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.

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.

Thus, if you or someone in your family may pay Washington state estate taxes? Especially that top 35% rate? You want to understand how the estate tax works. And what steps you may be able to take to minimize the burden.

To help with this thinking, this long-ish blog post. It explains how the new higher-tax-rates Washington state estate tax formula works. And it points out the handful of tax planning gambits affected taxpayers will want to consider.

Basic Washington State Estate Tax Formula

Let’s start by reviewing the basic formula. Washington taxes estates using the following formula for decedents dying July 1, 2025 or later:

Estates up to $3,000,000 pay zero estate tax due to an exclusion amount. (State law adjusts this exclusion amount for inflation after 2025. But for purposes of this discussion, we’re mostly going to ignore the adjustment. That ignorance makes the math easier.)

Estates between $3,000,000 and $12,000,000 pay a graduated tax that starts at 10% but then steadily marches up to the top 35% tax rate. A $12,000,000 estate created between July 1 and December 31 of 2025, for example, pays $1,930,000 in estate taxes. But the table below summarizes the actual tax brackets.

Estates greater than $12,000,000 pay $1,930,000 in estate taxes plus 35% of the amount by which the estate exceeds $12,000,000.

Example 1: A Washington resident dies with a total estate of $22,000,000 in late 2025. His estate pays no estate taxes on the first $3,000,000 of value due to the exclusion amount. The estate pays $1,930,000 on the next $9,000,000 of value. And the estate pays $3,500,000 on the last $10,000,000 of value. In total, then, the estate pays $5,430,000 in estate taxes.

Washington State Estate Tax Formula “Standard Deductions”

In most cases, deductions reduce the size of the taxable estate.

Perhaps most important, most spousal transfers don’t get taxed.

Example 2: A married taxpayer dies with an estate equal to $22,000,000. The taxpayer’s will transfers $19,000,000 of that to his spouse. That spousal transfer probably reduces the estate value to $3,000,000. The $3,000,000 exclusion amount shelters that $3,000,000. Thus, the estate pays zero estate taxes.

Note: Credit shelter trusts, as your attorney can explain, often let married taxpayers in effect use the exclusion amount twice: $3,000,000 when the first spouse dies and another $3,000,000 when the second spouse dies. (In a guest blog post here, “Washington Estate Tax Tips Save Thousands” Redmond, WA attorney Raemi Gilkerson explains how these credit shelter trusts work.)

Charitable contributions also reduce the size of the taxable estate.

Estate administration costs (attorneys, accountants, appraisers and so forth) also get deducted from the gross estate to determine the taxable estate.

Qualified Family-owned Business Interest Deduction

In a tiny handful of situations, an estate may deduct the value of a qualified family-owned business interest in a small business to shelter up to roughly $3,000,000 of the estate. (Getting this deduction to work is tricky as described here, “Qualified Family-owned Business Interest Deduction: Updated for 2025.” But families and professionals want to at least investigate the deduction if they think it applies.)

Example 3: A taxpayer leaves a $12,000,000 estate. The estate spends $100,000 on administration costs and makes a $2,900,000 charitable contribution to a Seattle hospital. That leaves $9,000,000 in the estate. A qualified family-owned business interest worth $6,000,000 would, according to a very complicated formula, potentially create a qualified family-owned business interest deduction equal to $3,000,000. The regular exclusion amount shelters $3,000,000. That leaves a taxable estate of $3,000,000 on which the estate pays $420,000.

Out of State Adjustments

If a taxpayer owns out-of-state real estate or tangible personal property, that property reduces the Washington state estate taxes on a pro rata basis. If half a Washington resident’s estate consists of out-of-state tangible property, for example, the Washington state estate tax formula halves the estate taxes owed.

Example 4: A taxpayer dies with a $22,000,000 estate in late 2025. As example 1 shows, if the taxpayer’s property all sits in Washington state, the estate pays a $5,430,000 estate tax. But if the estate includes a $6,000,000 home in Palm Springs (so out-of-state real estate) and $5,000,000 of gold stored in a Los Angeles bank vault (so out-of-state tangible property), $11,000,000, or 50 percent of the taxpayer’s $22,000,000 estate is “out of state.” In this case, then, the estate reduces the $5,430,000 estate tax by 50 percent, so from $5,430,000 to $2,715,000.

Some Washington Estate Tax Planning Concepts

Start kicking around the concepts described in the preceding paragraphs and you can (surely with your attorney’s help) spot a handful of techniques to reduce your estate taxes. But let me point out the obvious ideas.

Relocate Out of State

The first obvious gambit for anyone facing a large Washington state estate tax liability? Relocate to just about any other state. A no-income-tax state like Nevada, Florida or Texas maybe works best. But any other low-income-state western state like Arizona, Idaho, Montana or Utah works well too.  Washington’s top 35% estate tax is by far the highest in the nation. And most other western states (Oregon excepted) levy no estate tax.

