The Massachusetts Millionaire’s Tax and What to Do About It
By John Schachter, EA
In 2022, Massachusetts voters approved a ballot question that amends the state constitution to impose a 4 percent surtax on individual and trust income above $1 million. This in addition to the 5 percent individual income tax that already applies to all taxable income. Here is a description of the tax, and suggestions for how to avoid it if you can, or cope with it if you cannot.
The tax applies to tax years starting in 2023, and thereafter. Money raised this way is supposed to be spent on education and infrastructure.
As written, the law applies to income over $1 million on personal income tax return. Not a corporate excise tax return. The tax won’t apply to S corporations or partnerships, rather, on the income of the individual shareholder or partner. The tax will apply to trusts that pay personal income tax. And it will apply to individual trust beneficiaries.
The tax applies to taxable income in excess of $1 million. If your taxable income is $1.5 million, your Massachusetts tax will be $95,000. That’s 5 percent of the entire $1.5 million, plus 4 percent of the amount in excess of $1 million.
The tax will apply to income of nonresidents from Massachusetts sources. For example, if you like in Ohio but sell your Massachusetts rental property at a gain of more than $1 million, you will owe the tax on the excess.
The tax applies to taxable income. That’s income after deductions and exemptions. For example, a married couple can generally exclude from tax the first $500,000 of gain on sale of their principal residence. That couple would start with the sales price, subtract the commissions and other selling costs, subtract their cost basis in the home, and then subtract $500,000. If any gain remains, it would count towards the $1 million threshold for the 4 percent tax.
If you paid tax on your income to other states, you should be able to offset the Massachusetts tax, including this 4 percent surtax, with that other state tax. That way, you won’t pay tax twice on the same income.
What to do about the tax? Here are some ideas.
Sigh and pay up. The tax is the law. Once you have taken all possible deductions and exclusions, they’ve got you. Also, even with the tax, Massachusetts won’t be close to the highest-tax state. I am looking at you California, New York and New Jersey.
Move out of Massachusetts. For this to work you must change your domicile and, if you retain a home in Massachusetts, you must be outside the state for more than half of a given tax year. The Massachusetts tax authorities scrutinize purported changes of domicile, so make sure your move is for real before taking the position that you don’t live in Massachusetts any longer.
Minimize Massachusetts-source income. Nonresidents owe the tax on income from Massachusetts sources. Dividends and capital gains on stock of Massachusetts companies aren’t taxed to nonresidents by Massachusetts. Rental and business income and salary attributable to days worked in Massachusetts, on the other hand, are taxed by the state, as is gain from selling tangible assets located in Massachusetts.
Spread your income out, so you don’t exceed the threshold. For example, sell your business assets or your rental property in installments, so you never go over $1 million of income. But you will have to wait to get your money, which increases the risk that the buyer stiffs you. And you might be able to do great stuff with the money if you had it in your hands. Consider, therefore, whether just sighing and paying up might be the best option.
Split income among several taxpayers. It appears that spouses could file separate returns, and each would get a separate $1 million threshold. So, if Kate and Sonja are married to each other, and Kate makes $500,000 and Sonja makes $800,000, they could file separate Massachusetts returns and neither would be over the $1 million threshold, where on a joint return, they would be. You could do something similar with non-grantor trusts – the kind that pay their own taxes. Or by making gifts of income-producing property to family members. But for a 4 percent savings, the income better be big, or the strategy won’t be worth the overhead.
Seek nontaxable income and cash flows. For example, interest on Massachusetts municipal bonds is free of state tax. So are gifts and loans and a return of capital from a company. Massachusetts taxes distributions from retirement accounts, not the balance in the account. Massachusetts never taxes Social Security benefits.
Remember the rule that people freak out about taxes and can be scared into overpaying to avoid them. Don’t let that happen to you.
At John Schachter + Associates Inc., we help clients minimize their federal and state tax. Talk to us. Let us know if we can help you!
