On November 8, 2022, Massachusetts voted to amend its state constitution and authorize the “Millionaires Tax”. As a result, Massachusetts taxpayers who receive more than $1 million in taxable income in a year will be subject to an additional 4% tax on income in excess of $1 million beyond the 5% tax imposed on the income of all Massachusetts taxpayers. Although Evan Horowitz, executive director of The Center for State Policy Analysis at Tufts University, estimates that the Millionaires Tax will affect only 0.6% of Massachusetts taxpayers, the net cast by the Millionaires Tax may be broader than this statistic suggests. This is because the Millionaires Tax applies not only to taxpayers who earn a large annual salary year, but also to taxpayers who sell a capital asset like a home or business and have unusually high income in a single year.

Take, for instance, the example of a married couple who together earn $600,000 in salary annually. If the couple sells their home, which they purchased for $400,000, for a price of $1.4 million, then the couple will recognize $500,000 in taxable income on the sale ($1.4 million less the $400,000 cost basis and $500,000 capital gains tax exemption). Adding the income from the sale of the home to couple’s earned income nets a combined taxable income of $1.1 million, subjecting the couple to the Millionaires Tax. The $100,000 in excess of $1 million will be subject to the 4% Millionaires Tax, resulting in an additional $4,000 of income tax liability.

The Millionaires Tax will also apply in the case of a Massachusetts taxpayer who sells a business and recognizes net income in excess of $1 million. For example, a Massachusetts business owner who earns a salary of $200,000 and recognizes income on the sale of his or her business for $5 million will have reportable income of $5.2 million, subjecting him or her to the Millionaires Tax. The $4.2 million in excess of $1 million be subject to the 4% Millionaires Tax, resulting in an additional $168,000 of income tax liability.

Smart income tax planning could help the Massachusetts taxpayers described above mitigate or eliminate the impact of the Millionaires Tax. Since the Millionaires Tax threshold is $1 million for both a married couple filing income taxes jointly and married individuals filing income taxes separately, a married couple in which both spouses earn substantial income can reduce their exposure to the Millionaires Tax by filing separately. A Massachusetts business owner may be able to structure the sale of his or her business as an installment sale and, anticipating annual income from other sources, may attempt to remain under the annual $1 million threshold, or may increase the sale price to net the actual value of the business.

Taxpayers may also find refuge from the Millionaires Tax by relocating to a more income tax-friendly state or, if they prefer to remain in Massachusetts, create non-grantor trusts (trusts which function as separate taxpayers) to be administered by Trustees located in more tax-friendly states.

Our attorneys in the Private Client Services Practice can assist you with learning more about the Massachusetts Millionaires Tax and developing strategies for effective tax planning. Call us at 781-235-5500 or contact us to learn more.

This article is not legal advice and should not be taken as such or relied upon as legal advice.