September 30, 2021
Massachusetts enacts an elective tax on pass-through entities
On September 30, 2021, the Massachusetts legislature overrode the governor's veto of HB 4009,1 enacting an elective pass-through entity (PTE) tax.2 The PTE tax is intended to enable Massachusetts taxpayers who are PTE owners to deduct, for federal income tax purposes, state and local taxes exceeding the annual $10,000 deduction limitation ($5,000 for married individuals filing separately) imposed by IRC Section 164(b)(6) (the SALT deduction limitation), consistent with IRS Notice 2020-75 (see Tax Alert 2020-2690).
Under this provision, an eligible PTE (i.e., an S corporation under IRC Section 1361, a partnership under IRC Section 7701, or a limited liability company treated as either) can annually elect to pay a 5% excise tax on its "qualified income taxable in Massachusetts"3 (which is the same as the regular commonwealth personal income tax rate). Once made, the election is irrevocable and binding on all members of the electing PTE.
Qualified members4 of an eligible electing PTE can claim a refundable credit against their Massachusetts personal income tax. The credit equals each qualified member's proportionate share of tax due and paid by the eligible PTE multiplied by 0.9, and is available for the member's tax year in which the electing PTE's tax year ends.
This PTE tax election is effective for tax years beginning on or after January 1, 2021, but is not available in an income tax year during which the federal SALT deduction limitation under IRC Section 164 has expired or is otherwise not in effect.
The electing PTE's excise tax is in addition to any other Massachusetts tax imposed on the PTE. Further, the excise tax is due and payable on the eligible PTE's original, timely-filed return, which is due at the same time as a partnership information return or a corporate excise return under Chapter 62C of the Massachusetts General Laws. The new PTE tax laws do not change the filing requirements for qualified members of an electing PTE.
In November 2020, the IRS indicated its intention in Notice 2020-75 to propose regulations clarifying that a partnership or an S corporation computing non-separately stated taxable income or loss for federal income tax purposes could deduct state and local income taxes imposed on its net income for the tax year at issue without regard to the SALT deduction limitation (see Tax Alert 2020-2690). Those regulations have yet to be proposed. It was widely anticipated that most states would rush to enact an entity-level tax to provide the federal tax benefit to owners of PTEs in their states.5 Massachusetts becomes the latest state to enact such a "workaround" to the federal SALT deduction limitation by allowing a PTE or its owners to elect to pay state or local income taxes at the entity level.6
HB 4009 directs the Massachusetts Revenue Commissioner to promulgate regulations or other guidance to implement the new elective PTE tax. Hopefully, the guidance would (1) clarify whether the credit would be available to qualified members with income from more than one eligible PTE, (2) provide rules on applying these provisions to trusts and estates, and (3) establish estimated payment requirements.
EY will continue to monitor developments in this area.
1 The provisions of HB 4009 were formerly part of the commonwealth's fiscal year 2022 budget bill (2021 MA HB 4002). The governor vetoed HB 4009 on August 3, 2021. The House voted to override the veto on September 23, 2021, with the Senate voting to override the veto on September 30, 2021.
2 Adds new Chapter 63D to the Mass. Gen. Laws.
3 Section 1 of Chapter 63D defines "qualified income taxable in Massachusetts" as "the income of an eligible [PTE] determined under chapter 62 [Massachusetts personal income tax law] allocable to a qualified member and included in the qualified member's Massachusetts taxable income under … chapter 62."
4 A "qualified member" is defined in Section 1 of Chapter 63D as "a shareholder of an S corporation or a partner in a partnership, including a member of a limited liability company that is treated as an S corporation or partnership … , that is a natural person or trust or estate subject to tax under section 10 of chapter 62 [Massachusetts personal income tax law]; provided however, that a qualified person may be a resident, nonresident or a part-year resident."
5 Connecticut, Louisiana, Maryland, New Jersey, Oklahoma, Rhode Island and Wisconsin had already enacted PTE taxes (or PTE tax elections) before IRS Notice 2020-75 was issued.
6 After IRS Notice 2020-75 was issued, Alabama, Arizona, Arkansas, California, Colorado, Georgia, Idaho, Illinois, Minnesota, New York, Oregon and South Carolina, among others, enacted similar PTE-level taxes. In addition, similar elective PTE bills have been approved by state legislatures in Michigan (although the Michigan bill was vetoed by the Governor on July 13, 2021). Bills that would enact a similar PTE tax are being considered in North Carolina and Pennsylvania.