For federal estate tax purposes, the taxable estate includes the amount of any federal gift tax paid by the decedent within three years of his or her death. IRC § 2035(b).  This is commonly referred to as the “gross-up” provision.  My grandpa would call it paying taxes on taxes.  Washington does not have a gift tax or a “gross-up” provision.

The lack of a Washington gift tax or express gross-up provision leads some folks to conclude that there is no gross-up requirement under Washington law. After all, imposing Washington estate tax on gift tax paid seems nonsensical given Washington’s lack of a gift tax.  The Estate of Barry Ackerley, the former owner of the Seattle Sonics, took this position on its estate tax return and, when the Department of Revenue disagreed and assessed estate tax on the gift tax paid, challenged the assessment in Estate of Barry A. Ackerley v. Washington Department of Revenue.

If you also consider inclusion of gift taxes paid in a Washington taxable estate to be nonsensical, then congrats! Four justices agree with you, and if they were NBA officials then I could stop writing and go watch the Blazers game.^[1]  Unfortunately this is the Washington Supreme Court and five justices are needed for a majority.  Five justices ruled last week that the decedent’s Washington taxable estate includes the gift tax paid within three years of death.  As my grandpa (a sometimes Sonics fan) would put it: Washington estates must pay taxes on taxes.

Washington’s estate tax law establishes the starting point for calculating a Washington taxable estate as the federal taxable estate. Washington law incorporates the federal definitions and, in doing so, relied on the detailed federal statutory scheme to give guidance and direction to Washington estates on what to include in the gross estate.  According to the Court, the definition of Washington taxable estate includes the gift taxes paid within three years of death because the legislature did not specifically exempt the gross-up rule from inclusion in the taxable estate.  The Estate also argued that the gift taxes paid were not a “transfer” and, therefore, could not be subject to a transfer tax.  The Court interpreted the term “transfer” in accordance with the federal definition and adopted the approach of the U.S. Tax Court, which rejected this argument in 2002.  Because Oregon’s estate tax law is similarly connected to federal law, it is likely the Oregon Department of Revenue would use the Washington Supreme Court’s analysis in support of the same result under Oregon law.

This case underscores the importance of gifting early, especially if the gifts are part of a succession plan for a family business. For state estate tax purposes, many individuals want to delay gifts to keep control of the property until the last possible moment, then he or she finally makes the gift, removing it from the state taxable estate and avoiding the state estate tax.  For federally taxable estates, the gross-up is one more reason why individuals should avoid delaying their gifting plan.  Paying estate taxes is a substantial burden on the family business and especially problematic for manufacturing, distribution, and retail businesses which tend to be capital intensive.  Inadequate advance planning on how to fund payment of estate taxes can result in the business being forced to sell property to raise sufficient cash to pay estate taxes.  Early gifting can help preserve the family manufacturing, distribution or retail business by avoiding both the state estate tax and the need to pay estate tax on the gift tax paid.  Of course, some folks may enjoy paying taxes on taxes.  They also probably cheer for the NBA officials during games.

^{[1] The author acknowledges that the Blazers did not play between when the Opinion was filed and the publication of this writing.
The author also admits that many years ago she sometimes watched Sonics games even when they were not playing the Blazers. She regrets nothing, including those times she cheered for the Sonics over the Suns.}