The federal Tax Reform Act of 1986 (TRA) required several different types of taxable entities to adopt the calendar year as their federal tax year. Many of these entities, which generally include partnerships, S corporations, personal service corporations, and trusts, have adopted a calendar tax year for Massachusetts tax purposes as well as for federal tax purposes. The Massachusetts tax treatment of trusts which are changing to a calendar year has been discussed in Technical Information Release 87-8. The corresponding treatment of partnerships, S corporations, and personal service corporations has been discussed in Technical Information Releases 87-13 and 88-3. This TIR applies to beneficiaries of those trusts affected by TRA § 1403 and IRC § 645.

A taxable entity's adoption of a calendar tax year requires the entity to recognize a "short tax year" when the changeover to the calendar tax year occurs. This short tax year runs from the end of the entity's last non-calendar fiscal year to the following December 31st. Changes in taxable year required by the TRA have generated short tax years ending on December 31, 1987.

The recognition of a short tax year may cause income bunching problems for some taxpayers. In order to alleviate the bunching of income received by distributees of pass-through entities, the federal tax law, through TRA §§ 806 and 1403, authorized many distributees to spread over four years the income received from the pass-through entity for the short tax year. Massachusetts Department of Revenue Technical Information Release 87-13 discussed the extent to which the four-year spread is available, for Massachusetts tax purposes, to partners and Massachusetts S corporation shareholders. It concluded that these taxpayers must adopt the same treatment of short year income on their Massachusetts return as on their federal income tax return. However, with the exception of shareholders of corporate trusts which are also Massachusetts S corporations, TIR 87-13 did not address the ability of trust beneficiaries to adopt the four-year spread of short year income. This TIR announces that trust beneficiaries, other than those affected by TIR 87-13, may not adopt the four-year spread for their short year trust income.

As a general rule, trusts do not operate as pass-through entities in Massachusetts. Instead, trusts subject to G.L. c. 62, §§ 10(a), 10(d), are taxable at the trust level, and distributions to beneficiaries are not subject to Massachusetts income tax. Beneficiaries of these trusts will experience no bunching of income because of the short tax year. They may not spread their short tax year trust income.

The same rule applies to the beneficiaries of all other trusts not covered in TIR 87-13. That is, no trust beneficiary may spread short tax year trust income even if that income is taxable to the beneficiary rather than to the trust under Massachusetts law, and even if the beneficiary spreads the short tax year income for federal income tax purposes. This rule applies, without limitation, to distributions to resident beneficiaries of non-resident trusts which are taxable under G.L. c. 62, § 11, and distributions to income beneficiaries of pooled income funds, charitable remainder annuity trusts, or charitable remainder unitrusts which are described in G.L. c. 62, § 10(c).

Trust beneficiaries who use the four-year spread for federal income tax purposes but who, in accordance with this TIR, do not spread short year trust income on which they must pay Massachusetts tax, will experience a discrepancy in the trust income declared on their federal and Massachusetts returns over the four-year period. An explanation of this discrepancy must be stated on the taxpayer's Massachusetts return in each of those years. See Form 1, Schedule E, Part III, Line 2.

Stephen W. Kidder
Commissioner of Revenue

April 5, 1988

TIR 88-5