The new Massachusetts “Millionaires Tax” imposes an additional 4% income tax on the portion of annual taxable income in excess of $1 million (indexed for inflation), starting in 2023. The new tax will affect high-income taxpayers annually and may affect some taxpayers on a one-time basis as a result of certain events, such as upon the sale of an expensive home or sale of a business.
There are some methods to avoid the Millionaires Tax, as detailed below.
Married taxpayers may want to speak with their accountant about filing separate Massachusetts income tax returns if both spouses have sufficiently high income. Also, in the event of a one-time sale of a large asset by one spouse, prior to the sale, an interest in the asset could be transferred to the other spouse so that each spouse would report a portion of the gain on his/her separate state tax return. Filing separately could effectively shelter an additional $1 million and would not require the couple to file separately for federal income tax purposes. Note that this will work currently, but the legislature could change the law to close this loophole.
Gifting property (or an interest in property) prior to its sale can transfer the capital gain (or a portion thereof) on the sale from the owner to the donee(s). A presale gift (preferably several months before the sale) can be made to family members or to so-called “non-grantor” trusts (trusts that are treated as separate taxable entities). These trusts can be for the benefit of children and other beneficiaries, or, if desired, can include the donor’s spouse (so-called spousal limited access non-grantor trusts (SLANTs)).
These trusts can also be drafted as non-resident trusts in a jurisdiction without income tax (a non-Massachusetts trustee would be required), although Massachusetts-source income would still be subject to the Massachusetts income tax. If the owner of the asset does not have estate tax exemption available to shield a presale gift from estate tax, and does not want to pay gift taxes, the transfer can be structured as an incomplete gift to a special type of non-grantor trust.
For clients who have substantial income in existing irrevocable grantor trusts (trusts for which the donor is treated as the owner for income tax purposes), making changes to these trusts to convert them to non-grantor trusts may be desirable. This can also include changing the jurisdiction of the trusts to a state that does not impose an income tax (a non-Massachusetts trustee would be required), although again, this would not prevent Massachusetts-source income from being subject to Massachusetts income tax.
Of course, a change to non-grantor trust status will eliminate the significant estate planning benefits of paying the income tax for the trust (which under current law is not treated as a gift). For those subject to significant estate taxes, this benefit is likely to be more valuable than the cost of the additional Massachusetts income tax. A close analysis is required here.
Making major sales on the installment method is another way to avoid the Millionaires Tax, since gain would be recognized over multiple years. There may be economic risks in this approach that must be considered.
Moving to another state can eliminate Massachusetts income tax entirely, except on Massachusetts-source income, which includes income from a Massachusetts-based business (including employee compensation and flow-through subchapter S income or partnership/LLC income from a Massachusetts business) and income from real property located in Massachusetts.
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