Massachusetts Millionaire Tax – Will This New Tax Impact Your State Tax Return?
Author: Nick Prigitano
Recently citizens in Massachusetts were asked to vote on an amendment to the state constitution to levy a surtax on certain high-earning individuals. After a tight vote, the amendment passed, and starting in 2023 the Mass. Millionaire Tax will begin to take effect.
In this post we’ll explore some of the details of this new tax, whom it may impact, and potential tax-planning implications.
What Is the Mass. Millionaire Tax?
The Mass. Millionaire Tax is an additional surtax of 4% on taxable income over $1 million for Massachusetts taxpayers. This tax stacks on top of the normal Mass. state tax (5% for most taxable income) for a total effective tax of 9% for income above the million-dollar threshold.
It’s important to note that this tax only affects income above $1 million. All income up to that threshold is still subject to normal Mass. tax rates. If you hit $1 million of taxable income, the surtax does not look back and tax all your income, just the amount above the $1 million threshold.
Unlike the estate tax in Massachusetts (which also has a $1 million initial exclusion), the new Millionaire Tax is adjusted for inflation. So, the threshold will increase annually based on a cost-of-living adjustment formula.
Lastly, as reported by NBC Boston, the 4% surtax is simply an addition to the tax code as an exception. Any other changes to the tax code would have to go through a similar amendment process. This one change to Mass. taxes, at least as of the current law, does not allow other tax increases or changes to take effect more easily.
Who Will Pay the Mass. Millionaire Tax?
While it’s true that the new tax only impacts taxpayers with income over $1 million, some taxpayers who normally have lower incomes may unexpectedly find themselves subject to the tax. There are two main possible scenarios in which someone not typically subject to the tax may find themselves paying the surtax in a given year. These are individuals selling their home and business owners.
With real estate prices skyrocketing in recent years, this additional tax may concern some Mass. residents who are planning on selling their home in the near future. Thankfully, even with higher home values, most sellers won’t be subject to this additional tax.
The key language is that the new tax is levied on taxable income. For many sellers, even homes of significant value do not generate much in the way of taxable income. This is for two reasons. First, the way capital gains work is that someone is only taxed on the difference between what they sell the home for and what they purchased the home for plus the cost of any material improvements over the years (the basis). The second reason is that primary home sellers get an additional break in the Federal tax code, which Massachusetts follows. If you’re selling your primary home and it has been your primary residence for at least the past two years (among some other stipulations), there is an additional exclusion on capital gains realized. For single filers, the exclusion is $250,000, and for married individuals it’s $500,000. That means if you’re married and you file a joint return, your total gain would have to exceed $500,000 before any of it would be taxable to you.
Example: Mary and Mike bought their primary home in 2000 for $250,000. In 2010, they built an addition costing $100,000. In 2023 they sold their home for $750,000. To calculate the potential tax, they take the sales price minus the basis of the home ($350,000) to come up with a net gain of $400,000. Since they file a joint return and the home has been their primary residence for over two years, they are eligible for a capital gain exclusion of $500,000 on the home sale. Since their calculated gain is less than that, they are not subject to any tax on the sale of their home.
As we can see from the example above, even though a taxpayer sells a home for significantly more than what they bought it for, it may not be subject to any tax and thus not be subject to the new Millionaire Tax.
In fact, according to reporting from the Boston Herald, last year only 895 home sales generated enough gain to make them subject to the tax.
Another group of Mass. residents who may have to pay the tax are business owners. If they normally wouldn’t be subject to the tax, the time when it is most likely to apply is when they sell their business. A successful, profitable business can fetch a healthy sum. Depending on how the sale is structured, if the seller is paid in a lump sum, that may trigger the Mass. Millionaire Tax.
Potential Tax Planning
With new taxes come new tax planning opportunities. For home sellers, regardless of whether you may be subject to this tax, the big thing to do is keep good records of all the improvements you’ve made over the years. Certain improvements increase the basis of your home, so when you finally sell, the amount of the taxable gain may be less. Even if your income in that year is not subject to the surtax, you will still owe less for normal Mass. taxes and federal taxes as well.
For business owners who are planning on selling their business, it may make sense to adjust the structure of the sale. Instead of receiving a lump sum, creating an installment sale that spreads the proceeds of the sale over the course of a few years may limit your income enough that the additional surtax does not apply.
Although there is a new tax in Massachusetts, most taxpayers will not be subject to it. In fact, it’s estimated to only affect roughly 20,000 taxpayers each year.
A common misconception about the amendment is that it will impact many taxpayers when they sell their home. However, because of the way capital gains on the sale of a primary residence are currently structured, most sellers won’t have enough taxable income from the home sale to push their income above $1 million.
It may be a little trickier for business owners who are looking to sell their business in the future. However, there may be ways to spread out the proceeds from the sale to keep their income below $1 million each year.
If you need help with your tax planning or financial planning in general, please reach out to our team.
This is not to be considered investment, tax, or financial advice. Please review your personal situation with your tax and/or financial advisor. Nick Prigitano, CFP® is an advisor at Milestone Financial Planning, LLC, a fee-only financial planning firm in Bedford NH. Milestone works with clients on a long-term, ongoing basis. Our fees are based on the assets that we manage and may include an annual financial planning subscription fee. Clients receive financial planning, tax planning, retirement planning, and investment management services, and have unlimited access to our advisors. We receive no commissions or referral fees. We put our clients’ interests first. If you need assistance with your investments or financial planning, please reach out to one of our fee-only advisors.