Washington State vs. Federal Estate Tax

Posted August 12, 2025, By Cole Ferrier

You might be wondering what a financial planner, who isn't an attorney, has to do with estate planning. It's a fair question, and the answer gets to the heart of what a comprehensive financial plan should accomplish. While I am not an attorney and cannot draft legal documents, my role is to work with my clients to help them understand their goals and talk through their options. We model different scenarios and clarify what they truly want to achieve for their family and their legacy.

This process empowers my clients. When they eventually meet with their estate planning attorney, they can explain precisely what they want and why. They aren't just showing up to receive a standard set of documents; they are active participants in designing their own plan. Furthermore, an attorney needs a complete picture of a client's financial situation to provide the best advice. By sharing relevant sections of the financial plan we've already built, we can streamline that process, making the collaboration with the legal expert more efficient and effective.

With that role clarified, let's dive into one of the most critical, and often misunderstood, areas of planning for Washington residents. A foundational principle of financial planning is using the right tool for the right job—you wouldn't use a screwdriver to hammer a nail. In estate planning, however, I see Washington residents making this exact mistake all the time. They apply a federal playbook to a state-level problem because they used generic documents, resulting in an inefficient plan that leaves a significant amount of money on the table—money that should have gone to their families but instead ends up with the state treasury.

The problem arises from a fundamental misunderstanding of key structural differences between the two systems. The federal government operates a unified gift and estate tax system with portability for married couples. Washington State has an estate tax with no gift tax and no portability.

These aren't minor details; they are structural differences that change the entire game. Failing to grasp these distinctions is a critical bug in your financial operating system. Let's debug this issue, deconstruct the two systems, and build a playbook specifically designed for the unique rules Washington residents must navigate.

The Federal System: One Big, Unified, and Portable Bucket

Think of the federal estate tax system as one giant bucket. As of the passing of the One Big Beautiful Bill, this bucket holds $15 million per person starting in 2026 (this number is indexed to inflation). This is your lifetime gift and estate tax exemption. Every significant gift you make during your life and all the assets you leave behind at death are drawn from this same, single bucket.

For married couples, the federal system has a powerful feature called portability. If the first spouse to die doesn't use their entire exemption, the surviving spouse can "port" the unused portion over and add it to their own. This effectively allows a couple to easily combine their exemptions, sheltering over $30 million from federal tax without complex planning.

The critical takeaway is that under the federal rules, large gifts reduce your exemption, but for married couples, any unused exemption from the first spouse to die is not lost as long as an estate tax return is properly filed.

The Washington System: A Separate, Urgent, and Unforgiving Problem

Now, let's turn to Washington. Our state presents a very different challenge.

First, the exemption is dramatically lower: $3 million per person as of 2025.

Second, the tax rates are steep, climbing to 35% on the portion of a taxable estate over $9 million. This makes the Washington estate tax a much more immediate concern for a far greater number of families.

But here is where the playbook truly diverges, creating two major issues for the unprepared.

The Portability Trap: A Critical Flaw for Married Couples

Washington State does not have portability. This is a crucial, and often costly, distinction. Each spouse has a $3 million exemption. If that exemption is not used when the first spouse dies, it is lost forever. It does not transfer to the surviving spouse.

Many couples have simple "I love you" wills, where all assets pass directly to the surviving spouse. While simple and intuitive, this approach is a tax trap in Washington. By leaving everything to the survivor, the couple effectively wastes the first spouse's $3 million exemption.

Let's see this in action with a married couple who has a combined estate of $6 million:

• Scenario A (The Trap): The husband dies first and leaves his entire $3 million share of the estate to his wife. Because transfers between spouses are unlimited, no tax is due at this time. However, his $3 million Washington exemption vanishes, unused. Years later, the wife dies with a $6 million estate but only her own $3 million exemption. Her estate will owe Washington estate tax on the unprotected $3 million.

• Scenario B (The Solution): The husband dies first. His will directs $3 million of his assets into a trust (often called a Credit Shelter or Bypass Trust). This uses his $3 million exemption. The trust can be structured to provide for his wife for the rest of her life. When the wife later dies, her own estate is only worth $3 million, which is fully covered by her own exemption. The total Washington estate tax due is $0.

By using a trust to "capture" the first spouse's exemption, the couple avoids a significant tax bill. This is not a loophole; it is a way to navigate Washington's non-portable system.

The Trade-Off: Estate Tax vs. Capital Gains Tax

However, this elegant solution introduces a new, critical trade-off. The assets placed in that Credit Shelter Trust, while protected from the estate tax, come with a hidden cost: they do not get a second step-up in basis when the surviving spouse dies.

