Wednesday, January 5, 2022

Words Have Meaning and Specific Words Have Specific Meaning

William Delaney, EA
Westwood, MA

Now comes Mass. Gen. Laws Ch. 63D, Sec. 7 which directs that “The commissioner shall promulgate regulations or other guidance to carry out the purposes of this chapter.” 


“(ii) provide rules on the application of this chapter to eligible trusts and estates,…”


This has to do with the new MA Elective Pass-Through Entity Excise Tax -                (MGL Ch 63D).  The law, under §1, defines an eligible pass thru entity (PTE) as an S corporation, a partnership, or an LLC taxed as a C corporation or partnership.  There, the law has stopped.  Nothing “additional” has been included in the statutory definition of a PTE.  However, in §7, the legislature refers to eligible trusts and estates, and appears to have left it up to the MA Commissioner of Revenue to write rules and/or other guidance which would move certain trusts and estates (as defined by the commissioner) under the statutory umbrella wherein a PTE resides.  We didn’t place them there said the legislature when it wrote the statute---we told the commissioner that he could exercise his discretion and do so. 


Now we have (in proposed form) a TIR which does exactly that.  It makes certain trusts (as explained in the TIR) eligible to make the election.  And, the result is wonderful!  The trust pays the tax; there is a K-1 which passes credit for the tax payment to the trust beneficiary, and the beneficiary (on his/her Form 1) may claim credit of up to 90% of this amount against the income tax imposed on the pass-through income.  Again, wonderful!  The state has just increased your tax rate by 10% on the pass-through income!


Of course, there must be a benefit to this stuff and nonsense, so let’s look to the federal return.  On the federal 1041 there is allowed a deduction for taxes paid (which, one would presume, includes this excise tax), so the amount of pass-through income (DNI) is net after deductions.  Voila, there it is, the federal pass-through income has been reduced, so the additional state tax is more than offset by the federal 1040 tax saved*.  Ingenious!  Except, this doesn’t work, for reasons not addressed in either MGL or the TIR.


First, §1 defines Qualified Member as a shareholder of an S corporation, a partner in a partnership, or a member of an eligible LLC.  The TIR did not change or alter this MA statutory definition to include beneficiaries of a trust.  Therefore, while the trust may pay the excise tax, the beneficiary may not claim a credit for this payment, so he/she pays again.  A 100% jump in state tax for the ineligible beneficiary!


Second, IRS Notice 2020-75, which claims to be the precursor of federal regulations to be issued on this excise tax concept, limits eligible entities to S corporations and partnerships.  The IRS is telling us, in advance, that the regulations do not contemplate any such deduction by a trust or estate on the federal 1041.  If the trust, when filing its federal form 1041, cannot claim a tax deduction for this MA excise tax, the pass-through federal income will match the pass-through MA income, so there is no federal income tax savings which would at least offset the additional state tax paid!  Checkmate!



*If the federal distributive net income (pass-through income) is $10,000 and a MA 5% excise tax is imposed, the DNI is reduced to $9,500 for purposes of reporting on form 1040.  Since MA does NOT allow deductions for state tax paid, the MA income remains at $10,000.

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