Taxachusetts Welcomes You!

Over this past summer, while many were enjoying the sun and warm weather, the Massachusetts State Legislature voted to move the Fair Share Amendment, commonly known as the Millionaire’s Tax, to a popular ballot vote in November of 2018. 

What you need to know about the Massachusetts Millionaire’s Tax

The Fair Share Amendment proposes to amend the Massachusetts state Constitution by adding a four-percentage point rate increase to income taxes already in place on annual income in excess of $1 million. Currently, personal income is taxed at two rates by the Commonwealth – 12% on short-term capital gains and 5.1% on everything else.  Therefore, this measure could result in Massachusetts tax rates as high as 16% on some income.  If approved, the measure will take effect for tax years beginning on or after January 1, 2019. As a simple example, if a taxpayer has $2 million of ordinary income taxed in Massachusetts today, his or her state income tax will be $102,000. If the Fair Share Amendment passes the same taxpayer’s bill to the Commonwealth in 2019 would be $142,000.

The amendment, while sparse in language, appears to be written broadly enough that it will apply to any income of any Massachusetts taxpayer, including wages, active trade or business income from a flow through entity, or portfolio income such as capital gains. The amendment does not single out residents of the Commonwealth only, meaning that even non-residents who earn wages in Massachusetts or own a business with Massachusetts nexus could face higher tax rates on business profits that are apportioned to the Commonwealth in excess of $1 million. The amendment also does not appear to distinguish between income earned by individuals or trusts that are Massachusetts resident trusts.  

In addition, the Fair Share Amendment also creates a so-called marriage penalty in Massachusetts that previously did not exist. Since Massachusetts is generally a flat-tax state there, is not a big difference between two taxpayers filing as single persons or as married filing jointly. However, since the Fair Share Amendment makes no distinction between single and married taxpayers, it appears that those who file joint returns and combine their income could be subject to the tax where two single taxpayers would not. For example, two single taxpayers who each earn $1 million would pay only the 5.1% tax on their respective incomes. However, those same taxpayers filing a joint return would pay a 9.1% on half of their income. 

Many are wondering, will this measure pass? While it is impossible to say for sure, what is true is that this measure will be voted on by the entire state population but only affect a small percentage. Also, a constitutional amendment approved by popular vote is required to enact this change because the state Constitution currently mandates that a class of income must be taxed at a uniform rate for all taxpayers.  Since this bill represents a fundamental transformation from a flat tax to a graduated tax, the amendment is required. In the months leading up to the vote there surely will be lobbying on both sides of the issue. The text of the Fair Share Amendment proposes that funds raised by this levy would be used to fund spending on quality public education and infrastructure improvement, common goals that everyone can rally behind. However, it is expected that business groups will argue that the amendment will do more fiscal harm than good, pointing to high-taxed states that have lost jobs and wealthy taxpayers to more tax-friendly locales as evidence. Further, there are others who believe the amendment’s constitutionality is debatable because it appears to appropriate revenue for specific purposes, which is not allowed on a ballot initiative. Finally, the merits of moving from a fundamentally flat tax system to a graduated rate system and whether the state is opening a door to further progressive changes will surely be debated. How this all plays out remains to be seen. 

While determining if this bill is passed may be limited to their vote, Massachusetts taxpayers and their advisers can start thinking now about life when and if the Fair Share Amendment passes.

  • Flow through businesses (partnerships LLC’s and S corporations) with nexus in more states than just Massachusetts should review how they apportion income to the state. Resident taxpayers may evaluate what it takes to become a non-resident. Under Massachusetts law, there are two ways the Commonwealth will classify an individual as a resident:
    • Physical presence: If a taxpayer has and maintains a home within the state (owned, rented, or leased) and is physically present within the Commonwealth on any portion of 183 days in a year, then that taxpayer will be considered a statutory resident for that year and pay tax on 100% of his or her income in Massachusetts. This statutory residency is a bright line test and one the Department of Revenue has been more aggressive in asserting.   
    • Domicile: The Commonwealth can also argue that an individual is domiciled in Massachusetts, and therefore a resident for income tax purposes, if that individual’s center of vital interests are here. Such interests include family, social and religious ties, business activity, as well as a variety of other factors. For an individual to terminate residency in state, that individual must break domicile and show closer connections to another state, which often requires  a major change in lifestyle (i.e., simply spending more time at the lake in New Hampshire is not enough).
  • Individuals who cannot change their domicile can think about how to manage portfolio assets to minimize annual income recognized in Massachusetts, in particular capital gains, or possibly use trust planning to minimize exposure to Massachusetts taxes.
  • Married taxpayers may consider filing separately in the Commonwealth as it is possible to file jointly for federal purposes and separately for state purposes. Resident spouses may want to consider how investment assets are allocated and which spouse recognizes capital gains to keep both spouses under the $1 million threshold. 
  • Trustees should evaluate whether earnings on trust assets will be subject to the tax. Massachusetts residency rules for trusts are different than for individuals, and often some basic planning can help minimize exposure to state income taxes for established trusts. 

Whether resident here or not, Massachusetts taxpayers should start talking with their tax advisers now regarding these potential changes. Having a good set of plans in place will be critical, as the Massachusetts Department of Revenue will be on the lookout for taxpayers trying to avoid the rules.