Note: Relocating subjects you to a new state’s income taxes, if any. But even with high income tax states (like California), paying income taxes over decades may often cost less than paying estate taxes.

A caution: If you move out of state but keep a home in Washington state, your estate applies the same pro rata formula described in example 4 with the difference that your intangible property gets “sourced” to your new state.

Example 5: A taxpayer with a $22,000,000 estate knows that without any tax planning, his estate will owe $5,430,000 of estate taxes. Thus, he terminates his Washington state domicile, relocates to Austin, Texas, and clearly establishes his new domicile there. He keeps his Washington state home, however, valued at $2,200,000. That means he still holds 10 percent of his estate inside Washington and so will need to pay 10 percent of $5,430,000, or $543,000, in Washington state estate taxes.

Gift Either to Heirs or Charities

Washington state levies no gift tax. Thus, a taxpayer can save her or his estate from paying state estate taxes by gifting large amounts to heirs pre-mortem. The only wrinkle here is that federal gift taxes paid within three years of the death get added back to the Washington taxable estate. ( Consult your tax advisor if that is potentially your situation.)

Charitable gifts to organized charities should also reduce the taxable estate.

Example 6: A single taxpayer with a $12,000,000 estate knows his estate will pay $1,930,000 in estate taxes if he dies without reducing the taxable estate’s size. Thus, he gives away $1,000,000 to each of two children while alive and makes a $1,000,000 testamentary charitable contribution. Those gifts reduce the estate from $12,000,000 to $9,000,000 and drop the estate tax from $1,930,000 to $1,070,000.

Move Assets Out of State

A taxpayer reduces her or his Washington taxable estate by purchasing real estate or holding tangible personal property out of state.

Example 7: Another single taxpayer with another $12,000,000 estate also knows her estate will pay $1,930,000 in estate taxes if she dies without reducing the estate’s size. She buys a $2,500,000 home in Palm Springs and moves $500,000 of artwork and collectibles from her Seattle home to her new Palm Springs home. If she later dies with not 100 percent but only 75 percent of her estate inside Washington state? She reduces her estate tax from $1,930,000 to 75 percent of $1,930,000, or $1,447,500.

Bigger Fish to Fry

One other gambit (or non-gambit?) to mention. Maybe you don’t worry about this Washington estate tax stuff. Or at least don’t worry about it very much. Don’t get me wrong. The new estate tax rates seem like terrible tax policy for a  bunch of reasons.

But what I’m thinking here: You living close to friends and family? Staying connected to the community network you’ve spent decades building? That stuff is pretty valuable. Probably more valuable than the estate tax most taxpayers will pay.

Thus, unless avoiding the Washington state estate tax makes a big difference to your heirs? You may have bigger fish to fry here. Seriously.

A Closing Technical Point about Inflation

As mentioned earlier, Washington state law adjusts the $3,000,000 exclusion amount and the up to $3,000,000 qualified family-owned business interest deduction amount for inflation. Thus, for estates of decedents who die in 2026 or later years? Inflation will surely push up these amounts. That $3,000,000 applicable in 2025 amount might grow to $3,100,000 in 2026 or 2027.

But a technical point: No inflation adjustment occurs for the dollar values in that table of estate tax rates and brackets. Washington state tax law ignores the effect of inflation for those amounts. That ignorance maybe doesn’t sound like a big deal. But if annual inflation runs 3-percent roughly, it steadily reduces the size of that band of lower rates that average 21 percent-ish. Thus, over time, more estates will pay that 35 percent tax rate on a portion of their estate’s value.

Want to Estimate Your Estate’s Tax?

If you want to experiment with your estate’s possible estate tax burden, you can use this calculator: Washington Estate Tax Calculator

The post Planning for the 35% Washington State Estate Tax appeared first on Evergreen Small Business.

Deductions Protect Most Taxpayer’s Estates

Fortunately, the state provides a couple of big deductions and both are enlarged starting July 1, 2025: A standard $3,000,000 deduction that everyone gets. (Prior to the new law, the standard deduction was $2,193,000.) And that single deduction means most people’s estates don’t pay the state estate tax.

Further, a qualified family-owned business interest deduction that can technically shelter as much as another $3,000,000 starting July 1, 2025. (Before that date, the qualified family-owned business interest deduction equaled $2.5 million and wasn’t indexed for inflation.) That extra deduction potentially means small business owners’ families and heirs can sometimes avoid state estate taxes on as much as $6,000,000 of their estate in late 2025.

