Washington State Legislature Introduces Bill to Expand Capital Gains Tax to Qualified Small Business Stock

The Washington State Legislature has recently introduced Senate Bill 6229 (and complementary House Bill 2292), which would impose the State’s capital gains tax to gains realized from the sale of Qualified Small Business Stock (QSBS). Federal tax law provides substantial incentives to encourage investment in startup C corporations. These benefits are often referred to as the Internal Revenue Code 1202 exclusion or the QSBS exclusion. The specifics of the QSBS tax benefits are beyond the scope of this client alert. However, at a high level, most investors can exclude up to $10 million of capital gains if they hold their QSBS for three years and can exclude up to $15 million of gains if they hold their QSBS for five years. (These numbers reflect changes made to the One Big Beautiful Bill (OBBBA) last summer.)  

Reasonable minds can debate the merits of this policy, but there is no question that it is popular with many investors. Because Washington State has historically looked to federal tax law for purposes of determining the base on which Washington State will impose its 7.0–9.9% capital gains tax, QSBS gains have also been exempt in the State. In other words, because QSBS gains were exempt from federal capital gains tax, they were excluded from the measure of tax for Washington State’s capital gains tax.

Senate Bill 6229 would modify state law by requiring taxpayers to add back any gains or losses from the sale or exchange of QSBS when calculating Washington State’s 7.0–9.9% capital gains tax. A hearing was held January 27 in which startup founders and venture capitalists testified against the bill’s implementation. Geekwire published a summary of this testimony. If Senate Bill 6229 is passed into law, it would constitute an additional measure to address the state budget shortfall by imposing a tax that would only apply to certain higher-income Washingtonians.

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