Washington state taxpayers paying the new Millionaires Tax may assume the itemized deductions they use on their federal income tax return also somehow work for the state income tax.
That assumption is wrong. Only two of the usual deductions “work.” And both get limited.
Which means your Washington state income tax may be quite a bit larger than you first guess. And you probably want to plan ahead.
Note: The new state income tax doesn’t start until January 1, 2028. More background information here: The New Washington State Millionaires Tax.
Two Brackets, Two Deductions
To truly understand Washington’s new income tax, a quick summary is in order. For most planning purposes, taxpayers can think about the law this way:
The tax has two brackets. The first $1,000,000 gets taxed at zero percent. Amounts over $1,000,000 get taxed at 9.9 percent.
And then the tax provides two deductions. One deduction for charitable contributions to in-state charities. One deduction for gambling losses.
That’s basically it: Two tax brackets. Two deductions.
But here’s the trap. For federal income tax purposes, the standard deduction is an alternative to itemized deductions. Taxpayers use either the standard deduction or their itemized deductions, whichever number is bigger.
Washington’s Millionaires Tax works differently. The “standard deduction” is not really an alternative to itemized deductions. It is more like an exclusion. Or a zero-percent tax bracket.
Which means most of the deductions you think about when you think about “taxable income” are missing.
Medical and Dental Expenses
The first missing Washington millionaires tax deduction: medical and dental expenses.
For Washington Millionaires Tax purposes, medical and dental expenses do not reduce taxable income.
That means even in a catastrophic year, taxpayers should not assume medical expenses shelter income from Washington state income tax.
The workaround for business owners? Make sure the business provides good medical insurance if that is practical. The self-employed health insurance deduction reduces federal adjusted gross income. And because the Washington tax starts with federal AGI, reducing AGI should usually reduce Washington taxable income too.
Health savings accounts also matter. HSA contributions reduce federal AGI. That means HSA contributions should also usually reduce the income number that feeds the Washington tax calculation.
And then ditto for individual health insurance policies. Good health insurance that avoids any implicit self-insurance makes more sense than it might in other states.
State and Local Taxes
State and local taxes mostly do not work as state income tax deductions either.
For federal income tax purposes, individual taxpayers may deduct state and local taxes, subject to the federal SALT cap. But for Washington Millionaires Tax purposes, taxpayers should not assume those state and local tax deductions reduce Washington taxable income.
One possible workaround exists for business owners and investors in pass-through entities.
Washington’s new law includes a pass-through entity tax. That tax is complicated. And pretty inflexible. But for taxpayers who owe large state income taxes because they own interests in partnerships, LLCs, or S corporations, the pass-through entity tax is something to study carefully.
The reason? A properly structured pass-through entity tax may reduce business income before that income reaches the owner’s federal AGI. And anything that reduces federal AGI may also reduce the Washington Millionaires Tax.
Home Mortgage Interest
Home mortgage interest is another missing deduction.
No regular Schedule A-style mortgage interest deduction appears in the Washington Millionaires Tax formula.
This produces a weird result.
Suppose someone owns $1,000,000 of investments that generate $60,000 of investment income. Also suppose that same person has a $1,000,000 mortgage that generates $60,000 of mortgage interest.
For federal income tax purposes, the $60,000 of investment income and the $60,000 of mortgage interest may basically offset each other. The taxpayer may think, “No net income.”
But for Washington Millionaires Tax purposes, only the $60,000 of investment income matters. The $60,000 of mortgage interest does not.
One backdoor workaround? Pay down or pay off the mortgage.
If the taxpayer uses the $1,000,000 of investments to pay off the $1,000,000 mortgage, the taxpayer simultaneously gives up the $60,000 of investment income and saves $60,000 of mortgage interest. That netting may seem to produce no economic benefit. But it may reduce Washington taxable income. And perhaps result in less Washington state income tax.
Note: Under federal law, only grandfathered mortgages would allow interest on a $1,000,000 mortgage to be deducted. The general point still applies, however. Washington does not give taxpayers a normal mortgage interest deduction.
Investment Interest
Investment interest creates a similar trap.
Suppose someone owns $10,000,000 of investments funded with $10,000,000 of margin debt. The investments generate income. The margin debt creates interest expense.
For federal income tax purposes, the taxpayer may expect to net the investment interest expense against investment income. But for Washington Millionaires Tax purposes, that netting may not work.
