Substantial changes to the Massachusetts estate tax, capital gains tax and the Massachusetts Millionaires Tax recently became law under legislation titled An Act to Improve the Commonwealth's Competitiveness, Affordability, and Equity (Act), which was signed by Gov. Maura Healey on Oct. 4, 2023. Residents of Massachusetts, non-residents with Massachusetts property, those administering estates in Massachusetts and those with income taxable in Massachusetts should understand how these changes operate to reduce estate taxes and short-term capital gains taxes and increase the taxable income of high-income earners.
What Is the Massachusetts Estate Tax?
The Massachusetts estate tax is a transfer tax on the value of a decedent's estate before distribution to any beneficiary of the estate. It applies to decedents 1) who are residents of Massachusetts at the time of their death and 2) non-residents with real estate or tangible personal property located in Massachusetts. The rate of the tax is graduated, meaning that the percentage increases as the value of a decedent's estate increases.
How Does the Act Change the Massachusetts Estate Tax?
Formerly, if the value of a decedent's estate did not exceed $1 million, no tax was owed; however, if the value of the decedent's estate exceeded $1 million, the entire value of the estate was subject to tax. Accordingly, the $1 million limit was really a filing threshold and not an exclusion. To preserve the exclusion, a married couple with proper estate planning could protect $1 million from Massachusetts estate tax upon the first death between the spouses, but if the surviving spouse had an estate valued at more than $1 million, every dollar would be taxed. For taxpayers with larger estates, trust planning was essential to protect $1 million from estate tax for each spouse. Note that portability, which exists under federal estate tax rules, is not applicable to the Massachusetts estate tax.
The Act increases the exclusion amount from $1 million to $2 million and treats the new amount as a true exclusion, as it now applies regardless of whether the decedent's estate exceeds $2 million. Estates exceeding $2 million will be subject to tax on the excess at a rate starting at 7.2 percent and increasing with the size of the estate, up to 16 percent. For a married couple, trust planning is still required to maximize the use of the exclusion for each spouse.
Under the Act, if a resident dies owning real estate or tangible personal property outside of the Commonwealth, any estate tax owed will be reduced proportionately by the value of such property. On the other hand, non-residents owning real estate or tangible personal property within the Commonwealth will still pay tax to the Commonwealth in an amount proportionate to the value of such property if the non-resident has a Massachusetts taxable estate exceeding $2 million. For non-residents, the Massachusetts taxable estate includes all property, wherever it is located. Therefore, Massachusetts continues its punitive computation for non-residents by treating the entire estate of the non-resident as if it were taxable by Massachusetts and then applying a fraction of real estate and tangibles in the Commonwealth over total assets to the tax so computed, thereby significantly limiting the benefit to them of the new $2 million exemption. Note that some taxpayers transfer real estate to limited liability companies (LLCs) to convert real estate that is taxable by the Commonwealth to intangible property that is not taxable by the Commonwealth, but it is not certain that doing so without a legitimate business purpose will be respected.
When Does the Act Apply?
Importantly, the Act was effective as of Jan. 1, 2023. Estates of decedents who died during 2023 that have already paid Massachusetts estate tax may be entitled to a refund.
Brass Tacks
Under the previous Massachusetts estate tax, an unmarried decedent with an estate of $2 million would have paid $99,600 to the Commonwealth. Under the Act, that same decedent will not pay any tax.
More significant is the benefit to married couples with proper estate planning. Under the previous Massachusetts estate tax, a married couple with $4 million who planned appropriately for the tax would pay $182,000 at the death of the surviving spouse. Under the Act, that same couple will not pay any tax.
Capital Gains Tax
The Act reduces the short-term capital gains rate from 12 percent to 8.5 percent, effective Jan. 1, 2023. As the long-term capital gains rate in Massachusetts is 5 percent (equal to the Massachusetts ordinary income tax rate), short-term capital gains represent a 3.5 percent surcharge on that income.
Massachusetts Millionaires Tax
The Massachusetts Millionaires Tax, enacted in 2022, imposes an additional 4 percent income tax on a Massachusetts tax filer's return reporting income over $1 million. Accordingly, Massachusetts taxes the first $1 million of income at 5 percent and any income thereafter at 9 percent. To legally report less income on a return, some married taxpayers would elect to file their returns separately with the Commonwealth and jointly at the federal level, which afforded favorable tax treatment at both levels.
To foreclose the availability of this income tax planning, the Act requires married couples to elect the same status with Massachusetts as they do at the federal level. Accordingly, the Act does not foreclose the opportunity to legally reduce the reportable income of one spouse under a Massachusetts return; however, married couples will have to weigh that benefit against lost benefits at the federal level. This requirement can pose a challenge for couples who wish to claim a different domicile for tax purposes.
Questions
If you have any questions about the changes to the Massachusetts estate and income taxes, please contact the authors, your estate planning counsel or another member of Holland & Knight's Private Wealth Services Group.
Primary Contacts:
David Scott Sloan, Co-Chair, Global Private Wealth Services Group
Shari A. Levitan, Chair, New England Private Wealth Services Group