Avoiding or Mitigating a Possible Millionaire’s Tax in Massachusetts

In November, Massachusetts voters will decide whether to approve a constitutional amendment to impose a 4% surtax on household income greater than $1 million. Known as the Fair Share Amendment, the 2022 ballot measure would raise the current 5% tax rate imposed on income over $1 million to 9%. If enacted, this would be effective January 1, 2023. This article sets forth planning options for taxpayers considering how they may mitigate the financial impact of the millionaire’s tax if the ballot measure is approved and takes effect.

Background

Under the current Massachusetts individual income tax regime, household income above $1 million is taxed at 5%. In 2021, Massachusetts lawmakers voted to put a constitutional amendment on the 2022 ballot called the Fair Share Amendment that would add a 4% surtax (9% total) on household income above $1 million. The amendment was challenged by the Massachusetts High Technology Council as well as several state lawmakers who argued that the state’s attorney general failed to provide a fair and concise summary of the ballot measure. However, on June 22, 2022, the Massachusetts Supreme Judicial Court ruled the summary provided on the ballot was permissible. This paves the way for the ballot question to be voted on in November.

Movin’ Out

High net worth individuals residing in Massachusetts may consider moving to no or low-tax states (e.g., Florida and New Hampshire) to reduce their overall tax burden. The wide-spread adoption of remote work as a result of the COVID-19 pandemic is likely to spur many employees and business owners to further consider moving to a no or low-tax state.

However, moving to another state and substantiating claims of having established a domicile in another jurisdiction requires careful planning. States struggling to fill massive revenue gaps that may be precipitated by a recession are likely to pursue high net worth individuals who claim to be no longer subject to tax within their jurisdiction.

As part of moving forward with a plan to move to a no or low-tax state, one must review each state’s residency requirements and document the clear transition from one residence to another. Incorrectly or incompletely transferring residency can result in multiple states asserting residency or domicile. Properly establishing residency in a new state and documenting the changes that occurred to break domicile with the previous state allows the taxpayer to create a clear and detailed analysis to provide to states if/when a taxpayer’s domicile is challenged under audit.

Like many areas of tax law, there are common misperceptions about state tax residency and the consequence of a move. The following are issues often misunderstood:

• Tax residency may change within a tax year – an individual is not required to report as a resident of a single state for the entire year.
• Any portfolio income and capital gains earned one day after the move are not taxable in the state the taxpayer left so long as the move to the new state occurred prior to the income event – the state may not like it, but that is the law (note – the new state where the taxpayer moved gets to pick up all of this income, so it works both ways).
• A business owner residing in State A who sells equity in a business operating solely in State B generally would not report the resulting gain to State B. If the transaction is treated as an asset sale, State B may impose a tax.

Being present in a state more than six months does not necessarily require a resident tax filing, and being absent from a state less than six months does not mean you are a nonresident. While some states have a bright-line test (e.g., New York: 183 days, plus permanent place of abode), many do not (e.g., time in California may raise a presumption of residence but is never solely determinative of residency). In every situation, each taxpayer must consider their unique facts and circumstances.

Manage Income Timing

Short of pulling the plug on Massachusetts residency, taxpayers may consider other ways to blunt the impact of the new tax. To the extent a taxpayer maintains control over the timing of income events, such taxpayer may consider accelerating income prior to the effective date of any increase in Massachusetts tax. Taxpayers should weigh the benefit of avoiding an additional 4% tax against the accelerated cash payments required for both federal and state taxes.

Stay Put With a Pass Through

Even without the prospect of a millionaire’s tax, the federal Tax Cuts and Jobs Act of 2017's $10,000 cap on state and local tax (SALT) deductions added another item to the con column when weighing whether to remain in Massachusetts.

In response to the $10,000 cap, Massachusetts, California, New York and several other states have recently enacted so-called SALT cap workaround laws.

Under SALT cap workaround laws, state income tax is imposed directly on the pass-through entity, converting a limited deduction into a deduction at the entity level. The pass-through income is reduced by the tax payment, which in turn reduces the federal taxable income. The pass-through owner is generally provided a credit or deduction for the pass-through entity tax paid, creating little or no incremental state tax.

Business owners who decide against moving in response to the Fair Share Amendment could mitigate the impact of the tax by considering the state’s pass-through entity tax regime. Using these Massachusetts and other state workaround laws as planning tools would not reduce the Massachusetts tax liability, but they would provide a federal tax benefit for the increase in the Massachusetts tax.

The Takeaway

High net worth taxpayers in Massachusetts, who already can be said to live in a high-tax state, will face even higher taxes if voters approve the Fair Share Amendment in November. Recent trends in workforce mobility and the state’s new SALT cap workaround law provide potential opportunities for avoiding or mitigating the tax. Contact an Andersen SALT advisor to discuss how you can incorporate these options in your tax planning.