The obvious response? De-leverage.
Borrowing to hold investments becomes less attractive when the income counts for Washington purposes but the related interest expense does not.
Casualty and Theft Losses
Casualty and theft losses may create the most surprising results.
Suppose someone suffers a large theft, embezzlement, fire, storm, flood, or similar loss. For federal income tax purposes, the tax law may give the taxpayer some relief.
Washington’s Millionaires Tax generally does not.
That can produce an ugly result.
Someone might have $2,000,000 of income and then suffer a $2,000,000 casualty or theft loss. For federal income tax purposes, the taxpayer may not be treated as if they enjoyed $2,000,000 of real economic income.
But Washington may still tax the income while ignoring the loss.
That will surprise people.
Federal Estate Tax on Income in Respect of a Decedent
Another missing deduction doesn’t matter until it becomes catastrophic: the federal estate tax deduction on income in respect of a decedent.
And this millionaire tax missing deduction requires some explanation and an example.
Suppose someone liable for the millionaire income tax and estate taxes wins a state lottery worth $10,000,000 and then dies while the lottery payments are still being made.
The right to receive the future lottery payments may be included in the estate. That may trigger both federal and state income taxes and estate taxes on the $10,000,000 or some portion of the winnings.
Federal income tax law recognizes the potential “stacking” problem inherent in taxing this income both on an income tax return and estate tax return. The accounting works like this for a Washingtonian: The topline $10,000,000 is subject first to a 20% state estate tax, or $2,000,000. That leaves $8,000,000. That leftover $8,000,000 is next subject to a 40% federal income tax, or $3,200,000. That leaves $4,800,000. That leftover $4,800,000 is essentially subject to a roughly a 40% federal income tax, or roughly $1,920,000. That leaves roughly $2,900,000.
For Washington decedents estates created at the time of this writing in late 2026? This accounting example shows roughly how the math works.
But the new millionaire’s tax effective starting in 2028? That new tax ignores all the earlier federal and state estate taxes and the income taxes. Thus, the millionaire tax formula taxes the $10,000,000 at the 9.9% rate. Roughly, that’s another $1,000,000. That leaves $1,900,000, or 19% of the original income. In effect, the state income tax taxes income already grabbed by estate taxes and federal income taxes.
That is a big deal. And taxpayers facing this risk lack good planning options. Probably the two obvious if extreme responses are a domicile change (see Washington State Residency Rules for Millionaires Tax and Changing Your Washington State Residency for information about how to do this) and aggressive gifting (See Tax-inclusive Gift Strategy and Planning for the Washington Estate Tax for more information on this other gambit.)
Sidebar: Anyone who wins a big lottery probably needs to seriously consider changing domicile unless they make a smart choice about how to take the payments, something we’ve pointed out before here: Powerball Lottery Tax Planning.
Other Missing Deductions
Other even more niche federal itemized deductions may also disappear for Washington Millionaires Tax purposes. Examples include:
- A deduction for amortizable bond premium.
- An ordinary loss attributable to a contingent payment debt instrument or an inflation-indexed debt instrument, such as a Treasury Inflation-Protected Security.
- A deduction for repayment of amounts under a claim of right if over $3,000.
- Certain unrecovered investment in a pension.
- Impairment-related work expenses of a disabled person.
These deductions are obscure. Most taxpayers never use them.
But the taxpayers targeted by the Millionaires Tax are not ordinary taxpayers. They often own complicated investments, receive unusual income, participate in partnerships, inherit assets, or experience one-time events.
So the missing obscure deductions may matter.
The Bottom Line
Should Washington have ignored these deductions?
That is a policy question. And probably one the Legislature and Department of Revenue will discuss and fine-tune over time. (I try avoid predicting tax law changes but I’m going to go out on a limb here and guess that deductions for catastrophic medical expenses and casualty and theft losses might be added.)
But if you may be affected by the Millionaires Tax, know this: many of the deductions you expect to reduce taxable income are missing.
The state gives taxpayers a $1,000,000 zero bracket. It gives a limited deduction for charitable contributions to in-state charities. It gives a limited deduction for gambling losses.
But after that? Many of the usual federal deductions disappear.
Plan accordingly.
Additional Information
Washington Millionaires Tax Statistics
Washington Millionaires Tax Marriage Penalty
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