There is substantial confusion and some blatant misinformation about how the Millionaires Tax would apply to pass-through entities and small businesses. Let’s take a clear-eyed look at how these are treated in the proposed legislation.
Before doing so, it is important to first note that the proposed Millionaires Tax:
- Will affect less than 1% of Washington households;
- Is a tax on personal income, not business income; and
- Provides the most substantial small business tax break in Washington state history by doubling the Business and Occupation (B&O) tax credit and increasing the B&O tax return filing threshold to $250,000.
What are pass-through entities, and how are they taxed?
Most businesses in Washington state are pass-through entities, meaning that business profits “pass through” to owners as income. This category includes sole proprietorships, partnerships, limited liability companies (LLC’s), and S-corporations.
Pass-through entities can include farms, restaurants, consulting firms, law firms, real estate developers, or general contractors. These businesses are not subject to the federal corporate income tax(opens in new tab) because they are not C-corporations. Instead, profit from Washington’s pass-through entities is taxed under the federal individual income tax.
What taxes do pass-through entities pay at the federal level?
At the federal level, partners, owners, or sole proprietors of pass-through entities are only taxed on their profits. The profit (or net income) of a pass-through entity or business equals gross income minus allowable business expenses(opens in new tab). Allowable business expenses include operating costs, salaries, rent, supplies, and large-scale equipment purchases under Section 179(opens in new tab). Additionally, partners and shareholders may qualify for the Section 199A qualified business income (QBI) deduction(opens in new tab) (up to 20% of QBI, subject to income and wage limitations), further reducing their taxable income.
What taxes do pass-through entities pay in Washington state?
Washington does not currently have an income tax, so profit from pass-through entities is not taxed as personal income at the state level. Pass-through businesses, like all other businesses, are subject to the state’s Business & Occupation (B&O) tax on their gross receipts. The tax rate depends on how each business is classified(opens in new tab), ranging from 0.138% for specific manufacturing activities like wheat processing to 2.1% for services and other activities generating at least $5 million in revenue in the prior year.
How will the proposed Millionaires Tax interact with pass-through entity taxation?
The vast majority of small businesses and pass-through entities in Washington state will not be affected by the Millionaires Tax. Washington’s Millionaires Tax uses the federal adjusted gross income as a starting point to calculate total taxes owed (Section 301(opens in new tab)). Any deductions (including allowable business expenses) carried forward from the federal level are carried over into Washington’s taxable income, apart from certain federal capital gains (including property), which are not taxed in Washington state.
After federal deductions and expenses are removed, if a partner or shareholder does make a profit over $1 million, there are multiple safeguards in the Millionaires Tax legislation to prevent double taxation:
- Section 204(opens in new tab) provides a 100% credit for state B&O taxes paid on the gross receipts of pass-through businesses. For example: a sole proprietorship makes $1,150,500 in profit and pays $25,000 in B&O taxes. The $15,000 that would otherwise be owed for the Millionaires Tax is more than offset by the $25,000 credit for B&O taxes already paid. This business owner would pay $0 in Millionaires Tax.
- Section 205(opens in new tab) provides a 100% tax credit for Washington state capital gains taxes. Like the B&O tax credit, if a household would otherwise owe $10,000 for the Millionaires Tax, but has paid $10,000 in state capital gains tax, they would pay $0.
- Section 502(opens in new tab) allows pass-through entities to elect to pay the Millionaires Tax at the entity level. If they choose to do so, they can deduct those taxes as a business expense when filing federal taxes (up to $40,000(opens in new tab)) in 2025, thereby decreasing federally taxable income.
The following scenarios illustrate how state taxes would be paid by sample pass-through entities in Washington with the same amount of total gross receipts under the Millionaires Tax:
Scenario 1: Family-Owned Restaurant
Gross receipts: $5,000,000
Deductible expenses (payroll, food, rent, equipment, etc.): $4,850,000
Net operating profit: $150,000
Estimated QBI deduction: $30,000 (20% of net operating profit)
Additional capital gains: None
Wage base for Millionaires Tax: $120,000
The restaurant deducts all ordinary and necessary business expenses before calculating profit. This business is also eligible for the QBI deduction, so the owner reports $120,000 in pass-through income.
| B&O tax = $23,550
Subject to the 0.47% retail rate $5,000,000 × 0.47% = $23,550 | WA Capital Gains Tax = $0
Does not apply | Millionaires Tax = $0 Does not apply (taxable income below $1M threshold) |
Scenario 2: High-Margin Consulting Firm
Gross receipts: $5,000,000
Deductible expenses (payroll, rent, travel, admin): $2,000,000
Net operating profit: $2,900,000
Additional capital gains (stock sale): $500,000
Wage base for Millionaires Tax: $3,500,000
After deducting expenses, the owner reports $3.5 million in income. As a consulting firm (a specified service trade or business), the owner is not eligible for the federal QBI deduction at this income level.
Credits and safeguards:
- 100% credit for B&O taxes paid
- 100% credit for Washington capital gains taxes paid
- Option to elect entity-level payment and deduct up to $40,000 federally
| B&O tax = $105,000
Subject to 2.1% service rate: $5,000,000 × 2.1% = $105,000 | WA Capital Gains Tax = $15,540 7% on gains above $278,000 = $15,540 | Millionaires Tax = $127,050
Tax on income above $1M: ($3,500,000 − $1,000,000) × 9.9% = $247,500; minus B&O and cap gains =$127,050 |
Scenario 3: Multi-Generation Wheat Farm
Gross receipts: $5,000,000
Deductible expenses (equipment, labor, inputs, depreciation): $4,600,000
Net operating profit: $400,000
Land sale gain: $800,000
Estimated QBI deduction: $80,000 (20% of net operating profit, not including land sale)
Total economic income: $1,200,000
Wage base for Millionaires Tax: $320,000
| B&O tax = $0 Farmers are exempt from B&O tax(opens in new tab) on wholesale sales of agricultural products they grow or produce. | WA Capital Gains Tax = $0 Capital gains from the sale of real estate are excluded under the capital gains tax. | Millionaires Tax = $0 Does not apply (taxable income of $320K is below $1M threshold and does not include capital gains from the sale of real estate). |
This historic bill is the first step in fixing Washington’s upside-down tax code, the second most regressive tax code in the country. We know what makes our economy strong and life more affordable for everyday Washingtonians: fully funded education, health care, and social services; and a robust network of small businesses that work to keep wealth in the communities they are a part of.