Someone who dies in the last half of 2025 with a $10,000,000 estate, for example, might shelter as much as $6,000,000 from estate taxes and then only have their estate pay estate taxes on the remaining $4,000,000.

But it’s tricky. So, let’s go over the details.

Qualifying for the Qualified Family-owned Business Interest Deduction

The “qualified family-owned business interest deduction,” or QFOBI deduction, burdens taxpayers with a handful of requirements.

First, the business must be an active trade or business. A passive business can’t use this deduction. Estates, for example, can’t use this deduction for real estate investments.

Second, the business must represent more than half of the estate and be worth $6,000,000 or less. (These twin requirements mean, practically, the estate needs to include a business interest that makes up more than half of an estate no larger than $12,000,000.)

Third, either the decedent or a family member must have materially participated in the business for five of the eight years before death by working 35 hours a week or in a hands-on managerial role.

Note: The QFOBI deduction doesn’t use the popular Section 469 material participation rules from Regulation 1.469-5T(a) but older estate-related rules from Section 2032A(e)(6). Those regulations treat ~35 hrs/week (or season-long full-time for seasonal operations) as a safe harbor, but a well-documented managerial role can also work.

Fourth, at least one family member or in a pinch a key-employee with ten years of employment needs to work full-time for the three years that follow the date of death. (Practically, this probably means any family member like an heir needs to be working in the business before the date of death.)

But meet these requirements and the estate probably slides another big chunk of estate out of the taxable category and into the non-taxable category. That move may save hundreds of thousands of dollars.

Examples of QFOBI Deduction Working

Let me provide a couple of examples of the qualified family-owned business interest deduction working. All examples will assume the taxpayer dies during the last half of 2025.

Example 1: Martha has an active business worth $5,000,000 while the remaining assets in the estate are worth $4,000,000. Thus, the total estate is $9,000,000. Her son materially participated in the operation for the five years prior to her death and will continue to operate the business for the three years following her death. The estate may deduct $3,000,000 of the $5,000,000 small business. The estate may also take another “standard” $3,000,000 deduction. That leaves $3,000,000 of leftover, taxable estate. And in the last half of 2025, that estate would trigger about $400,000 of Washington state estate tax. (Compare this example to example 3 below.)

Example 2: John has an active business worth $6,000,000 while the remaining assets in the estate are worth $5,999,999. Thus, the total estate is $11,999,999. His son, also named John, materially participated in the operation for the five years prior to his death and will continue to operate the business for the three years following his death. The estate may exclude $3,000,000 of the $6,000,000 small business. And the estate may also take another “standard” $3,000,000 deduction. That leaves $5,999,999 of leftover, taxable estate. And in the last half of 2025, that estate would trigger about $1,100,000 of Washington state estate tax. (Compare this example to example 4 below.)

Tip: We have a simple calculator you can use to estimate Washington state estate taxes: Washington State Estate Tax Calculator 2025 Version.

Examples of QFOBI Deduction Not Working

Let me provide a couple of examples of the qualified family-owned business interest deduction not working.

Example 3: Thomas has an active business worth $4,000,000 while the remaining assets in his estate equal $5,000,000. Thus, the total estate is $9,000,000, the same total as in Example 1. He materially participated in the operation for the five years prior to death and an adult child, already working in the operation, will continue to operate the business for the following three years. The estate may not exclude $3,000,000 of the $5,000,000 small business because the business does not represent 50 percent or more of the estate. The estate only will get to take the “standard” $3,000,000 deduction. That leaves $6,000,000 of leftover, taxable estate. And in the last half of 2025, that estate would trigger about $1,000,000 of Washington state estate tax. (Compare this example to example 1 above.)

Example 4: George has an active business worth $6,000,001 while the remaining assets in the estate are worth $5,999,999. Thus, the total estate is $12,000,000. His son, also named George, materially participated in the operation for the five years prior to his death and will continue to operate the business for the three years following his death. The estate may not exclude $3,000,000 of the $6,000,001 small business because the business value exceeds $6,000,000. The estate may however take the “standard” $3,000,000 deduction. That leaves $9,000,000 of leftover, taxable estate. And in the last half of 2025, that estate would trigger about $1,900,000 of Washington state estate tax. (Compare this example to example 2 above.)

Common Trip-wires

Easy-to-make mistakes can torpedo the qualified family-owned business interest deduction. Thus, let me quickly summarize these.

Day-1 Participation Gap

If no heir or other family member or ten-year key employee is already on the payroll when Mom or Dad dies, the three-year clock possibly can’t be met. (A ten-year key employee can stand in if no family member can.) Thus, families wanting to use this deduction need to plan now—and avoid post-mortem scrambling.

Tip: Probably material participants also want to document their work. Timesheets, management minutes, crop plans—anything that shows hands-on control—may make a difference.

