The Washington state estate tax affects only a small percentage of the state’s decedents. (The threshold for paying taxes is $3,000,000, and although data is sparse, it appears that less than one percent of estates exceed this amount.)
But when do taxpayers’ estates pay the tax? Oh. Rates start at 20%. And it will eventually increase to 35%.
Also, as bad as it may seem to have your estate or the estate of someone in your family paying this tax? The situation can be much worse because of the way “decedent income” is taxed.
The problem in a nutshell: State estate taxes can fully tax “pre-tax” income with respect to a decedent.
What is income in respect of a deceased person?
Good and important question. And one we can best answer with a simple example. The most common form of income with respect to a deceased person is wages that someone earned but had not yet received when they died. That income has not yet been subject to income taxes. Therefore, federal tax laws tax it.
Example: Someone dies with $10,000 in accumulated wages. Wages paid after death represent income with respect to a decedent. The estate or heirs pay the income taxes that 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 can tax the full $10,000.
Now a single payroll? probably not that big deal. A family that has just lost a breadwinner has much bigger problems and worries. And most estates do not pay Washington state estate tax.
But if an estate pays Washington state estate taxes, the IRD issue becomes important. And here’s why.
IRD includes a lot of things. Includes most retirement account balances, such as traditional deductible IRAs, 401(k), 403(b), and 457(b), and cash balance retirement plans. The IRD includes some of the common stock compensation income provided to employees of technology companies, including non-qualified stock options, restricted stock units, restricted stock awards, and then other deferred compensation or stock deferral plans. The IRD may also include large windfalls (lottery winnings, royalties from songwriters and authors, and whistleblower awards from the SEC and IRS) that will not be collected until years or decades after estate taxes are due. (More on this in a few paragraphs).
How Washington State Handles IRD
The problem here? Essentially, the state estate tax formula forgets about income taxes.
Example: A Washington State decedent’s estate includes $10,000,000 IRD and is subject to Washington State’s top 35% estate tax. (This tax rate could apply to a single person’s estate equal to or greater than $22,000,000 in 2025.) That tax is then equivalent to $3,500,000. The $10,000,000 IRD is also subject to a 37% federal income tax and a 3.8% net investment income tax. Those rates total 40.8%, which means another $4,080,000 in federal income taxes.
In the end, the combined federal and state income taxes equal 75.8% of the $10,000,000. That is, approximately a 76% tax.
How Federal Estate Taxes Handle IRD and State Estate Taxes
The tax situation worsens if the decedent’s estate pays federal estate taxes because the estate exceeds the base exclusion amount ($15,000,000 in 2026). Cumulative wealth and income taxes essentially reduce IRD amounts to zero in the worst case scenario.
Example: The estate of a Washington decedent includes $10,000,000 of IRD subject to Washington State’s 35% estate tax. That results in a state estate tax of $3,500,000. That leaves $6,500,000. The 40% federal estate tax reaches $6,500,000, resulting in another $2,600,000 of federal estate taxes. That leaves $3,900,000. The 40.8% federal income tax “taxes” the $7,400,000 left over from the $10,000,000 IRD after paying the federal estate tax of $2,600,000. That works out to $3,100,800 in income taxes. In the end, the taxes amount to $9,200,800 on $10,000,000 of IRD. So more than 92%.
And believe it or not, the situation can get even worse in some situations. There is a nightmare scenario.
The Nightmare Scenario IRD Problem
This is the nightmare scenario: a decedent with IRD that the estate or beneficiaries will not collect for many years.
For example, let’s say an estate includes $10,000,000 of IRD but that money is not yet available. Perhaps the money represents a windfall with a payout spanning several decades. A lottery annuity, for example. A Washington estate could owe estate taxes today and won’t have the money to pay them for years. That would mean that as the lottery pays out, federal income taxes, estate taxes, and then penalties and interest will eat up all of the IRD plus some of the non-IRD estate.
Example: The deceased from Washington with $10,000,000 in IRD has that money because she won a lottery of $1,000,000 a year. At his death, there remained 15 years of $1,000,000 payments that the estate and Washington state tax returns valued at $10,000,000. The estate owes $3,500,000 in Washington estate taxes on that IRD. Because property cannoteven start pay up to one year later when the next payment appears, penalties and interest will be calculated. When the estate receives the $1,000,000 lottery payment, approximately $400,000 goes toward paying federal income taxes and almost $300,000 can go toward paying penalties and interest. Only about $300,000 goes toward paying the actual estate tax liability of $3,500,000. Because taxes, penalties and interest consume most of the annual lottery payment, it will take years for the estate to pay the estate tax bill, if it can at all.
Some quick final comments
What do you do about it? You’ve already taken the first step (maybe), which is to recognize the potential size of the problem if your estate includes a substantial IRD.
As for remedies or palliative measures? The first step is probably to consult with a good estate planner. All of the usual federal estate planning techniques and methods are likely to be accelerated when discussing IRDs potentially subject to Washington State estate tax. (Here’s an introduction to the basic techniques: Washington State Estate Tax Planning Techniques. But if you are potentially taxed on a large amount of IRD? You’ll also want to look at the more sophisticated techniques available.)
So, three final comments and ideas to discuss with your lawyer or accountant.
First, an interesting feature of Washington’s estate tax regime is that the state No tax donations. Therefore, while a large gift to heirs may trigger federal gift taxes or exhaust the federal basic exclusion amount, such gifts generally do not trigger additional Washington state estate taxes.
Note: Starting in 2026, you can give up to $15,000,000 without triggering gift taxes. Married? The amount doubles: you and your spouse can donate up to $30,000,000 together.
Second, I’m usually not a big fan of Roth accounts. (See a list of all the blog posts discussing why here.) But paying taxes now to convert a large $10,000,000 tax-deferred IRA (and IRD) into a smaller but equivalent after-tax Roth account of $5,900,200 (non-IRD)? This often makes sense if you save Washington state estate taxes. If you convert a $10,000,000 traditional IRA and avoid the top estate tax rate, for example, the tax savings equals approximately $1.6 million.
And then thirdly, the other obvious option to at least consider: someone with a lot of IRD in their assets might want to consider changing their domicile.
Additional Resources
Need more general information about the new state estate tax? Check out this blog post: Planning for Washington State’s New 35% 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.
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