"Step-up in basis" is a tax rule that adjusts the cost basis of an inherited asset to its fair market value at the date of the owner's death. This is incredibly valuable because it can wipe out decades of taxable capital gains.

Let's break down the trade-off:

• Assets Inherited Outright: When the husband dies, the wife inherits his half of their stock portfolio. Those shares get a step-up in basis to their value on his date of death. When the wife dies years later, those same shares get a second step-up in basis to their value on her date of death. This means the heirs inherit the stock with a cost basis equal to its current market value, erasing all capital gains that accrued during the wife's lifetime.

• Assets in a Trust: The assets the husband places in the Credit Shelter Trust also get a step-up in basis at his death. However, because the trust (not the wife) technically owns these assets, they are not part of the wife's estate when she dies. Therefore, they do not receive a second step-up. The heirs will inherit the assets from the trust with the same cost basis from when the husband died, potentially leaving them with a large, embedded capital gains tax bill.

This creates a classic planning dilemma: do you use a trust to avoid a definite estate tax now, at the cost of creating a potential capital gains tax for your heirs later? The answer is to not choose one or the other, but to plan for both. This is where asset location becomes a crucial strategy. You can work with your advisor to carefully select which assets fund the trust and what investments are held in the trust and which ones are held outright.

The Gifting Superpower

The second major difference is the rule that changes the rest of the playbook: Washington has no gift tax.

This means you can give away unlimited amounts of money during your lifetime without it ever affecting your $3 million state estate tax exemption. The state doesn't have a "unified bucket." It only looks at the assets you own on the day you die. This creates a powerful, straightforward, and often underutilized planning opportunity.

The Washington Playbook: A Multi-Tool Approach

For married couples with an estate over the combined $6 million threshold, the first step is often using trusts—funded with carefully selected assets—to preserve both exemptions. For individuals or couples who have done that and still face a tax liability, the next tool is a systematic, long-term gifting strategy.

Because lifetime gifts are not taxed and do not reduce your state exemption, you can methodically transfer wealth to your heirs while you are alive, ensuring your estate falls below the taxable threshold upon your death.

A Case Study in State-Specific Planning:

Let's reconsider our married couple with an $8 million estate. They have already set up trusts to ensure they can use both of their $3 million exemptions. Their combined $6 million exemption would still leave $2 million exposed to Washington estate tax.

Here’s how they add gifting to their playbook:

1. The Goal: Reduce the total estate from $8 million to $6 million to align with their combined exemption.

2. The Strategy: Over a period of several years, the couple decides to gift a total of $2 million to their children.

3. The Execution: They gift $400,000 per year for five years.

4. The Result: At the end of five years, their estate is now valued at $6 million. When they pass away, their estate can be fully sheltered by their trusts, which captured their combined $6 million exemption.

The Washington Estate Tax due is now $0.

By combining trust planning with a disciplined gifting strategy, this couple saved their family a massive tax bill.

Conclusion: Stop Playing by the Wrong Rules

Your financial plan should be an elegant, efficient machine built with tools perfectly suited for the job at hand. For Washington residents, this means recognizing that a federally-focused estate plan is the wrong tool. It’s like trying to run Windows software on a Mac—it’s simply not compatible with the operating system.

The good news is that Washington's system, while unforgiving to the unprepared, offers a clear and powerful path for those who understand its logic. For married couples, using trusts to preserve both state exemptions is the foundational first step. However, this must be done with careful consideration of the trade-off between estate taxes and future capital gains taxes. From there, the ability to make unlimited lifetime gifts is a planning superpower.

Don't let a misunderstanding of these two separate systems lead to a costly, avoidable error. Review your estate plan, understand the specific rules you are playing by, and make sure your strategy is built for the reality of Washington State.

Take Action Today

An outdated or mismatched estate plan is not a neutral document; it's a liability. If your plan hasn't been reviewed through the specific lens of Washington State's tax laws, you could be leaving your family's inheritance exposed.

If you are ready to build a playbook that is optimized for your unique situation and the state you call home, please reach out. Let's work together, with your estate attorney, to ensure your financial plan is as clear, simple, and effective as it can be.

Contact us today for a consultation.

Resources:

• Washington State Department of Revenue - Estate Tax: https://dor.wa.gov/taxes-rates/other-taxes/estate-tax

• Engrossed Substitute Senate Bill (ESSB) 5813 (2025 Changes): https://app.leg.wa.gov/billsummary?BillNumber=5813&Year=2025