Self-employment Tax Mismatch

The estate regulations presume material participation when the taxpayer paid SE tax. If past returns lack a Schedule SE, expect the Washington Department of Revenue to press hard on use of the deduction.

Business Worth > $6 million

One final trip-wire to mention. The new version of the Washington state estate tax (ESSB 5813) lifts the QFOBI deduction cap from $2.5 million to $3 million for deaths on or after July 1, 2025, and adds annual CPI indexing thereafter. Thus, the deduction grows with inflation starting in the calendar year 2026.

However, the business worth cap of $6 million is frozen. Thus, while the potential QFOBI deduction will get bigger each year, the number of firms eligible (because they’re worth $6 million or less) will shrink with inflation. Thus, keep this economic reality in mind for planning. Especially if the business valuation you’ll be using is one in a decade or two… or three

Gut-check on the Qualified Family-owned Business Interest Deduction

One final comment: The QFOBI deduction is tricky to use. As you now know if you didn’t before, the requirements an estate needs to meet are pretty limiting. Between you and me? What the state legislature cooked up here, about as absurd as it gets.

But that said, if you’re in a situation where your family or your clients operate a small business that represents the major share of their wealth? You want to at least think about using the QFOBI estate deduction. It’s often (as the examples above show) going to save hundreds of thousands of dollars. And even a million dollars in some cases.

The post Washington’s Qualified Family-Owned Business Interest Estate Tax Deduction: Updated for 2025 appeared first on Evergreen Small Business.

And, just so there’s not confusion, I am not talking about the ProPublica folks and their semi-self-righteous reporting about the hacked tax returns of billionaires.

No, what I’m referring to? The IRS Personal Wealth Study 2016. That study, based on estate tax returns filed for people who died in 2016, appeared in May of 2021. And it provides a fascinating window into the wealth and finances of the top third of the top one percent. So the richest 734,000 people in the country.

Why this Matters

Folks who want to understand mechanically how someone gets really wealthy benefit by digging into the data. So, I’m thinking policy makers, sure. But also voters and citizens. Also maybe parents talking to their kids about jobs and careers?

Small business owners who want to understand how entrepreneurship impacts wealth benefit by looking at the data. Interesting intersections exist, it appears, between wealth building and entrepreneurship.

Finally, those professionals among us who serve these folks benefit from carefully looking through the data and assessing what it means. The accountants, attorneys, investment advisors, bankers and so on.

You’re probably going to want to read the summary reports the IRS published if you find this discussion at all interesting. (I provide links to those at the end of this blog post.) But let me give you an overview of the study and the data it summarizes. And then let me also point to some things that jump out to me.

IRS Personal Wealth Study  2016: An Overview

First, though, a quick overview of how the study works.

The IRS requires estate tax returns be filed when a taxpayer’s death may trigger federal estate taxes. The threshold for when estate taxes kick in changes semi-regularly. But in 2016, any taxpayer dying with an estate in excess of $5.45 million potentially owed federal estate taxes.

Accordingly, in 2016, tax law required the estate of any taxpayer who died with gross assets greater than $5.45 million to file an estate tax tax return. Roughly 14,000 estates filed such a tax return.

The IRS then coupled that estate tax data with mortality information to estimate how many other living taxpayers’ gross assets exceeded $5.45 million. Again, this would be in 2016.

A simplified example to illustrate: If the estates of one percent of 40-year-old males who died had gross estates exceeding $5.45 million? The IRS thinks that one percent of gross estates of 40-year-old males who lived had gross estates exceeding $5.45 million.

Some really interesting statistics drop out of their study. A few morsels of which I’ll point out in the paragraphs that follow.

The Birds-eye View of the Top Third of the Top One Percent

A good place to start? With a birds-eye view of the folks the IRS calls top wealth holders.

The table below gives this snapshot, providing the net worth data and then the number of individuals in a handful of wealth brackets:

Explaining the Table’s Information

For example, that “Under $5.45 million” bracket counts up and calculates the mean net worth for the taxpayers whose gross estates exceeded $5.45 million but whose net worths in the end fell under that threshold (probably due to debts.) As the table shows, 151,529 individuals fall into this bracket. Their mean net worth? Almost $3.7 million.

The next bigger bracket up reports on individuals with net worths of $5.45 million to $10 million. That bracket actually includes more than half of the top wealthholders. Their mean net worth equals slightly over $7.1 million.

The even bigger dollar brackets? Ever bigger net worth numbers. Ever smaller groups.

Two other notes: First, those mean averages run way higher than median averages according to the IRS personal wealth study. While the mean net worth of the top third of the top one percent equals roughly $12.8 million—see that last row in the table—the median net worth of these folks is around $7 million. (Figure C in the IRS Personal Wealth Study 2016 document gives this median information.)

