Executive summary: Massachusetts Millionaire’s Tax
Voters recently approved a constitutional amendment to impose an additional 4% tax on Massachusetts individual incomes over $1 million. Affected individual taxpayers should begin planning now to mitigate the impacts of the tax increase, which will take effect in 2023.
Enacted tax changes and potential impacts
On Nov. 8, 2022, Massachusetts voters narrowly passed a referendum to amend the Massachusetts Constitution and impose an additional 4% individual income tax on Massachusetts income over $1 million. The additional tax will go into effect beginning Jan. 1, 2023. Another constitutional amendment would be required to eliminate or otherwise change the 4% new additional tax.
As a result of the amendment, the state’s individual income tax rate for income over $1 million will effectively increase from 5% to 9% on wages, long-term capital gains, dividends, interest and other income, and from 12% to 16% on short-term capital gains, making Massachusetts’ personal income tax rate on short-term capital gains one of the highest in the nation. For pass-through entities (PTEs), in absence of further guidance, Massachusetts pass-through entity withholding tax and elective pass-through entity tax rates will not change.
It is unclear how much guidance will be provided with respect to the implementation of the new tax, including how the additional tax rate will be applied where a taxpayer is reporting both short-term capital gains and income subject to the state’s 5% rate. For additional insights on the debates surrounding and potential impacts of this amendment, please read our previous alert Massachusetts so-called Millionaires' Tax heads to 2022 ballot.
Takeaways and observations
While the Massachusetts Department of Revenue has yet to issue guidance regarding the amendment and its implementation for tax years 2023 and later, taxpayers should proactively consider the potential impacts on changes in residency, social security benefits, pension income, retirement plan distributions, inheritance taxes and other estate and gift tax obligations. In addition, owners of PTEs where the PTE elected to be taxed at the entity level may need to factor in additional individual estimated tax payments to account for the surtax, as PTE tax rates remain at 5%.
Individuals who expect to report over $1 million of Massachusetts income in 2023 or any future year should begin planning now to mitigate the effect of the higher tax rate, including identifying any steps that can be taken before the end of the calendar year. For example, affected taxpayers considering relocation should not do so without due diligence and a thorough understanding of how such relocation could impact future tax planning. It is important for taxpayers to plan for a residency change in advance. Notably, it has been common for state taxing authorities and courts to call into question changes in residency where taxpayers relocated with the sole intent to reduce tax liabilities, even in cases where the taxpayer registered a car, cast a vote, and purchased a home in the new jurisdiction. There are dozens of factors that taxpayers should review when considering tax minimization planning through residency changes.
Taxpayers with questions about the Millionaires’ Tax should speak to their Massachusetts state and local tax advisers for more information.
Finally, the Massachusetts Millionaires’ Tax had both strong supporters and opponents, but ultimately won the approval of voters in the November election with 52% of the vote. While the 2022 legislative sessions resulted in individual income tax rate decreases in many jurisdictions, the concept of tax increases for wealthy individuals remains popular with voters in many states. Several jurisdictions have considered these types of wealth taxes, and California’s November ballot included a measure to increase taxes on incomes over $2 million that was ultimately rejected by voters. For additional insights on the state and local tax issues and outcomes associated with the November 2022 elections, please read our alert: Election results on state tax issues underscore the need for flexibility.