want to document how little time and how inconsequential the in-state activities.

The post Changing Your Washington State Residency appeared first on Evergreen Small Business.

But when taxpayer estates do the pay the tax? Ouch. Rates start at 20%. And rise ultimately to 35%.

Further, as bad as that may sound if your estate or the estate of someone in your family pays this tax? The situation may be far worse because of the way “income in respect of a decedent” is taxed.

The problem in a nutshell: State estate taxes may fully tax the “pre-tax” income in respect of a decedent.

What is Income in Respect of a Decedent?!

Good and important question. And one we can best answer with a simple example. The most common form of income in respect of a decedent are the wages someone earned but hadn’t yet been paid when they died. That income hasn’t yet been subjected to income taxes. Thus, federal tax laws tax it.

Example: Someone dies with $10,000 of accrued wages. Those wages paid after death represent income in respect of a decedent. The estate or heirs pay the income taxes the decedent would have paid on the $10,000.  Maybe $3,000 to $4,000 in most cases. Thus the estate or heirs may only receive $6,000 or $7,000. But Washington state may tax the full $10,000.

Now a single payroll? Probably not that big a deal. A family that’s just lost a breadwinner has far bigger issues and concerns. And most estates don’t pay the Washington state estate tax.

But if an estate does pay Washington state estate taxes, the IRD issue grows in significance. And here’s why.

IRD includes a bunch of stuff. It includes most retirement account balances like traditional deductible IRA, 401(k), 403(b) and 457(b) and cash balance retirement plans. IRD includes some of the common equity compensation income provided to technology company employees including nonqualified stock options, restricted stock units, restricted stock awards and then other deferred compensation or stock deferral plans. IRD can also include large windfall amounts—lottery winnings, composer and author royalties, and SEC and IRS whistleblower awards—which won’t be collected until years or decades after the estate taxes are due. (More on this in few paragraphs.)

How Washington State Handles IRD

The problem here? The Washington estate tax is imposed on the full value of income in respect of a decedent (IRD) without regard to the income taxes that will later be owed.

Example: A Washington decedent’s estate includes $10,000,000 of IRD and is subject to the top 35% Washington estate tax rate. The resulting state estate tax equals $3,500,000.

When the IRD is later received, the estate or beneficiaries receive an income-tax deduction under IRC §691(c) equal to the estate tax attributable to the IRD. As a result, only $6,500,000 of the IRD is subject to federal income tax. At a combined 37% federal rate plus 3.8% net investment income tax, that produces an additional $2,652,000 of federal income tax.

In total, the combined Washington estate tax and federal income tax equal $6,152,000 — an effective tax rate of roughly 62%

How Federal Estate Taxes Handle IRD and State Estate Taxes

The tax situation becomes even worse when federal estate tax applies because the decedent’s estate exceeds the basic exclusion amount. In that case, income in respect of a decedent (IRD) can be subjected to Washington estate tax, federal estate tax, and federal income tax.

Example: A Washington decedent’s estate includes $10,000,000 of IRD. Washington estate tax at 35% produces a $3,500,000 tax. Because Washington estate tax is deductible for federal estate tax purposes, the federal taxable estate attributable to the IRD equals $6,500,000, resulting in $2,600,000 of federal estate tax at a 40% rate.

The total estate tax attributable to the IRD is therefore $6,100,000. Under IRC §691(c), that amount becomes an income-tax deduction when the IRD is later received. As a result, only $3,900,000 of the IRD is subject to federal income tax. At a combined 37% federal rate plus 3.8% net investment income tax, this produces an additional $1,591,200 of income tax.

In total, combined Washington estate tax, federal estate tax, and federal income tax equal $7,691,200 — an effective tax rate of nearly 77% on the $10,000,000 of IRD.

And believe it or not, the situation can in a handful of situations get even worse. There is a nightmare scenario.

The Liquidity Nightmare: Estate Taxes Due Before IRD Pid

Here’s the true nightmare scenario: a decedent’s estate includes substantial income in respect of a decedent (IRD), but the estate will not actually receive the income for many years.

This can occur, for example, when IRD consists of a long-term payout stream such as a lottery annuity, structured settlement, or deferred compensation arrangement. In these cases, the estate tax is due shortly after death—even though the cash needed to pay that tax may not arrive for decades.

Example: Suppose a Washington decedent dies owning the right to receive $1,000,000 per year from a lottery annuity, with 15 annual payments remaining. For estate-tax purposes, the annuity is valued at $10,000,000. Washington estate tax at the top 35% rate produces a $3,500,000 estate tax liability attributable to the IRD.

The problem is timing. The Washington estate tax is generally due within nine months of death, but the estate does not receive its next $1,000,000 lottery payment until a year later. As a result, the estate must either borrow to pay the tax or request extensions while interest accrues.

When the first $1,000,000 annuity payment is eventually received, a substantial portion is immediately consumed by federal income taxes. Even after accounting for the §691(c) deduction, roughly $250,000 to $300,000 of the payment may go to federal income tax and net investment income tax. The remaining cash is then applied toward interest and principal on the estate tax obligation, leaving only a fraction of each annual payment to reduce the underlying estate tax balance.

Because the annuity payments are relatively small compared to the upfront estate tax liability, it can take many years for the estate to fully retire the tax debt. During that period, interest continues to accrue, and heirs may receive little or no net benefit from the IRD for a long time.

In extreme cases, the estate may be forced to borrow repeatedly or even liquidate non-IRD assets simply to service the estate tax obligation created by the IRD itself.

Some Quick Final Comments

What do you do about this? You’ve already taken the first step (maybe) which is recognizing the potential size of the problem if your estate includes substantial IRD.

As far as remedies or palliative measures? Your first step is probably to confer with a good estate planner. All the usual federal estate planning techniques and methods probably get turbocharged if you’re talking about IRD potentially subject to Washington state’s estate tax. (Here’s a primer of basic techniques: Washington state estate tax planning techniques. But if you’re potentially taxed on a lot of IRD? You’re going to want to look at the more sophisticated techniques available too.)

Thus, three closing remarks and ideas to discuss with your attorney or accountant.

First, an interesting feature of Washington’s estate tax regime is, the state doesn’t tax gifts. Thus, while a large gift to heirs might trigger federal gift taxes or use up the federal basic exclusion amount, those gifts typically don’t result in additional Washington state estate taxes.

Note: Starting in 2026, you can gift up to $15,000,000 without triggering gift taxes. Married? The amount doubles: You and your spouse can together gift up to $30,000,000.

Second, I’m usually not a big Roth account fan. (See here for a list of all blog posts that discuss the reasons here.) But paying the taxes now to convert a big $10,000,000 tax-deferred IRA (and IRD) to a smaller but equivalent after-tax $5,900,200 Roth account (which is not IRD)? That often makes good sense if it saves Washington state estate taxes. If a $10,000,000 traditional IRA gets converted and you’re avoiding the top estate tax rate, for example, the tax savings roughly equal $1.6 million.

And then, third, the other obvious option to at least consider: Someone with a lot of IRD in their estate may want to consider changing their domicile.

Additional Resources

Need more background information on the state’s new estate tax? Check out this blog post: Planning for the New 35% Washington State Estate Tax.

Want to estimate what state taxes an estate might pay? This calculator makes a good estimate for estates created after July 1, 2025: Washington State Estate Tax Calculator.

The post The Washington Estate Tax Income in Respect of Decedent Problem appeared first on Evergreen Small Business.