Second, the IRS says the threshold wealth required for an individual to join the top third of the top one percent equals roughly $1.5 million. (Figure E in the IRS Personal Wealth Study 2016 supplies this insight.)

If you and I assume that every individual top wealth holder is married to another individual top wealth holder—which isn’t as farfetched as you might think based on the data—that means in 2016 a household or family needed about $3 million of net worth to join the top third of the top one percent.

And now, let’s dig into the data…

Big Surprise in the Personal Wealth Study

The big surprise the data provides? The IRS says far fewer rich people exist that many think and than the media commonly reports.

For example, you just read the IRS study and data suggest a family or household needs about $3 million to join the top third of the top one percent.

Many economists like Eric Zwick, Emmanuel Saez, Gabriel Zucman as well as the Survey of Consumer Finances sponsored by the Federal Reserve estimate that a family or household needs about $3 to $4 million to join the top one percent. In other words, you commonly hear or read that to join the ranks of the richest 1,250,000 families in the country, you need $3 million to $4 million in net worth.

But the IRS says their data show you can’t possibly have more than about 365,000 households with $3 million or more of net worth. That would be the absolute maximum. And you could have far fewer.

Why the Disagreement?

Why this disparity occurs? It’s complicated. But in the case of the economists mentioned above it appears to boil down partially to the way the economists look at the income the wealthy report on their tax returns. The economists don’t really know how much wealth people possess. So they look at people’s tax return income and then convert (or “capitalize”) that income into wealth.

But then other additinal factors explain why the IRS’s numbers come in so low, too. For one thing, some economists think the wealthy do a good job at moving their wealth out of their estates before they die. (I doubt this—at least for the great majority of wealthy folk—based on how I personally see people plan their estates.) For another thing, the IRS’s approach to extrapolating from estates to the living shows extreme sensitivity to small changes in input–which could mean their formula doesn’t work well.

Where this conflict between economists and the IRS leaves those of us who look at and like the IRS’s statistics? Not sure. But maybe we remind ourselves the IRS data skew much lower than conventional wisdom. And as a result, we maybe need to approach that data with skepticism. But then at the same time, this companion idea: Maybe we also keep in mind the possibility that IRS may be right.

A final further thought about the low IRS numbers: If you do work in a role where you deliver services to the top wealth holders? The IRS personal wealth study probably provides more practical details about how the wealthy work, live and invest.

Which nicely leads to my next point…

The Archetype Multimillionaire According to the IRS

The IRS personal wealth study allows one to describe the archetype multimillionaire by looking at the wealth bracket that includes half of the individuals in the top third of the top one percent.

The table below summarizes some of the key financial bits of information about this bracket.

Again this caution: Those dollar values shown in the table represent arithmetic means. Not medians. The median averages probably run about half or maybe two-thirds of the mean. (The IRS provides some of these values in its very useful summary.)

But ignoring that mean-versus-median wrinkle, the average multimillionaire—so the average person in the top third of the top one percent—possessed about $7.1 million of net worth in 2016. (I guess the average person in the top third of the top one percent probably had a median net worth of a little over $5 million based on the tables shown in the actual IRS personal wealth study.)

About 72 percent of these individual owned their own homes. A very nice home obviously if the mean equals $800,000. (Remember, we are talking 2016 dollars. Also for what it’s worth, I’m guessing that the median home value is probably half the mean average.)

On average, the person held a huge pile of cash. That makes sense given the thing I talk about in the next section.

Seventy percent held a retirement account and these folks enjoyed  a very decent sized retirement account balance: More than $1 million on average.

These people also often held a big, two-million-ish chunk of publicly held stock.

Obviously, these top-third-of-the-top-one-percent-ers have made a way better-than-average living. They also bought a nice house. They probably followed the standard advice to save for retirement.

But in many respects the data suggest they look pretty unremarkable. Except for one thing I’ll discuss next…

Business Ownership Dominates

The big striking feature that appears, at least to this accountant’s eyes, are those business-y assets.

About a third of these folks hold a two-million-dollar chunk of stock in a closely held corporation.

Nearly 40 percent own an investment in a noncorporate entity like a professional services partnership. Or an interest in an S corporation.

A little over 10 percent own an interest in a farm or ranch. Or all of a farm or ranch.

Slightly more than half, 55 percent, possibly own investment property.

You can get an Excel spreadsheet with all the gritty details (see link to IRS statistics page below). But back of the envelope calculations suggest and the Federal Reserve in its survey confirms that a big percentage, around 70 percent, own a business or a part of a business.

The point  here? These people have also often combined good luck with the right skills to own all or part of a successful small business.

Risk and Illiquidity Premiums?

