Washington state taxes the estates of high-net-worth residents and high-net-worth nonresidents who own property in the state. The tax rates start at 10 percent and rise as high as 35 percent. Thus, estate tax amounts quickly get large.
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:
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 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: Geroge 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 () 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 legislative 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.
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