In June 2021, the Massachusetts legislature voted overwhelmingly to approve a proposed constitutional amendment commonly known as the Millionaires’ Tax, or the Fair Share Amendment. The Millionaires’ Tax would impose a 4% additional tax on income in excess of $1 million effective Jan. 1, 2023. The legislature’s approval of the amendment allows it to appear on the Nov. 8, 2022 general election ballot. If approved by voters, the state constitution will be amended to include the tax in addition to the existing tax rate, which is currently 5% on general income and 12% on short-term capital gains. RSM Washington National Tax specialists previously opined on the policy implications of the proposal. In this article, RSM reviews the proposal and what it means for Massachusetts taxpayers.
The ballot measure
Currently, the Massachusetts tax rate on wages, long-term capital gains, dividends, interest and other income, is 5% for all taxpayer income levels. Short-term capital gains are taxed at 12%. If voters approve the ballot measure, the Massachusetts tax rate on income in excess of $1 million will increase by 4%. Substantively, the Millionaires’ Tax has a multitude of consequences. If approved, the state’s personal income tax rate for incomes over $1 million will effectively increase from a flat 5% to a progressive 9% tax on wages, long-term capital gains, dividends, interest and other income, and, from 12% percent on short-term capital gains to 16%. The latter is among the highest personal income tax rates on short-term capital gains in the nation.
By the numbers
As described by the text of the amendment, revenue received from the additional tax must be allocated for critical education and transportation ventures. While official revenue estimates have not been produced, various reporting suggests the tax could raise over $1 billion per year. While the mechanics of how the tax will be imposed are unclear, (whether by category of income or based on aggregate income), an illustration of how a high-income taxpayer may be impacted follows below:
An individual taxpayer whose gross income consists of $2 million of wages and $1 million of long-term capital gains, would currently owe $150,000 in income tax ($3,000,000*.05).[1] Under the Millionaires’ Tax, the same income would result in a total tax liability of $230,000 ($3,000,000*.05, plus the addition tax on income in excess of $1 million, or $2,000,000*.04), an increase of $80,000 of tax, or over 50%.
The example is to broadly demonstrate the impact of the tax, even though the mechanics of the calculations remain subject to final regulation.
Furthermore, the Millionaires’ Tax may have an even greater effect on owners of S corporations that generate Massachusetts source income. If the same $3 million of Massachusetts income from our example is earned by an S corporation with at least $6 million of gross receipts, the income will be subject to a 2% or 3% additional tax rate. This effectively subjects some S corporations to a total 12% rate relative to the 8% state corporate tax rate.
To complicate the Massachusetts taxing scheme even further, an elective tax on income of pass through entities (e.g., partnerships and S corps) is likely to pass effective for years beginning on or after Jan. 1, 2021. This pass-through entity (PTE) tax legislation is intended to provide federal tax relief by allowing for a state tax deduction workaround of the federal $10,000 limitation. A pass-through entity may annually elect to pay tax at 5%. Owners of the pass-through entity are then entitled to a 90% Massachusetts credit for the entity level tax paid. This election allows for a federal tax deduction on the Massachusetts income tax paid by the pass through entity. Importantly, the elective PTE tax is imposed at the same rate as the general individual income tax rate of 5% and therefore electing owners would still be subject to the 4% Millionaires’ Tax without the benefit of a federal tax deduction that the PTE is designed to alleviate. Pass-through entity owners will need to carefully review and model how the new tax could impact their total tax liability.
Criticism
Critics of the Millionaires’ Tax have argued that while it may only directly affect a small percentage of the Massachusetts population as well as nonresidents that earn income from Massachusetts based businesses, it will almost certainly have an indirect effect on jobs and long-term tax revenues. Due to the ongoing pandemic, many businesses have increased mobility by operating remotely with limited office presences. Consequently, the barriers to relocation have fallen considerably as many industries, Wall Street and workforces embrace a fully or hybrid approach to remote work. Affected businesses such as consulting firms, hedge funds, investment complexes, investment advisors, software and other professional services, as well as their owners and highly-paid employees, are anticipated to exit the Commonwealth for lower or no-tax jurisdictions.
The measure has also received criticism from the small and mid-sized business community as entrepreneurs and business owners routinely invest more on growth and employment rather than personal compensation in the early life cycles of a business. Often it is only upon retirement, transition to subsequent generations, or another divesture, that these business owners generate income in excess of $1 million. Coupled with high housing, living, and property tax costs, the measure may make it less attractive to establish or maintain a business in the Commonwealth.
Takeaways and observations
The Massachusetts Millionaires’ Tax ballot measure has both supporters and opponents, with current polling indicating approval ratings of over 70%. The proposal will likely receive significant media attention in the next several months giving proponents and opponents opportunity to sway voters. While the true economic consequences of its passage are unknown, individuals and businesses are certain to respond in advance of the election, especially in the current virtual work environment.
Massachusetts taxpayers can begin to prepare for the tax now by modeling its impact on current and prospective incomes with consideration of other new tax provisions like the pass-through entity tax. Additionally, individuals relocating or considering relocating from the Commonwealth should not do so without a plan. State audits of residency have recently increased dramatically as taxpayers have taken advantage of remote working environments by relocating to low or no tax jurisdictions like Florida, New Hampshire or Texas. Taxpayers must carefully consider residency planning before performing such a move.
Taxpayers with questions about the Millionaires’ Tax or general Massachusetts tax planning should speak to a Massachusetts state and local tax adviser.
[1] Where the income is earned by an S corporation with at least $6 million of gross receipts, the income will be subject to an additional 2%-3% entity-level ‘sting tax’ before the income passes up to the individual owner. However, the amount of the sting tax will flow up as a deduction on the individual shareholders federal tax return.
