Filing Mandate Seen As Way To Seal Surtax “Loophole”

Report: Tax Avoidance Could Cost State $200 Mil to $600 Mil

FEB. 13, 2023…..Pointing to the potential for state income surtax revenue collections to underperform to the tune of between $200 million and $600 million if high-income households employ a legal tax avoidance strategy, the Massachusetts Budget and Policy Center on Monday called on the Legislature to require that Bay Staters use the same filing status for their federal and state income taxes.

The state’s new 4 percent surtax kicks in on income that exceeds $1 million, and that threshold applies to both joint filers and single filers. A married couple that earns a total of more than $1 million could file their taxes jointly at the federal level and then separately for their Massachusetts taxes, effectively affording themselves two $1 million limits rather than the one they would face if they filed jointly.

“Consider Wesley and Leona, a married couple with a combined income of $2.1 million. Wesley makes $2 million and Leona makes $100,000,” MassBudget wrote in a report released Monday. It added, “If this couple jointly files income tax to Massachusetts, they would pay a surtax of 4 percent on $1.1 million for a total surtax of $44,000. Filing singly, Leona would pay no surtax, and Wesley would pay surtax on $1 million of his $2 million income: a total surtax of $40,000.”

CommonWealth Magazine pointed out Monday that firms like Ropes & Gray and Morgan Lewis have already advised clients to consider filing Massachusetts income taxes separately to blunt the effect the new surtax will have on their tax liability.

MassBudget said that kind of “inconsistent” filing could result in at least $200 million in unrealized surtax revenue for the state, based on the recent estimate that $1 billion in surtax revenue will be available to be spent in fiscal year 2024. MassBudget also pointed to a different estimate from the Institute on Taxation and Economic Policy, which pinned the potential unrealized revenue at $615 million annually.

The left-leaning think tank said the issue would be addressed by a bill (HD 2310 / SD 1167) filed by the legislative sponsors of the Constitutional amendment that created the surtax, Rep. Jim O’Day of West Boylston and Sen. Jason Lewis of Winchester. That legislation would add one line to state tax law: “A married couple must file a joint return for any year in which they file a joint federal income tax return.”

“Lawmakers aren’t going to want to tell their constituents that the ballot question they just approved won’t fully deliver its investments because legislators failed to close a simple tax loophole,” Phineas Baxandall, policy director at MassBudget, said. “This should be easy.”

But the idea drew a sharp rebuke Monday from the Massachusetts Fiscal Alliance, which has opposed the surtax for years. MassFiscal spokesman Paul Craney pointed out that the surtax was passed by a relatively narrow margin (52 percent to 48 percent) and said that the attempt to now prevent couples from filing their taxes as individuals represents “moving the goal post from how the voters considered the tax last November.”

“Before lawmakers could figure out how to spend the money from this new tax hike, or how it will negatively impact our state’s economic competitiveness, some lawmakers are looking to supercharge the income tax surcharge by adding further restrictions. These lawmakers want to return to the day of Taxachusetts as soon as possible and this tax along with their legislation does just that,” Craney said.

While the idea that millionaires could start to leave Massachusetts to avoid having to pay the new surtax has gotten a lot of attention, economists think that legal tax avoidance strategies — like structuring transactions in a way that minimizes reported taxable income or curtailing stock trading — will have a greater effect on surtax revenue, which is intended to be spent on transportation and education initiatives.

A study last year from the Center for State Policy Analysis at Tufts University estimated that Massachusetts could lose about 500 families and about $100 million in tax revenue from relocation but that tax avoidance could reduce the state’s surtax revenue by about $670 million. Armed with the estimates of possible behavioral and filing strategies, state budget officials last month estimated that they will collect $1 billion in surtax revenue in fiscal year 2024.

MassBudget also said Monday that allowing Bay Staters to use different filing statuses for their federal and state taxes could also incentivize couples to “illegally misreport the division of income between the two spouses” if only one earns more than $1 million.

“By mischaracterizing a portion of the higher-income filer’s income as earned by the lower-income filer, they would exploit their separate $1 million exemptions,” MassBudget said. “To prevent this type of tax evasion, the Commonwealth might need to step up scrutiny and controls of how taxpayers attribute income from their assets.”

The bill highlighted Monday in the MassBudget report is not the only one that O’Day and Lewis filed this session to tweak the surtax proposal that they shepherded through the Legislature over the last two legislative terms.

Another bill (HD 2236 / SD 1166) would shield surtax receipts from the existing requirement that capital gains revenues above a certain level be stashed into state savings or put towards specific benefit accounts.

“The Massachusetts Constitution now mandates that Fair Share revenue be spent on education and transportation only. However, Massachusetts law requires that revenue from capital gains be deposited into the Massachusetts Rainy Day Fund, state pension fund, and retiree benefits funds. The bill would resolve this conflict and ensure that Fair Share’s capital gains revenue are not deposited into these funds,” O’Day wrote in a newsletter to constituents.

And the bill would also exclude surtax money from the any future calculation of state revenue for the purposes of Chapter 62F, the 1980s voter law that puts a cap on state revenue growth and last year triggered nearly $3 billion in mandatory rebates. Under the O’Day/Lewis proposal, surtax revenue would not count towards the calculation of state revenue and surtax payments would not count towards a taxpayer’s liability if or when future rebates are calculated.

“This bill is extremely necessary and upholds the will of the voters,” O’Day wrote.