Many business owners hear “Washington has no state income tax” and assume compensation planning isn’t important. In reality, federal payroll taxes are often the largest factor.
When you pay yourself a W-2 salary, the business and employee pay:
- Social Security tax
- Medicare tax
- Federal unemployment tax
- Washington unemployment tax (ESD)
- Washington Paid Family & Medical Leave (PFML)
Distributions generally avoid many of these employment-related taxes.
This is why S-corp owners often see meaningful tax savings when part of their earnings are taken as distributions instead of salary.
Washington Unemployment (ESD)
Washington employers must pay unemployment taxes through the Washington Employment Security Department.
Your rate depends on factors such as:
- Industry
- Claims history
- Age of the business
- Experience rating
The more salary you pay yourself and employees, the more unemployment tax exposure you create.
While the tax is usually not enormous for owner compensation, it is still part of the overall cost of payroll.
Paid Family & Medical Leave (PFML)
Washington requires payroll contributions for Paid Family & Medical Leave.
This applies to employee wages, including wages paid to owner-employees of S corporations.
As compensation rises, PFML contributions rise as well.
Distributions are generally not subject to PFML because they are not wages.
Seattle’s JumpStart Payroll Expense Tax
This is where compensation planning can become much more important for larger Seattle businesses.
The tax applies to certain employers with employees working in Seattle and compensation above specified thresholds.
Businesses often encounter problems when:
- High-paid executives are concentrated in Seattle
- Owners pay very large salaries
- Growing firms cross payroll thresholds without realizing it
For many small businesses, JumpStart is not a concern. For larger professional service firms, technology companies, and rapidly growing businesses, it can become a significant planning issue.
For Washington business owners, the salary-versus-distribution decision is often more favorable than in high-income-tax states because Washington does not impose a personal income tax on wages or S-corp distributions. That means the primary tax planning focus is usually payroll taxes, B&O taxes, and local business taxes rather than state income tax.