It’s hard to believe, but the Massachusetts legislature passed it’s first changes to the state’s tax code in over 20 years on October 3^rd, 2023. Bill, H4104, is called “An Act to Improve the Commonwealth’s Competitiveness, Affordability, and Equity” and there are many significant changes in the bill that affect a wide range of taxpayers. The most important changes relate to the Massachusetts Short-Term Capital Gains tax, the Massachusetts Estate tax, and the potential loophole to the Massachusetts Millionaire Tax. Senate President Karen E. Spilka said “It is the largest bipartisan legislative tax relief proposal in over a generation, and I think in probably everyone’s collective memory” during a press conference announcing the passing of the tax cuts.

Except as noted below, these changes go into effect for the 2023 tax year.

Short-Term Capital Gains Tax Rate

Massachusetts has an arcane rule that taxes short-term capital gains differently than other ordinary income. Prior to the passage of this bill, the short-term capital gains rate was 12.5% which was 7.5% higher than the ordinary income rate of 5%. Almost every other state (that has state income taxes) and the Federal Government treat short-term capital gains the same as ordinary income.

To normalize this discrepancy, the bill cuts the current rate of 12.5% to 8.5%. Massachusetts Governor Maura Healy wanted the rate dropped to the 5% ordinary income tax so that Massachusetts would drop out of the group of only three states that tax short-term gains more than ordinary income so maybe we’ll see the rate drop to 5% in a future bill.

Estate Tax Exemption and Uniform Estate Tax Credit

Massachusetts, prior to the passage of this bill, had the lowest (tied with Oregon) estate tax exemption amount in the country set at $1,000,000. The bill raises the threshold at which the estate tax applies from $1 million to $2 million which means that estates valued at less than $2 million will not be subject to the estate tax. This is a significant change but in comparison to the other 11 states that have an estate tax, Massachusetts’s estate tax exemption is now only higher than Oregon and Rhode Island.

This bill also gets rid of the so called “cliff effect” of the estate tax, where any estate that was valued over $1,000,000, was subjected the entire estate to estate tax. To change this and reduce the estate tax burden on estates, this bill includes a new uniform estate tax credit of $99,600, that effectively gives estates a tax credit for the value of the estate under the new $2,000,000 estate tax exemption amount. This means that estates are no longer subject to the “cliff effect”.

The estate tax changes are effective for estates created January 1, 2023 or later, which means that estates of people who died in 2023 can take advantage of these new exemption and credit amounts. If an estate tax return has already been filed for someone who died in 2023, the personal representative of the estate should file an amended return to recover the extra estate taxes paid.

Millionaire’s Tax Loophole

The Massachusetts Millionaire Tax, which is an additional surtax of 4% of taxable income over $1,000,000 for Massachusetts taxpayers, went into effect in 2023. A potential loophole to this tax exists if married taxpayers were to file separately in Massachusetts even if they filed jointly on their Federal Income Tax return. Splitting the income between spouses who collectively exceeded the $1,000,000 threshold but not separately could allow them to avoid the 4% surtax by filling separately in Massachusetts.

The new law requires taxpayers to file a joint Massachusetts return in any year they file a joint Federal return (effective as of January 1, 2024). This aims to eliminate the loophole created when the Millionaires’ Tax was enacted at the beginning of 2023 (i.e., a 4% surtax on income over $1 million). Because the surtax applies per return, married couples could file separately to avoid it, which will no longer be the case.

Child and Dependent Care Tax Credit

The Massachusetts’ child and dependent tax credit will increase from $180 per dependent to $310 in 2023 and then to $440 in 2024 and beyond. This change will make the child and dependent care tax credit the most generous universal child and dependent care credit in the country.

Earned Income Tax Credit

The Massachusetts’ earned income tax credit will increase from 30% to 40% of the federal credit amount for taxpayers that are eligible for the federal earned income tax credit.

Senior Circuit Breaker Credit

The Massachusetts senior circuit breaker credit maximum amount will double from $1,200 to $2,400. This allows seniors who are age 65 or older and meet certain income requirements and who rent or own a home in Massachusetts to get the credit for rental expenses or property taxes paid.

Rental Deduction

The Massachusetts rental expense deduction of 50% of rent paid to a landlord for a principal residence in Massachusetts is increased to from a maximum deduction of $3,000 to $4,000.

Commuter Transit Benefits

The bill increases the types of expenses eligible for the commuter expense deduction which has a total limit of $750 in expenses. Currently only EZ Pass tolls and weekly or monthly passes for MBTA, bus, commuter rail and commuter boat expenses are eligible. Going forward public transit fares, regional transit authority fares, commuter boat fares, bikeshare memberships, bicycle purchases (including electric bicycles), bicycle maintenance, bicycle repair, and bicycle storage, are now eligible for the commuter expense tax deduction.

Septic System Tax Credit

The bill triples the maximum credit available for homeowners that are replacing or repairing a failed septic system from $6,000 to $18,000. The credit is available for 40% of the expenses paid and there is not change to this amount meaning the maximum amount of expenses attributable to the credit calculation is $45,000. The bill also increases the amount of the total credit that can be claimed each year from $1,500 to $4,000 per year.

Chapter 62F

You may remember the Chapter 62F Tax provision that allows for taxpayers to receive a credit if total tax revenues in a given year exceed an annual cap tied to wage and salary growth in Massachusetts. For tax year 2021, this amount was $2.941 billion, and this entire sum was returned to Massachusetts taxpayers (residents, non-residents, trusts and estates) in proportion to the taxes the taxpayer paid for 2021. The estimated amount of the refund was 13% of taxes paid.

The bill makes changes to how refunds work under Chapter 62F. If this provision is triggered again, the proportional system of refunding taxes paid will be replaced with an equal payment system. This doesn’t seem very fair and this part of the bill may come up against legal scrutiny.

Summary

There’s a lot of good news for Massachusetts taxpayers in this bill. The monetary benefits will be different for every taxpayer but based on the breadth of the provisions, all taxpayers should get some benefit from the changes.

If you have any questions about how An Act to Improve the Commonwealth’s Competitiveness, Affordability, and Equity will affect your personally or if you need help with your tax planning or financial planning in general, please reach out to our team.