Tuesday, June 8, 2021

Part 1 of 3: How Massachusetts Attempted to Tax S Corporations and Their Shareholders

Back in the late 1970s, your editor wanted to test the boundaries of his newly minted graduate degree in taxation, so what better way to do so (thought he) than to sign-up for the annual tax seminar offered each year at Boston University.  This was strictly a tax lawyer presentation, so could I now follow it and read tax law with them?  To my delight, when I attended and started to follow the presentations it appeared that I could, thanks to my Bentley College training!

 

In the afternoon, there was a panel discussion of MA state taxation and whether or not the Commonwealth could reach beyond the water’s edge and tax the overseas income of international corporations which filed returns in MA.  The speaker was a deputy commissioner whose every word on taxation was closely followed and even referenced in CCH MA taxation material.  Absent a Code or MGL citation, he was cited as the authority because of a presentation he had made somewhere.

 

The deputy commissioner argued, yes we can tax beyond the water’s edge.  He was challenged by another panel member, the tax counsel for a major CPA firm, and a former MA Commissioner of Revenue.  The former Commissioner argued no you cannot, and provided a cite.  Well, thought I, this will be interesting but my little balloon soon burst when the deputy commissioner responded by saying…

 

                         What difference does it make, we are doing it!

 

You could hear a pin drop in that room, and the attention of the panel swiftly changed to another topic.  No one else had a word to say to the guy who made tax law in MA.

 

Some of you will remember one of our annual state tax update seminars when we held them in Sturbridge.  Fred Laskey became MA Commissioner of Revenue in 1991 and he attended one of our seminars and spoke about his plans for the revenue department.  He told us about a national survey which had been conducted to rank state departments of revenue and MA ranked dead last.  Commissioner Laskey pledged to reform things and do better.  Both he and his successors did just that, until now.

 

Are we falling back to the “old” way of doing things (what difference does it make, we are doing it)---read on and make up your own mind.

 

When the Congress first enacted the PPP (paycheck protection program) we were told that most employers would qualify for a $10,000 loan and that part or all of it might later qualify for debt forgiveness.  This looked like free money, so folks applied and sought our help with their applications.  And, it did prove to be so, the SBA was forgiving the debt and this really looked like free money.  Then the IRS stepped in (as they were required to do, so don’t fault them) and reminded us that debt forgiveness income is taxable.  IRC §61(a)(11).

 

Well, everyone was upset---how can this be, said they.  Yes, how can this be said the Congress???  It’s easy---you guys didn’t exempt or exclude it when you wrote the law, so the IRS is just reminding us that you wrote a failed attempt to pass on a free lunch.  Later, when the Congress enacted the CARES Act they decided to fix the problem and declared that their intent was for this to be tax free.  [CARES Act §1106(c) - Treatment of Amounts Forgiven].

 

The way that the Congress did this was simple.  They said that the amount of the forgiven loan shall be excluded from the gross income of an eligible recipient.  The Act carefully explains this---if you are either an individual or an entity who received the loan proceeds, the funds are not part of your gross income.  Gross income is what you start with.  Example (for an individual):

 

Wages…………………………………………………………………..$ 50,000

Debt forgiveness income……………………………………………… 10,000

 

Gross Income…………………………………………………………… 60,000

 

The Congress said that this eligible recipient (individual) now has:

 

Wages……………………………………………………………………$ 50,000

 

Gross Income……………………………………………………………$  50,000

 

Now you see it; now you don’t, said the Congress.  The $10,000 has disappeared---it has been EXCLUDED from the starting point, and this is what we meant to do the first time, when we got it wrong.  Now the Department of Revenue has a problem---the Congress made this income disappear, so how can they tax something which isn’t there (in the current federal tax Code).  Well, it doesn’t matter reasoned the Department, because individuals are taxed based on the federal tax Code in effect on 1/1/2005, and the Congress didn’t change that Code, so we can tax individuals who are shareholders of S corporations even though they did not borrow, nor did they receive the funds.  We have all the authority which we need under state statute to include this in S corporation pass-through income, so they didn’t change their position to conform with expressed Congressional intent.

 

                              What does it matter, we are doing it.

 

Can they do that (ignore the Internal Revenue Code) and pass-through the income to an S corporation shareholder.  Stay tuned because next week we will give you the answer to that important question.

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