The Massachusetts Department of Revenue has provided guidance on its workaround to the federal income tax system’s $10,000 limit on deductions for state and local taxes for individuals (the “SALT Cap”). On March 18, 2022, it released Technical Information Release 22-6: Pass-through Entity Excise, providing guidance on the new excise tax election created by chapter 63D of the Massachusetts General Laws. The full text can be found here.

Overview

Certain entities such as an S corporation, limited liability company, or a partnership which is taxed as a pass-through entity for federal income tax purposes (a “PTE”) can elect to pay a pass-through entity excise tax (the “Excise”) to Massachusetts of 5% on certain income. The PTE can deduct the Excise paid from its income for federal tax purposes and accordingly reduce the taxable income allocated to its members without invoking the SALT Cap.^[1] Each member of the PTE benefits from the reduced PTE income and each Qualified Member (see below) of the PTE can apply a credit of 90% of its portion of the Excise against its Massachusetts income tax liability. Because only 90% of the Excise is creditable against Massachusetts income tax liability, there are scenarios where Qualified Members may pay more total tax if a PTE elects to pay the Excise.

Key Definitions

• A PTE which can make the Excise election is:
  • A partnership, an S corporation, or a limited liability company which is treated as either a partnership or an S corporation for federal income tax purposes;
  • doing business in Massachusetts or deriving income subject to Massachusetts income tax at the member level; and
  • not a disregarded entity for federal income tax purposes (e.g., a single member LLC).
• Qualified Members include natural persons, trusts, estates, and disregarded entities belonging to natural persons, trusts, or estates.

Calculation

The Excise is calculated as 5% of the PTE’s Massachusetts taxable income, which is made up of (a) the PTE’s income attributable to Qualified Members who are resident in Massachusetts, plus (b) (i) the PTE’s income attributable to Qualified Members who are not residents of Massachusetts multiplied by (ii) the PTE’s Massachusetts apportionment percentage for the tax year.

A Qualified Member’s Massachusetts tax credit resulting from the Excise paid by the PTE to Massachusetts is 90% of its share of the Excise (using a fraction equal to (x) the Qualified Member’s income included in parts (a) or (b) of the PTE’s Massachusetts taxable income in the above paragraph divided by (y) the PTE’s Massachusetts taxable income).

A Qualified Member still may pay more total tax than it would have prior to the imposition of the SALT Cap (specifically, the 10% not creditable against Massachusetts taxes) but will pay less in aggregate for income that would otherwise result in Massachusetts taxes exceeding the SALT Cap. However, if the Qualified Member’s total Massachusetts tax liability would be less than $10,000 without the Excise, the Qualified Member will pay more in total taxes if the PTE elects the Excise (again, due to the not-creditable 10%). There is no opt-out (or opt-in) election for individual members, meaning that the election is made at the PTE level for all Qualified Members.

Election Filing and Payment

The election itself will be made on the PTE’s Massachusetts income tax return (although not if the return is being amended or filed late) for any year in which the SALT Cap is in effect. The SALT Cap is currently scheduled to sunset on December 31, 2025.

Estimated Excise must be paid by the PTE quarterly throughout the year although the election itself cannot be made until the end of the year.

Additional details regarding the filings and payments required to elect the Excise are contained in the Release.

Disclaimer

This summary does not include or address every provision of the applicable tax laws discussed above. Any information contained in this communication is not intended as a thorough, in-depth analysis of specific issues. It is also not sufficient to avoid tax-related penalties. This has been prepared for informational purposes and general guidance only, and does not constitute legal advice. You should not act upon the information contained in this publication without obtaining specific legal advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and Hinckley Allen, its members, employees, and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

[1] See IRS Notice 2020-75.

Follow Hinckley Allen on Twitter and LinkedIn for the latest news and updates.