Tuesday, June 22, 2021

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

Last week, we were at the point where the MA legislature was going to pull us out of the tax trap developed by the department of revenue, but they failed to do so…


Well, now we have the DOR coming to our rescue with recently revised Tax Filing Season Frequently Asked Questions. 


FAQ – Did Massachusetts update the treatment of loan forgiveness income?


Yes.  Loan forgiveness income is excluded from gross income for personal income taxpayers…”


OK, so here (apparently) is how things stand.  Self-employed individuals who would otherwise be taxed by MA on debt forgiveness income are no longer subject to tax.  They meet the federal and MA definition of an eligible recipient.  Individual shareholders of MA S corporations who would be taxed by MA on their corporation’s non-existent debt forgiveness income, will no longer be taxed on income which was never there and which the legislation did not mention! 


Apparently, the Department of Revenue reconsidered its position and reversed itself by issuing an FAQ.  This was followed-up by TIR 21-6 (4/30/21) wherein the Commissioner said (Part IV) “…PPP loan borrowers subject to the Massachusetts personal income tax, including Schedule C filers, certain partners in a partnership, and S corporation shareholders should not include in Massachusetts gross income the amount of a PPP loan forgiven under §1106(b) of the CARES Act during the 2020 tax year.”


However, the TIR, unlike the FAQ, only allows the “deduction” for tax year 2020.  It is a correct reflection of the state statute, which says…


“SECTION 23.  Notwithstanding any general or special law to the contrary, for the taxable year beginning January 1, 2020, the following items shall be deducted from federal gross income…”


This means that any PPP loan forgiveness income for tax year 2021 is fully taxable to Massachusetts S corporation shareholders if the Commissioner’s previous deviation from the language in the CARES Act is allowed to stand.


An excerpt from a noteworthy DC Circuit Court of Appeals decision may be appropriate here.  In Loving v. Internal Revenue Service, DC Cir. Ct. of Appeals No 13-5061 (2/11/2014) (written primarily by Circuit Judge Brett Kavanaugh, now of the US Supreme Court) the Court said:


“The IRS is surely free to change (or refine) its interpretation of a statute it administers…But the interpretation, whether old or new, must be consistent with the statute.”


The same admonition is surely appropriate to the administration of the Massachusetts Department of Revenue.  If you assert a position, issue the necessary authority consistent with the requirement to do so under statute.  If your position changes, issue the necessary authority consistent with the requirement to do so under statute.


Ask yourself this one last question---why did our state legislature only authorize a state tax deduction from income for individual taxpayers who meet the definition “…of an eligible recipient, as described in subsection (a) of the [CARES] Act…”  S corporation shareholders do NOT meet that definition (since they were never indebted) so why didn’t the MA legislature grant them a deduction from their income?


Could it be that the MA legislature actually looked at the federal CARES Act (someone did because they quoted from it) and concluded that S corporation shareholders were never taxable to begin with (contrary to the position taken by the MA DOR) so why grant tax relief to someone who does not need it?  Perhaps that explains why the MA DOR backed-away from its inconsistent interpretation of statute when it issued a subsequent FAQ/TIR---the state legislature did not agree with them.

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