Faced with a projected $16 billion deficit over the next four years, Washington Governor Bob Ferguson formally signed into law on May 20, 2025, a $78 billion 2025-2027 state biennial operating budget and a final tax package that is projected to generate $9 billion over the next four years.
The new tax package includes dramatic changes to the Business and Occupation (B&O) Tax, Retail Sales Tax, Capital Gains Tax, and Estate Tax, as described in more detail below.
B&O Tax (Engrossed Substitute House Bill 2081)
Modifying business and occupation tax surcharges, rates, and the advanced computing surcharge cap, clarifying the business and occupation tax deduction for certain investments, and creating a temporary business and occupation tax surcharge on large companies.
This bill includes B&O tax rate increases, surcharge increases, and the introduction of a new surcharge. Beginning January 1, 2027, the B&O tax rate for the retailing classification will increase from 0.471 to 0.5% of gross receipts, while the rates for the manufacturing and wholesaling classifications will increase from 0.484 to 0.5% of gross receipts. Other categories will also see rate increases. Beginning October 1, 2025, the B&O tax rate for the services and other activities category with gross income of over $5 million will increase from 1.75 to 2.1%.
The B&O surcharge on specified financial institutions will increase from 1.2 to 1.5% beginning October 1, 2025, a “specified financial institution” is a member of a consolidated financial institution group that reported an annual net income of at least $1 billion on its consolidated financial statement for the previous year, not including net income attributable to noncontrolling interests.
Additionally, the B&O surcharge for select advanced computing businesses will increase from 1.22 to 7.5%, and the combined annual cap on the surcharge paid by all members of an affiliated group will increase from $9 million to $75 million beginning January 1, 2026. A “select advanced computing business” is a person who is a member of an affiliated group with at least one member of the affiliated group engaging in the business of advanced computing, and the affiliated group had worldwide gross revenue of more than $25,000,000,000 during the immediately preceding calendar year. “Advanced computing” means designing or developing computer software or computer hardware, whether directly or contracting with another person. This includes modifications to computer software or computer hardware; cloud computing services; or operating as a marketplace facilitator as defined by RCW 82.08.0531, an online search engine, or online social networking platform.
The bill also introduces a new, temporary B&O surcharge on “high grossing businesses” with at least $250 million in Washington taxable income. The tax is 0.5% of the business’s annual Washington taxable income in excess of $250 million and is in addition to the other B&O taxes imposed on the income. This surcharge begins on January 1, 2026, and expires on December 31, 2029. There are several exemptions to this new surcharge, including financial institutions and taxpayers who pay the advanced computing surcharge. The calculation for the $250 million threshold also excludes taxable income derived from manufacturing activities; wholesaling or retailing activities of products manufactured by the taxpayer; and sales of food, food ingredients, food stamp purchases, prescription drugs, timber, timber products, wood products, fuel, and petroleum products processed by an affiliated business in Washington.
Finally, the bill also clarifies the B&O tax deduction for investment income in response to last October’s Antio[1] decision issued by the Washington Supreme Court, which affirmed that the deduction provided in RCW 82.04.4281 for the investment income of persons is only applicable if such income is from investments that are incidental to the main purpose of a person's business, without providing a bright line rule for what constitutes “incidental to the main purpose of the person's business.” Under the bill, investments are generally considered incidental to the main purpose of a business if less than 5% of the business’s total worldwide gross income is derived from such investments annually. Nonprofit organizations, retirement accounts, and certain family investment vehicles, as well as the recipients of distributions from these accounts, may continue to deduct the proceeds from these investments, regardless of whether the investments are incidental to the main purpose of the person's business. Collective investment vehicles, including mutual funds, collective funds, or similar investment vehicles meeting certain criteria may also generally continue to deduct the proceeds from investments.
Retail Sales Tax (Engrossed Substitute Senate Bill 5814)
Modifying the application and administration of certain excise taxes.
