Washington state’s estate tax hits only a small percentage of the state’s decedents. (The threshold for paying tax is $3,000,000, and though the data is scarce, it looks like less than one percent of estates trip over this amount.) But when taxpayer estates do the pay the tax? Ouch. Rates start at 20%. And rise […] The post The Washington Estate Tax Income in Respect of Decedent Problem appeared first on Evergreen Small Business.
Washington state’s estate tax hits only a small percentage of the state’s decedents. (The threshold for paying tax is $3,000,000, and though the data is scarce, it looks like less than one percent of estates trip over this amount.)
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? Essentially, the state estate tax formula forgets about the income taxes.
Example: A Washington state decedent’s estate includes $10,000,000 of IRD and is subject to the top 35% Washington state estate tax. (This tax rate might be the case for a single person’s estate equal to or larger than $22,000,000 in 2025.) That tax then equals $3,500,000. The $10,000,000 of IRD is also subject to a 37% federal income and 3.8% net investment income tax. Those rates total 40.8% which means another $4,080,000 of federal income taxes.
In the end, the combined state estate and federal income taxes equal 75.8% of the $10,000,000. So roughly a 76% tax.
How Federal Estate Taxes Handle IRD and State Estate Taxes
The tax situation gets worse if the decedent’s estate pays federal estate taxes because the estate exceeds the basic exclusion amount ($15,000,000 in 2026). The cumulative estate and income taxes essentially zero out the IRD amounts in a worst case scenario.
Example: A Washington decedent’s estate includes $10,000,000 of IRD subject to Washington state’s 35% estate tax. That results in a $3.500,000 state estate tax. That leaves $6,500,000. The 40% federal estate tax hits $6,500,000 resulting in another $2,600,000 of federal estate taxes. That leaves $3,900,000. The 40.8% federal income taxes “tax” the $7,400,000 left over from the $10,000,000 of IRD after paying the $2,600,000 federal estate tax. That results in $3,100,800 of income taxes. In the end, taxes total $9,200,800 on $10,000,000 of IRD. So more than 92%.
And believe it or not, the situation can in a handful of situations get even worse. There is a nightmare scenario.
The Nightmare Scenario IRD Problem
Here’s the nightmare scenario: A decedent with IRD that the estate or beneficiaries won’t collect for many years.
For example, suppose an estate includes $10,000,000 of IRD but that that money isn’t yet available. Perhaps the money represents some windfall with a multi-decade payout. A lottery annuity, for example. A Washington estate might owe estate taxes today it will not have the money to pay for years. That would mean that as the lottery pays out, federal income taxes, estate taxes and then penalties and interest eat up all the IRD plus part of the non-IRD estate.
Example: The Washington decedent with $10,000,000 of IRD has that money because she won a $1,000,000 a year lottery. At death, 15 years of $1,000,000 payments remained which the estate tax return and Washington state valued at $10,000,000. The estate owes $3,500,000 in Washington estate tax on that IRD. Because the estate can’t even begin to pay until a year later when the next payment appears, penalties and interest will be calculated. When the estate receives the $1,000,000 lottery payment, roughly $400,000 goes to pay the federal income taxes and nearly $300,000 may go to pay the penalties and interest. Only about $300,000 goes to pay the actual $3,500,000 estate tax liability. Because taxes, penalties and interest eat up most of the annual lottery payment, the estate will take years to pay off the estate tax bill if it even can.
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.
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