In fact, can I share a hunch? I am pretty sure—no, wait, sorry, let me change that. I am certain that these people have borne significant business and financial risk to join the top third of the top one percent.

People who become business owners do not automatically join the top third of the top one percent. At least ten million small businesses exist in America. Some counts go as high as thirty million small businesses. Only a fraction of these folks end up in the top third of the top one percent, according to the IRS. Like maybe a quarter a million? Or maybe at absolute most half a million?

And so I think what jumps out here are two interesting features of all these business owners in the top third of the top one percent.

First, they’ve gotten lucky in a sense by getting a great long-run return on their high-risk business investment.

And then a second something connected to this, I think. They’ve unfortunately or fortunately been forced to hold and probably add to their business investment over years and years. Maybe over decades and decades.

That combination of a risk premium and a illiquidity premium—in this very best case scenario—delivers a great financial outcome.

Growth in the Ranks of the Wealthy

One final observation, and one I make for the benefit of the accountants, investment advisors, bankers and attorneys who read this blog.

That big bracket that represents the lion’s share of the top third of the top one percent? You know, the bracket showing people with a net worth of $5 to $10 million? Not only do most multimillionaires fall into that category. But that group appears to have grown over time relative to the population.

The IRS talks about that in their study. And I think that means if you provide services to this group—most tax accountants do—your business or professional practice probably should grow too.

By the way, the even higher brackets in the IRS personal wealth study report on people with $10 million to $20 million, $20 to $50 million and over $50 million. But the numbers of individuals in those categories are not growing in relative terms. Those market niches appear more stagnant in terms of real growth.

Which maybe makes sense. Because trees don’t grow to the sky. And because very possibly people move out of alternative assets (like a small business) and into traditional assets (like the publicly traded stocks and then bonds) as their wealth grows. Obviously, those moves may natually produce lower returns. And make it easier to spend.

Other Sources

The IRS’s short summary appears here: Publication 5536: Personal Wealth 2016.

A full analysis appears here: IRS Personal Wealth Study 2016 by Aaron Barnes.

The IRS provides Excel spreadsheets with all the agregated wealth data here.

The many components of the 2019 Survey of Consumer Finances appear here (that survey includes the 2016 numbers mentioned above). The best component to grab and read first is probably this one: Changes in Family Finances 2016 to 2019.

Finally, I want to provide a link to the defense by Professors Saez and Zucman of their wealth estimation methodology. I disagree with their tax-the-wealthy conclusions. And I suspect their methodology inflates their wealth estimates. But they’ve made wonderful contributions to the public debate on this subject. So here are two papers of theirs that address the issues discussed in this blog post. The Rise of Income and Wealth Inequality in America: Evidence from Distributional Macroeconomic Accounts and Wealth Inequality in the United States Since 1913: Evidence from Capitalized Tax Data

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She hasn’t even won her party’s nomination. And even if Senator Warren won the presidency, who knows whether enough moderate Democrats and Republicans would support her proposals.

However, because her wealth tax works so differently from the way income taxes work, and because other presidential candidates are talking “wealth taxes,” I’m going to describe the Warren wealth taxes.

After that, I want to discuss how these taxes impact small business entrepreneurs. Their effect will be seismic.

But this note: This blog isn’t a political news or opinions blog. The blog covers practical tax, business and financial issues.

Accordingly, I’ll describe and discuss how the Warren wealth tax works. Not whether or not the Warren proposals make policy sense…

Warren Wealth Taxes in a Nutshell

Senator Warren proposes three wealth taxes: a tax on all of the folks in the one percent, a tax on people she labels “ultra-millionaires,” and a tax on billionaires.

The One Percent Wealth-triggered Income Tax

The highest impact wealth tax proposed by Senator Warren is actually an income tax triggered by someone enjoying top one percent wealth.

That wealth-triggered tax works like this. If a taxpayer’s wealth puts them into the top one percent of the population, the taxpayer must use “mark-to-market” accounting and thereby pay income taxes on investment gains when the gains occur rather than when an investment gets sold.

Further, these top one percent taxpayers don’t use the capital gains tax rates (so maybe 0% but usually 15% or 20%) that people outside the top one percent use. Rather, they use ordinary income tax rates (so probably 40%-ish.)

Example 1: A top one percent taxpayer named George owns a small business. If it increases in value by $1,000.000, he owes income taxes on the $1,000,000 of “appreciation.” Probably the tax rate runs about 40 percent the way the Senator’s math works. So about $400,000 in taxes.

You can compare this to the situation someone outside the top one percent encounters for better understanding.

Example 2: George’s friend Martha also owns a small business that increases in value by $1,000,000. Martha doesn’t pay taxes on this increase in value however if she’s not part of the one percent. She will probably pay a 20% capital gains tax, so roughly $200,000, if she later sells the business.