This bill classifies certain services as retail services and therefore subjects them to retail sales tax and retailing B&O tax beginning October 1, 2025. This has the effect of greatly expanding the retail sales tax base to numerous previously excluded services, such as IT consulting services, IT training and technical support services, custom website development, custom software development, temporary staffing services, and advertising services.
“Advertising services” means all digital and non-digital services related to the creation, preparation, production, or dissemination of advertisements, including layout, art direction, graphic design, mechanical preparation, production supervision, placement, referrals, acquisition of advertising space, and rendering advice concerning the best methods of advertising products or services. It also includes online referrals, search engine marketing, and lead generation optimization, web campaign planning, the acquisition of advertising space in the internet media, and the monitoring and evaluation of website traffic for purposes of determining the effectiveness of an advertising campaign.
Advertising services do not include web hosting services and domain name registration; services rendered in respect to newspapers, printing and publishing, and local radio and television broadcasting; and services rendered for out-of-home advertising.
Most of the above services remain excluded from retail sales and retailing B&O taxes and continue to be subject to service B&O tax when the sale of such service is between members of an affiliated group as defined in RCW 82.04.299 (1)(f). Temporary staffing services utilized by hospitals and telehealth and telemedicine services will also continue to be subject to service B&O tax.
Significantly, the bill also repeals exemptions for certain digital automated services (DAS) that are now classified as retail services and subject to retail sales tax and retailing B&O tax. DAS now will include any service that primarily involves the application of human effort by the seller; live presentations; digital processing services; and digital advertising services. A retail sale of digital goods, digital codes, or digital automated services does not include these services, however, if the sale occurs between members of an affiliated group as defined in RCW 82.04.299 (1)(f).
Notably, the expansion of the sales tax to digital advertising services – while carving out exemptions for non-digital advertising such newspapers, printing and publishing, and local radio and television broadcasting – arguably results in discriminatory treatment in violation of the Internet Tax Freedom Act.
Capital Gains Tax and Estate Tax (Senate Bill 5813)
Increasing funding to the education legacy trust account by creating a more progressive rate structure for the capital gains tax and estate tax.
Beginning January 1, 2025, Senate Bill 5813 retroactively adds a new 2.9% tier on the sale of long-term capital assets valued at over $1 million that is on top of the current 7% levied on gains above $250,000 a year, for a total rate of 9.9%.
The bill also modifies the estate tax for the estates of decedents dying on or after July 1, 2025 by increasing the current exclusion amount from $2.193 million to $3 million, which amount will be adjusted annually for inflation based on the consumer price index starting in calendar year 2026.
Additionally, the bill increases the graduated tax rates for Washington taxable estates above $1,000,000, with those estates above $9,000,000 seeing a significant rate increase from 20% to 35%. The “Washington taxable estate” is the amount remaining after all allowable expenses and deductions, including the applicable exclusion amount. The below chart compares the current rates with the new rates:
Finally, the Qualified Family-Owned Business Interest deduction amount is increased from $2.5 million to $3 million, which amount will be adjusted annually for inflation based on the consumer price index starting in calendar year 2026.
Tax Preferences (Senate Bill 5794) -- Adopting recommendations from the tax preference performance review process, eliminating obsolete tax preferences, clarifying legislative intent, and addressing changes in constitutional law.
Senate Bill 5794 repeals several tax preferences beginning on January 1, 2026. These include (i) the B&O tax deduction for interest on real estate loans; (ii) the preferential B&O tax rates for prescription drug resellers, insurance producers, title insurance agents, surplus line brokers, and international investment management services; (iii) the international services B&O tax credit; and (iv) the international banking facilities B&O tax exemption.
Of note, due to affordable housing concerns the Governor vetoed the repeal of the B&O tax deduction for interest received by community banks on loans for residential property provided by RCW 82.04.4292.
[1] Antio, LLC v. Department of Revenue, 3 Wash.3d 882, 557 P.3d 672 (2024).
