In November of 2022, the state’s constitution was amended to add a new tax. Article 44 of the Massachusetts Constitution was amended by adding the following paragraph at the end thereof:
To provide the resources for quality public education and affordable public colleges and universities, and for the repair and maintenance of roads, bridges and public transportation, all revenues received in accordance with this paragraph shall be expended, subject to appropriation, only for these purposes. In addition to the taxes on income otherwise authorized under this Article, there shall be an additional tax of 4 percent on that portion of annual taxable income in excess of $1,000,000 (one million dollars) reported on any return related to those taxes. To ensure that this additional tax continues to apply only to the commonwealth’s highest income taxpayers, this $1,000,000 (one million dollars) income level shall be adjusted annually to reflect any increases in the cost of living by the same method used for federal income tax brackets. This paragraph shall apply to all tax years beginning on or after January 1, 2023. (emphasis added)
This constitutional change means that every taxpayer, whether a person, corporation, or trust, will now have to pay an additional 4% on annual income that exceeds $1 million. As a result, Massachusetts ranks among the states with the highest income tax rates.
Millionaire’s Tax Avoidance Planning: Fortunately, for most taxpayers, the Massachusetts millionaire tax is completely avoidable with proper planning. There are several techniques available for individual taxpayers (or for married couples filing a joint return).
- Change of Residency – moving to a state with lower income taxes. For many MA taxpayers, Florida is the preferred choice because there is no income tax, no estate tax and generally a lower cost of living. In order to avoid Massachusetts Income Tax (and the Millionaire’s Tax) you must be out of the Commonwealth for at least 183 days of the tax year. Remember that partial days in Massachusetts count as a full day. In order to change residency, at a minimum you must (1) get a driver’s license in your new state of residence, (2) register your car there and (3) register to vote in the new state.
- Use of Married Filing Separately – some married couples may avoid the tax by changing their filing status. By choosing “Married Filing Separately” married taxpayers may often bring the income below the $1 million threshold.
- NING Trusts – NING stands for Nevada Incomplete Non-Grantor Trust. This is a special type of irrevocable trust into which you may gift an income producing asset using Nevada law. The way the trust is set up the income from the trust owned assets escape MA income tax. The trust is taxed under Nevada law and Nevada has no state income tax on trust income. This is often a trust that is beneficial to someone who will be in the highest US tax bracket (37% in 2023 but will revert to 39.6% in 2026).
- Like Kind (1031) exchange – Used for investment real estate a like-kind exchange is essentially a swap of one real estate investment for another. Because of a specific provision in the Internal Revenue Code taxpayers who comply with the requirements of Section 1031 do not have to recognize any capital gain on the transaction.
- Qualified Personal Residence Trusts (QPRTs) – This type of irrevocable trust offers a way to transfer the home of a client at a discounted price. The client reserves the right to live in the property for a term of years. At the end of the term the ownership of the home transfers to an irrevocable asset protection trust usually for the benefit of one or more of the children.
- Domestic Asset Protection Trusts (DAPTs) – DAPTs are recognized in about 17 states in the US. By transferring assets that will create a large income event (like a business that is going to be sold, or a stock portfolio with large unrealized gains) to a DAPT the income caused by the sale of the asset can be moved to a state with a lower income tax, or no income tax at all.
- Entity Wrapping – By placing real estate or a business into an LLC that is organized in a state with lower or no income tax, then placing the first LLC into a second LLC organized in the same state as the first LLC, and then selling the first LLC (not the real estate or the business owned by the first LLC), the asset sold is the LLC organized in a state other than MA and therefore is not subject to the MA income tax. For example, if Mr. & Mrs. Jones owned a $2 million home in Osterville with a cost basis of $500,000, if they sold the real estate they would be subject to the millionaire’s tax. But if they first placed the home into a South Dakota LLC #1, then placed LLC#1 into South Dakota LLC #2 and then sold LLC#1 which owns the real estate, the income for the sale of LLC#1 belongs to LLC #2 and will be taxed in South Dakota, not Massachusetts. LLC#2 may distribute the proceeds in such a way that the income of Mr. & Mrs. Jones spread out over multiple years keeping the Jones’ income below $1 million. Because there are several options for taxation of LLCs, a client considering entity wrapping should consult with an advisor to be sure that the correct tax status for the LLCs is chosen.
- Charitable Remainder Trusts (CRTs): A CRT is a special type of Trust through which capital gains may be spread out over a period of years, thereby lowering the amount of income recognized in any given year. This may be used to eliminate the Massachusetts Millionaire’s Tax AND it can lower the US Capital Gains taxes on assets placed into the trust before a recognition event. Often dubbed a “Capital Gains Avoidance Trust” CRTs do not actually avoid capital gains, but instead they spread the capital gains and the tax thereon over a period of years – sometimes over the lifetime of the beneficiaries of the CRT – that is usually the person or persons setting up the trust. CRTs are often chosen because they can turn an income tax into a tax deduction. That is because CRTs include a charity to inherit whatever is left (if anything) after the death of the beneficiaries.
- Installment Notes: When selling real estate or a business most people will receive the full amount of the purchase at the closing. However, if you wanted to spread the recognition of capital gain out over a period of years you might chose to accept payment through an Installment Note. With a properly drafted Installment Note you pay tax on the income from the sale as you receive installment payments from the buyer. This approach has been used for many years to reduce the federal capital gains tax on the sale of real estate or the sale of a business. By delaying receipt of the proceeds from the sale the seller is also delaying the income tax liability. As long as the annual payments to the seller under the installment note keep the income (including the gain attributed to the payments from the sale) below $1 million no millionaire’s tax will be due. Many people set up the payments so that their income stays below the 20% US capital gains tax rate.
The Massachusetts millionaires tax may be avoided by C-Corporations and irrevocable trusts through many of the same techniques as individual taxpayers. In addition, C-Corps and trusts might employ income splitting techniques. For example, corporations might consider a spin-off of a division to reduce the income of the business to less than $1 million.
Irrevocable Trusts are normally treated as separate taxpayers, requiring a tax identification number (TIN), and special tax returns (US Form 1041 and MA Form 2). But when the terms of a trust require division into sub-trusts, each sub-trust can obtain a new TIN and file a separate income tax return. By creating sub-trusts for (1) individual beneficiaries or (2) marital deduction planning (in Massachusetts, we often use A-B-C planning) or (3) even to divide into shares for purposes of reducing the US Generation Skipping Transfer (GST) Tax, each sub-trust can file a separate income tax return, splitting the trust’s income into smaller pieces. By dividing trust income into small pieces, the Massachusetts Millionaire’s Tax can be avoided at the trust level.
Because capital gain income will unexpectedly push families into the Massachusetts Millionaires Tax, it is critical that trusts be written to take advantage of a “step-up in cost basis” whenever possible – not just when the donors pass away. There are techniques through which a step-up may be obtained when a beneficiary dies. This technique, called the Optimal Basis Increase Trust (OBIT) provisions, may be added to trusts that are multi-generational or dynasty trusts. Visit our OBIT provisions page to learn more.
If you think you may be subject to the Millionaire’s Tax in Massachusetts, it is critical that you meet with a qualified tax advisor, like Boyd & Boyd, P.C., as soon as possible. Which, if any, of the above-mentioned techniques may be right for you can only be determined after your advisor understands your particular needs. The above list is not exhaustive either. There may be other approaches that better fit your needs. The bottom line is that avoiding the Millionaire’s tax requires professional assistance. Seek out help as soon as you realize your income might exceed $1 million.