In mid-July, Massachusetts Gov. Charlie Baker signed House Bill 4002, the state’s fiscal year 2022 budget. The governor approved certain provisions at that time, including provisions related to state credits and incentives. However, a delay in the charitable tax deduction was vetoed, and subsequently overrode, and returned to the legislature for amendment provisions related to a new elective pass-through entity tax intending to help taxpayers minimize the impact of the federal state and local tax (SALT) deduction limitation.
Pass-through entity tax workaround
Effective from Jan. 1, 2021, House Bill 4002 would adopt an elective pass-through entity tax intended as a workaround to the individual SALT deduction limitation of $10,000 enacted by the Tax Cuts and Jobs Act in 2017. Qualifying entities, including S corporations, partnerships and certain limited liability companies, may elect to pay an excise tax on its Massachusetts taxable income at the rate of 5%, a rate identical to the state’s personal income tax rate. Unique among elective pass-through entity workarounds, the entity’s members are allowed a refundable state tax credit of 90% of the tax imposed. The credit is in an amount proportionate to each member’s share of the tax due and paid by the entity.
Qualifying entities must elect annually to pay the tax and the election is irrevocable for the year the election is made. The excise tax is due and payable on the entity’s original return and is due at the same time as the partnership information return or corporate excise return. Noteworthy, the elective tax is limited to taxable years where the federal SALT deduction limitation is effective.
The governor had returned the provision to the legislature for consideration of a 100% credit instead of the 90% credit as passed. The legislature rejected the amendment, returning the original proposal for the governor’s approval, but the provision was ultimately vetoed and sent back for potential override. As the legislature has already overrode several of the governor’s vetoes, and considering the provision was unanimously passed, it is likely the measure will succeed. As of the date of this article, the override vote has not been scheduled.
Credits and incentives
The budget makes changes to the state’s available credits and incentives. A few of the changes approved by the governor are highlighted below:
- Modification of the film tax credit to require either Massachusetts production expenses exceed 75% of the total production expenses for a motion picture or at least 75% of the total principal photography days of the film take place in the commonwealth, an increase from a 50% requirement
- Extension of the historic rehabilitation tax credit from Dec. 31, 2022 to Dec. 31, 2027
- Allowance of a refundable credit of $5,000 or 30% of the wages paid to qualified employees with a disability in the first taxable year of employment, whichever is less, and $2,000 or 30% in subsequent taxable years
Charitable deduction delay
House Bill 4002 included a delay to the charitable income tax deduction which was originally to become effective with the state income rate falling to 5%, effective for 2021 tax years. This would be the second delay to the deduction as it was also delayed in last year’s budget. The governor vetoed this year’s delay provision, but was overrode by the legislature. Accordingly, the deduction is delayed to at least 2023.
The reconciled budget avoided tax increases and passed unanimously in both state legislative chambers.
The pass-through entity tax workaround is expected to generate revenue for the state estimated at $90 million in fiscal year 2022 because members of electing pass-through entities are provided a partial, instead of a full credit. Every other state with an elective workaround has provided a full credit or exclusion of the income paid by the entity. Connecticut, the only mandatory workaround, provides an 87.5% credit.
The 2021 legislative sessions have seen over a dozen states adopt a pass-through entity tax workaround. As of the date of this article, over 21 workarounds have been adopted, or passed by state legislatures. Importantly, taxpayers should analyze and model whether making the election and paying the entity-level tax will result in a lower overall tax burden. Not all pass-through entity members may benefit from the election and there may be other tax considerations that make the election undesirable. Taxpayers are encouraged to contact their state and local adviser to determine if paying the entity-level tax is a favorable option.