Changes to the Massachusetts inheritance and income tax.

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Major changes to the Massachusetts inheritance tax

Major changes to the Massachusetts inheritance tax, capital gains tax, and Massachusetts millionaires' tax were signed into law by Governor Maura Healey on October 4, 2023. Residents, non-residents who have property in Massachusetts, and those who manage inheritances and receive taxable income in this state should understand how this legislative reform affects inheritance and other taxes.

Although the law was signed into law in October, it is retroactive to January 1, 2023, meaning that inheritances of those who died in 2023 and paid the Massachusetts inheritance tax may be granted a refund.

Significant changes in inheritance tax

Significant changes to the Massachusetts inheritance tax, capital gains tax, and millionaires' tax went into effect under legislation called the "Massachusetts Competitiveness, Affordability, and Fairness Act," which was signed into law by Governor Mora Healey on October 4, 2023. Massachusetts residents, non-residents with Massachusetts property, and those who manage Massachusetts inheritances and receive taxable income in Massachusetts should understand how these changes reduce inheritance tax, short-term capital gains tax, and increase taxable income for high-income individuals.

What is an inheritance tax in Massachusetts?

The Massachusetts inheritance tax is a tax on the transfer of inherited property before it is distributed to heirs. It applies to persons who die 1) who are Massachusetts residents at the time of death and 2) nonresidents with real estate or tangible chattel property located in Massachusetts. The tax rate increases gradually as the value of the inherited property increases.

How do the changes affect the inheritance tax in Massachusetts?

Previously, if the value of the inherited property did not exceed $1 million, no tax was required. However, if the value of the inherited property exceeded $1 million, tax was paid on the entire value of the inheritance. Thus, the $1 million limit was a threshold for filing a tax return rather than an exception. To preserve this exception, a married couple with proper estate planning could shield $1 million from the Massachusetts inheritance tax upon the death of one spouse, but if the surviving spouse had an estate worth more than $1 million, every dollar was taxable. For taxpayers with larger inheritances, trust-based planning was necessary to protect $1 million from inheritance tax for each spouse.

Note that the portability that exists under the federal inheritance tax rules does not apply to the Massachusetts inheritance tax. The law increases the exclusion amount from $1 million to $2 million and treats the new amount as a true exclusion because it now applies whether or not the decedent's inheritance exceeds $2 million. Inheritances exceeding $2 million will be subject to excess tax at a rate starting at 7.2 percent and increasing to 16 percent depending on the size of the inheritance. Planning is still required for a married couple using a trust to maximize the use of the exclusion for each spouse.

Under the law, if a resident dies owning real estate or tangible movable property outside of Massachusetts, any inheritance tax that is due will be reduced in proportion to the value of such property. On the other hand, nonresidents who own real estate or tangible movable property in Massachusetts will still pay tax in Massachusetts in an amount proportional to the value of such property if the nonresident's Massachusetts taxable estate exceeds $2 million. For non-residents, Massachusetts taxable estate includes all property, regardless of location.

Please note that some taxpayers transfer real estate to limited liability companies (LLCs) to convert Massachusetts taxable real estate into intangible property subject to Massachusetts tax, but it is unclear whether this will be respected without a legitimate business purpose.

When does the law come into effect?

It is important to note that the law came into effect on January 1, 2023. Estates of deceased individuals in 2023 who have already paid the Massachusetts estate tax may be eligible for a refund.

In conclusion

Under the previous Massachusetts estate tax, an unmarried heir with an inheritance of 2 million dollars had to pay 99,600 dollars in Massachusetts. According to the law, the same heir will not have to pay any tax. Married couples will benefit even more with proper estate planning. Under the previous Massachusetts estate tax, a married couple with 4 million dollars and properly planned taxes would have had to pay 182,000 dollars after the death of the surviving spouse. According to the law, the same couple will not have to pay any tax.

Capital gains tax

The law reduces the capital gains tax rate from 12 percent to 8.5 percent, effective January 1, 2023. Since the long-term capital gains tax rate in Massachusetts is 5 percent (equivalent to the regular income tax rate in Massachusetts), the short-term capital gains tax represents an additional 3.5 percent surcharge on this income.

Tax on millionaires in Massachusetts

The Massachusetts millionaire tax, enacted in 2022, imposes an additional 4 percent income tax on Massachusetts taxpayers reporting income over $1 million. Accordingly, Massachusetts taxes the first million of income at a rate of 5 percent, and any income above that amount at a rate of 9 percent. To legally reduce the income reported on their returns, some married taxpayers opted to file separate state tax returns while filing jointly at the federal level, which provided favorable taxation at both levels. To prevent such income tax planning, the law requires married couples to choose the same filing status at the Massachusetts level as they do at the federal level. Consequently, the law does not prevent the legal reduction of one spouse's income on the Massachusetts return; however, married couples will have to weigh this benefit against the lost federal benefits. This requirement can be problematic for couples who wish to claim a different residence for tax purposes.

The content of this article is intended for general guidance on the topic. Professionals should seek advice regarding your specific circumstances.