November 28, 2022
On November 8, Massachusetts voters voted “yes” to approve the imposition of a 4% surtax on Massachusetts taxpayers with income over $1 million. This so-called “Millionaire’s Tax” will be imposed on top of the state’s current 5% flat income tax. For example, a Massachusetts resident who earns $2 million in 2023 will pay 5% on the first million, or $50,000. With the 4% surtax on the second million, the tax on the second million will be $90,000. This results in an additional Massachusetts tax of $40,000.
According to IRS statistics,1 in 2019 over 19,000 sole proprietors, partnership partners, “S” corporations shareholders, and LLC members in Massachusetts would have been subject to this surtax.
Important points to note about the Millionaire’s Tax include:
- The surtax applies to one-time millionaires. A Massachusetts taxpayer may be subject to the surtax in one year but not another if they recognize a significant gain from the sale of a substantially appreciated asset such as a home or business.
- A single $1 million threshold applies to both single and married filing jointly filers. If a married couple would exceed the $1million threshold based on their combined income but not on their separate incomes, the couple should consider filing tax returns as married filing separately to avoid the surtax.
- The surtax will take effect on January 1, 2023.
- Taxpayers who would be subject to the surtax may wish to consider selling appreciated assets this year or enter into a tax-deferral transaction such as a like-kind exchange on the sale of real estate or an investment in a qualified opportunity zone fund. It is foreseeable that an increase in sales of appreciated securities, businesses, and real estate will occur by December 31, 2022.
- Taxpayers who will recognize a significant gain from the sale of an appreciated asset pursuant to an installment sale should consider whether it would be advantageous to recognize the entire gain in 2022, or alternatively, structure the installment payments over a greater number of years to keep the annual payments below the threshold amount. In deciding whether to accelerate the gain into 2022, the benefit of avoiding the 4% surtax should be weighed against the increased cash required for federal and state taxes.
- A taxpayer could move to another state with a lower income tax rate before recognizing a significant gain from the sale of certain property such as appreciated stock. Relocating to a different state does require planning, however, and it is important to review the residency requirements for each state and document the move to a new state thoroughly, as tax payers have the burden of proving they actually changed their domicile. The Massachusetts Department of Revenue (DOR) does audit taxpayers who attempt to change their domicile so it is reasonable to assume the DOR will prioritize reviewing tax returns of taxpayers who suddenly claim nonresident status after years of filing as a resident.
- The surtax will only apply to the portion of the taxpayer’s income over $1 million. For example, if the gain on the sale of a home is $1.2 million, the surtax would only be imposed on $200,000 of the gain.
- The $1 million threshold will be increased each year for inflation. Therefore, over time, taxpayers will need to have income of much more than $1 million to be subject to the surtax.
It is currently unclear as to whether the Millionaire’s Tax will apply to Massachusetts resident trusts and estates. One strategy that could help Massachusetts taxpayers avoid the surtax would be to transfer income-producing assets to a trust that is not subject to Massachusetts income tax or, for taxpayers who are charitably inclined, to transfer income producing assets to a charitable remainder unitrust. With the latter strategy, the taxpayer would receive an income tax charitable deduction when the trust is funded,no immediate recognition of gain, an annual income stream based on the annual value of the trust property or the trust’s annual income, and the named charity would receive the remaining trust assets at the end of the trust term. Provided the annual total of the taxpayer’s taxable trust distributions and other income does not exceed the surtax threshold, the surtax should not apply.
It is important to note that each of above-described mitigation strategies requires evaluation on a case-by-case basis depending on the specific facts. Even with this in mind, we expect additional year-end tax-driven transactions to occur.
If you have any questions regarding the Millionaire’s Tax, please contact Bill Morgan, Trusts & Estates Counsel, at 617-457-4061 or wmorgan@murthalaw.com.
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