Protecting Your Legacy: How Non-Grantor Trusts Shield Washington Families from Capital Gains Tax
Imagine being able to sell millions of dollars in appreciated stock and pay zero Washington state capital gains tax—legally and permanently. For many high-net-worth Washington residents, this isn’t just a dream; it’s an achievable reality through the strategic use of non-grantor trusts.
While this strategy requires careful planning and professional guidance, the tax savings can be extraordinary. For a family selling $10 million in appreciated assets, we’re talking about potential state tax savings of nearly $900,000.
Understanding the Legal Foundation
Washington’s capital gains tax has a crucial limitation that creates this planning opportunity: it only applies to individuals. The law specifically taxes “individuals” on their capital gains, but properly structured trusts are separate legal entities—not individuals.
When a non-grantor trust sells appreciated assets, the trust is the legal seller, not the person who created it. Since the trust isn’t an “individual” under Washington law, no state capital gains tax is due on the transaction.
What Makes a Trust “Non-Grantor”?
In tax terminology, trusts fall into two categories:
Grantor Trusts: For tax purposes, these are “invisible.” All income, deductions, and capital gains flow through to the person who created the trust (the grantor) and appear on their personal tax return. If a grantor trust sells assets, it’s treated as if the grantor sold them personally.
Non-Grantor Trusts: These are separate taxpayers with their own tax returns. When a non-grantor trust sells assets, the gains belong to the trust, not the person who created it.
The difference is crucial for Washington capital gains tax planning.
The SLANT Strategy: Keeping It in the Family
One of the most popular non-grantor trust strategies is called a Spousal Lifetime Access Non-Grantor Trust (SLANT). Here’s how it works:
The Setup:
- One spouse creates an irrevocable trust for the benefit of the other spouse and their children.
- The trust is carefully structured to qualify as a non-grantor trust
- The grantor spouse transfers appreciated assets to the trust (using their federal gift tax exemption)
The Payoff:
- The trust sells the appreciated assets with zero Washington state capital gains tax
- The beneficiary spouse can receive distributions from the trust for living expenses
- The family maintains practical access to the wealth while achieving massive tax savings
Real-World Example: Mark and Lisa own $8 million in Amazon stock from Mark’s early employment, with a cost basis of $200,000. Without planning, selling this stock would generate approximately $680,000 in Washington state taxes.
Instead, Mark creates a SLANT for Lisa’s benefit and transfers the stock to the trust. The trust sells the Amazon shares and pays zero Washington state tax—a savings of $680,000. Lisa can receive distributions from the trust for family expenses, maintaining their lifestyle while preserving wealth.
The “Toggle” Trust: Ultimate Flexibility
For families who want maximum flexibility, advanced planning involves trusts that can switch between grantor and non-grantor status. These “toggle” trusts allow families to optimize for different situations over time.
How it works:
- Create a trust with special powers that make it a grantor trust initially
- Transfer assets and let them grow while the grantor pays income taxes (considered an additional gift to beneficiaries)
- Before a planned sale, “turn off” the grantor trust status by releasing specific powers
- The trust becomes a non-grantor trust and can sell assets without Washington capital gains tax
- Optionally restore grantor trust status later for other tax benefit
This strategy is particularly powerful for business owners who know they’ll sell their company in the future but want flexibility in the meantime.
Beyond State Taxes: The Estate Planning Bonus
Non-grantor trust strategies don’t just save capital gains taxes—they also provide significant estate tax benefits. Assets transferred to these trusts are removed from your taxable estate, along with all future growth.
The numbers are compelling:
Washington’s estate tax reaches 35% for large estates
Federal estate tax is 40% above the exemption amount
Combined estate and capital gains tax savings can exceed $1 million for substantial estates
Important Considerations and Limitations
While non-grantor trust strategies are powerful, they’re not right for everyone:
You’re giving up control: Once assets are in an irrevocable non-grantor trust, you cannot simply take them back. The trust provides access through distributions, but you’re not the legal owner anymore.
Complexity and cost: These strategies require sophisticated legal documentation and ongoing administration. Setup costs typically range from $15,000 to $50,000, with annual administration fees.
Federal gift tax implications: Transfers to non-grantor trusts use your federal lifetime gift tax exemption (currently $13.61 million per person, but scheduled to drop by roughly half after 2025).
Trust income tax rates: Non-grantor trusts face compressed federal income tax brackets, reaching the top rate at much lower income levels than individuals.
Is This Strategy Right for You?
Non-grantor trust planning works best for families with:
- Substantial appreciated assets (typically $5 million or more for cost-effectiveness)
- Long-term wealth preservation goals
- Comfort with irrevocable planning
- Desire to benefit spouse and children
The strategy is particularly compelling for:
- Tech employees with large equity compensation positions
- Business owners planning eventual sales
- Families with significant investment portfolios
- Anyone facing large, one-time liquidity events
The Time Factor: Why Urgency Matters
Here’s the crucial point: you must implement these strategies before selling your assets. Once you’ve completed the sale, the capital gains tax is due, and there’s typically no way to undo the transaction for tax purposes.
Many families make the mistake of calling their attorney after they’ve already decided to sell, only to learn they’ve missed the planning window. The best results come from advance planning, ideally years before you expect to need liquidity.
Moving Forward
If you’re sitting on substantial appreciated assets, the potential savings from non-grantor trust planning likely dwarf the costs of implementation. For many families, these strategies represent one of the highest-return investments they can make.
The key is working with experienced professionals who understand both the technical requirements and practical implementation. Washington’s capital gains tax is still relatively new, and not all advisors have developed expertise in these specialized strategies.