A couple of wrinkles to note about the one percent tax.

The first wrinkle: Retirement accounts count toward net worth, but the mark-to-market accounting doesn’t apply to retirement accounts.

Example 3: George from example 1 also holds $2 million in his 401(k) plan. And that $2 million counts toward his net worth. But fluctuations in the 401(k) account balance don’t trigger mark-to-market accounting or taxes.

The second wrinkle: The mark-to-market accounting lets taxpayers carry losses forward though unfortunately not backward.

Example 4: George from examples 1 and 3 sees his small business lose money in year 2 and its value shrink by $1,000,000. That $1,000,000 mark-to-market loss in year two has no “retroactive” impact on year 1. George paid wealth-triggered income taxes on income he never actually realized. Should George someday rejoin the top one percent, however, he can use the $1,000,000 loss to shelter future mark-to-market gains.

Who Falls into the Top One Percent?

Simple math says about 1.7 million taxpayers fall into the top one percent.

But some disagreement exists about the wealth threshold that determines one percent status.

In the Senator’s discussions, I’ve been unable to find a specific dollar amount that triggers the mark to market requirement.

But the two economists advising Warren on the wealth tax, Emmanuel Saez and Gabriel Zucman, have written a lot about wealth. And in a relatively recent 2014 paper (see here) they pegged the threshold to one percent status at about $4 million. That sounds about right to me.

The Ultra-Millionaire Tax

Senator Warren labels top one percent taxpayers with $50 million or more in wealth “ultra millionaires.”

And she proposes levying an additional two percent wealth tax on the wealth in excess of $50 million that these folks hold.

Example 5: Abigail enjoys a net worth equal to $60 million, so $10 million in excess of the $50 million threshold. She therefore pays a two percent tax on that $10 million, or $200,000.

A note: Abigail as a member of the “top one percent” also uses the mark-to-market accounting rules and pays income taxes on asset appreciation.

The Billionaire Tax

Taxpayers with more than $1 billion in wealth pay the 2 percent ultra-millionaire tax on $950 million (so the wealth they hold in excess of $50 million but less than $1 billion). And then they pay a six percent wealth tax on the wealth they hold in excess of $1 billion.

Just to clear up a point of possible confusion: The six percent wealth tax actually combines two three percent wealth taxes. One three percent tax proposed in early 2019 (see here) to reduce wealth inequality, and then a second three percent tax proposed in late 2019 (see here) to pay for part of the Senator’s Medicare for All proposal.

But mechanically, the billionaire tax works pretty simply.

Example 6: Thomas enjoys a net worth equal to $2 billion. Under the Warren wealth tax proposals, therefore, he pays a two percent tax on $950 million and then a six percent tax on the second $1 billion. His total wealth tax equals $79,000,000.

Again, billionaires also pay the one percent wealth-triggered tax due to mark-to-market accounting rules. Obviously, a billionaire falls within the top one percent.

Grossing Up the Ultra-millionaire and Billionaire Wealth Taxes

One other note about the two percent and six percent wealth taxes.

If taxpayers subject to the two percent and six percent wealth taxes need to sell appreciated assets (like stock in Microsoft, Facebook, Amazon, Google, or Berkshire Hathaway) to actually pay the wealth taxes, that taxable sale amplifies the tax burden.

I mention this point because some of the early commentary seems to miss this subtlety.

Example 7: Thomas from example 6 sells founders stock to pay the $79 million of wealth tax he owes. He pays a combined federal and state income tax rate of 50 percent on the sale proceeds, however. As a result, he sells $158,000,000 of stock. He uses one half of the money to pay the income taxes he owes. He uses the other half to pay the wealth taxes he owes.

Note: I think the best way to model the impact of wealth taxes on “safe withdrawal rates” or “sustainable spend rates” is to treat the grossed up wealth taxes like an “asset  under management” fee. Which is an entirely different issue, so I won’t fall down that rabbit hole.

Assessing the Wealth Tax Impact on Small Business Entrepreneurs

Okay, so now let’s talk about how the Warren wealth taxes impact small business entrepreneurs. I spot three issues many small business owners and investors need to consider.

Don’t worry. I’ll make this quick…

Issue #1: One Percent Wealth-triggered Tax Impacts Big Group

A first issue for small business owners to consider: A really big group of business owners will feel the impact of the one percent mark-to-market accounting rules.

Obviously, the top one percent itself includes 1.7 million taxpayers.

But any business owner approaching one percent status needs to plan for and probably file wealth-tax related returns. These folks won’t actually know whether they owe taxes or not unless they “do the math.” Small business entrepreneurs close to one percent status may even want to file wealth-tax returns simply to document they don’t owe wealth taxes.

