Who wants to be a millionaire? Although higher household income is often something families strive for, with the passage of the Massachusetts Millionaires Tax (MMT) on November 8, 2022, having taxable income in excess of $1 million has become less attractive for 2023 and beyond. While it is estimated that only 0.6% of households will be impacted by the new tax annually, some households could find themselves subject to the tax as the result of a one-time event such as a significant Roth conversion or the sale of a home or business.
Beginning in 2023, if the taxable income on your Massachusetts income tax return is over $1 million, you will pay an additional 4% tax on the income exceeding the $1 million threshold. This is in addition to the other state tax, usually 5%, on income.
The following are a few planning ideas to potentially decrease the impact of the new tax.
Considerations before January 1, 2023:
Roth IRA Conversions: If you have any interest in a significant Roth IRA conversion, now may be the time to take action. When you convert a traditional IRA to a Roth IRA, you include the conversion amount in current income, but then enjoy tax-free growth on amounts inside the Roth IRA. In addition, a Roth IRA does not have required minimum distributions (RMDs). By converting traditional IRAs to Roth IRAs during 2022, you would be able to avoid the MMT on both the conversion amount and any future RMDs that might push your income over the $1 million mark.
Learn More: Roth Conversions: Is Now the Time?
Capital Gains and Losses: Accelerating capital gain recognition into 2022 and delaying capital loss harvesting to 2023 may be beneficial. The gains may cost you less in 2022, and the losses may have a bigger tax benefit in 2023.
General wisdom is to delay the recognition of income whenever possible. However, if you will be subject to the MMT, you would likely benefit from accelerating income into 2022. Going forward, using installment sales may help you manage the gain recognition on sales to keep you under the MMT threshold.
Considerations after January 1, 2023:
- Qualified Charitable Distributions (QCDs): If you are over age 70 ½, you can gift up to $100,000 per year from your traditional IRA to a qualified charity. Done properly, the QCD amount will count towards your RMD and you will not recognize income on the amount gifted directly to the charity. For those with philanthropic goals, using a QCD can be another option for lowering taxable income.
- Charitable Deductions: Beginning in 2023, Massachusetts will once again allow charitable deductions against taxable income. If you are pushing up against the MMT and charitably inclined, making charitable contributions beginning in 2023 may be attractive. Coupling that with using appreciated securities for the donation can be a double benefit by getting a full fair market charitable deduction and avoiding recognition of the embedded capital gains on the security gifted. If you will be subject to the MMT due to a one-time income event, such as a significant Roth IRA conversion or the sale of your home or company, you may wish to consider establishing a Donor Advised Fund (DAF) and deduction bunching by gifting multiple years’ worth of charitable gifts to the DAF currently, in order to offset your current income event. You could then request that the gifts be distributed to charities over multiple years in line with your charitable goals.
Learn More: Minimizing Taxes with Charitable Gift Bunching
Bond Investments: If you will be subject to the MMT, changing your municipal bond strategy to be Massachusetts focused will exclude that income from Massachusetts taxable income. In addition, the interest from U.S. Treasuries is not taxable in Massachusetts.
Commercial Real Estate and 1031 Exchanges: If you are thinking of selling and replacing a commercial real estate holding, you should explore utilizing a Section 1031 exchange that allows you to exchange the properties and delay any gain recognition until the ultimate disposition of the property.
Qualified Opportunity Funds: Before January 1, 2027, capital and qualified Section 1231 gains can be deferred by investing the gain amount in a Qualified Opportunity Zone utilizing a Qualified Opportunity Fund. Under this provision, gains must be properly reinvested within 180 days of the realization event.
New Hampshire Trusts: Depending on your situation, there may be opportunity to establish irrevocable New Hampshire trusts and avoid state income tax on ordinary income or capital gains, but not on Massachusetts-sourced income. Placing an income-producing investment or a business interest prior to a liquidity event in the trust may avoid the MMT. However, this only works if the ordinary income in a particular year is not withdrawn from the New Hampshire Trust.
Learn More: New Hampshire’s Trust Advantages
Is Married Filing Separately (MFS) an Option? A couple can file their federal income taxes as Married Filing Jointly (MFJ) and file their Massachusetts income taxes as MFS. Based on the language of the constitutional amendment that is the MMT, it appears that the tax is levied on a per return, and not per household, basis. If this is not interpreted differently by the Massachusetts Department of Revenue (MA DOR), a couple may be able to have up to $2 million of income in a year taxed only at the 5% rate. This may require shifting ownership of assets between spouses to accomplish the benefit.
Wealth Transfer: If your wealth plan goals include wealth transfer to your family, you have assets you do not anticipate needing during your lifetime, and your children or trusts for their benefit will not be subject to the MMT, you may wish to consider gifting assets sooner rather than later. This may help to both remove any future appreciation from your taxable estate and avoid the MMT.
Changing Domicile: Most income will not be taxable in Massachusetts if the taxpayer is not domiciled here. For an individual, changing your domicile is not easy, but there are plenty of families that have successfully moved their domicile to Florida or New Hampshire, two states without an income or estate tax. It is likely that the MA DOR will continue to be aggressive in verifying that a change in domicile is legitimate, so this is not one to be undertaken lightly.1
Learn More: Changing Your Domicile
Planning to avoid the additional tax may be time well spent. Some things can be done in 2022 to accelerate income into the current year, while others include opportunities for 2023 and beyond. It is important to consult with your tax and wealth advisors to help ensure you make the decisions in this area that best fit your individual circumstances and fulfill your objectives.
1 Although New Hampshire does have an interest and dividends tax.
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