Further, even a small business owner outside the top one percent may need to deal with the mark-to-market complexity if the business owner “partners” in some venture with someone who is inside the top one percent. Or someone who is approaching the one percent classification.

Finally, the carry forward accounting the mark-to-market rules envision mean a former member of the top one percent may need to continue preparing wealth-tax returns to get tax refunds. (Peek back at example 4 to see a situation where this occurs.)

In short, the one percent wealth-triggered taxes surely hit millions of small businesses. Sometimes with actual taxes. Sometimes just with the cost of the red tape.

Issue #2: Wealth and Wealth-triggered Taxes Create Liquidity Puzzles

The Warren wealth taxes, and especially the wealth-triggered taxes that stem from the mark-to-market accounting rules, also create a puzzle.

That puzzle? Where affected taxpayers get the actual cash to pay the wealth tax.

Example 8: Sixty-year-old James owns a $1 million dollar home, holds nearly $2 million in his retirement account, and then owns a small hardware store worth $1 million and generating $150,000 in annual profits. If the store profits double to $300,000 and the store value to $2 million, James books $1,000,000 of mark-to-market income and owes $400,000 in wealth-triggered income taxes. James also owes regular income taxes on the $300,000 of income. As a guess, maybe around $75,000? So, on $300,000 of cash profits, he owes perhaps $475,000 of tax?

That level of taxation creates a really tricky situation for the small business entrepreneur.

The Warren wealth tax plan allows taxpayers to pay the wealth taxes and presumably wealth-triggered taxes over five years, charging them interest on the “loan” from the government. Further, the Senator’s plan says the IRS will also be able to write appropriate rules to deal with extreme situations where a taxpayer simply lacks the liquidity to pay the wealth tax. But this all seems pretty dicey. Especially given Warren’s plan doesn’t allow for carrying back market-to-market losses. (Again, see example 4 earlier.)

Remember, too, the small business entrepreneur needs business profits not just to pay taxes but to pay his or her own family living expenses (housing, groceries and so forth) and to grow the business (additional inventory, fixtures and equipment, cash, and so on.)

The upshot of all this? The Warren wealth taxes require a business owner and his or his professional advisers to carefully plan for new giant tax liabilities.

One last comment, just to be fair to the economists who’ve advised Warren, apparently, on this wealth tax stuff. Saez and Zucman, in a 2019 research paper (available here) warn about this exact issue, saying “Taxing capital gains on accrual means a heavy tax on entrepreneurs growing a successful business and building up wealth.” They also warn in the same paper “Taxing capital gains on accrual means capricious taxation based on the ups and downs of volatile financial markets.”

Issue #3: Heavy Compliance Costs and Burden

One final issue to mention…

The work of annually valuing the odds and ends that make up the typical one percent taxpayer’s net worth? And then calculating the taxes? Gosh, that effort will prove costly and time-consuming.

The work and costs will start with the accounting and record keeping performed by taxpayers, their business advisers, and their small business’s employees. Most small businesses will need to do more and better bookkeeping.

Then, after that preparation, taxpayers will shoulder additional costs for real estate appraisers, business valuation experts and then specialists required for valuing things like a boat, car or household items.

Finally, after the returns get filed? The various wealth tax proposals all suggest heavy auditing of wealth tax returns in the early years. That back-end cost will be expensive.

The bottom-line here? Affected taxpayers, their accountants and also the IRS need to plan for a massive increase in their workloads due to preparing tax returns that include both income and wealth taxes.

And then this sidebar comment. The oft-quoted-by-Warren economists, Saez and Zucman, say the valuation work should be easy. Apparently based on the notion that small businesses can be valued “by using simple formulas” employing data the IRS already collects. This assertion of simplicity is awkwardly incorrect, as any tax accountant or IRS auditor working with small businesses knows. And for a variety of reasons including the fact that small business tax returns usually don’t include Schedule L (a balance sheet) and often use cash basis accounting.

Two Thoughts to Close

A couple of thoughts to wrap up this discussion. First, I don’t think people potentially affected by these proposals do anything yet except to stay alert to the discussion.

No, no, I agree wealth taxes will impact targeted taxpayers massively. But over-reactions like renouncing citizenship and moving to some other country? Or getting divorced for tax reasons? Or quitting work and moving to the mountains in Colorado, a la Ayn Rand? At the very least, that sort of talk seems premature.

Here’s my second thought. If Congress enacts wealth taxes, those wealth taxes will require a massive rethinking of both small business entrepreneurs’ business plans and affected taxpayers’ retirement plans.

The mark-to-market rules surely impact firms growing with reinvested profits, for example. Further, these wealth taxes surely dramatically dampen “safe withdrawal” and “sustainable spend” rates.

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