A. Introduction

Effective for tax years beginning on or after January 1, 1996, the Massachusetts legislature enacted major changes regarding the income tax treatment of capital gains and losses under G.L. c. 62. See St. 1994, c. 195. The purpose of this Technical Information Release (TIR) is to explain the proper treatment and reporting of capital gains and losses on Massachusetts 1996 Form 1 (Massachusetts Resident Income Tax Return), Form 1-NR/PY (Massachusetts Nonresident/Part-Year Resident Income Tax Return), Form 2 (Massachusetts Fiduciary Income Tax Return), Form 3 (Partnership Return of Income), Form 3K-1 (Partner's Massachusetts Information), Schedule S (S Corporation Distributive Income), and related schedules.

B. Issues

1. Short-term capital loss carryover. Massachusetts 1996 Form 1 and Form 1-NR/PY, Schedule B, line 15, state that the amount to be entered is the amount from U.S. Schedule D, line 7, column (f). However, to prevent carryover losses from being double counted, the instructions for line 15 require taxpayers to add to that figure as a positive amount any U.S. short-term capital loss carryover claimed in U.S. Schedule D, line 6. Taxpayers must follow these instructions when computing line 15.

2. Excess personal exemptions. In general, excess Part B exemptions may be applied against Part A income and Part C income as provided in proposed regulation 830 CMR 62.4.1(5)(b)2, and (6)(d). However, excess Part B exemptions cannot be used to increase capital losses, nor can they be used to convert capital gains into losses. In addition, excess Part B exemptions cannot be carried over to future years. See G.L. c. 62, § 3C(b). Massachusetts 1996 Forms 1 and 1-NR/PY, Schedule B, line 20 and Schedule D, line 9, require calculation of excess exemptions from the worksheet on page 13 of the Form 1 instructions or page 18 of the Form 1-NR/PY instructions. These worksheet instructions do not take these limitations on the application of excess Part B exemptions into account. Item A of the worksheet should read as follows: "Schedule B, line 18 ( If this is a loss, enter 0)" (amended language emphasized). Furthermore, item I of the worksheet should read as follows: "Enter Schedule D, line 8 ( if this is a loss, you have no excess exemptions. Enter "0" on Schedule D, line 9)" (amended language emphasized). Taxpayers with losses on both Massachusetts Schedule B, line 18 and Schedule D, line 8 should not complete the excess exemption worksheet and should enter "0" in Massachusetts Schedule B, line 20, and Massachusetts Schedule D, line 9.

3. 1996 installment sales: where to report long-term capital gain which was deferred for federal reporting purposes but reported in full on the Massachusetts return. Taxpayers should include any federal deferred long-term capital gain on Massachusetts Schedule D, line 1. Taxpayers should complete the remainder of Schedule D as instructed, unless otherwise provided in this TIR.

4. Prior year installment sales: where to report gain received in 1996 from a prior installment sale. Gains from installment sales prior to 1996 are classified as either capital gains or ordinary income under the Massachusetts law in effect on the date the sale or exchange took place. See proposed 830 CMR 62.4.1(7). Gains from such sales that are classified as capital gains are included in 12 percent income, but if the asset was held for more than one year when it was sold, the gain will be eligible for a 50 percent long-term gain deduction. Id. Such long-term gain is included in the 1996 Massachusetts Schedule D, line 1. The amount of such gains should also be included on the 1996 Massachusetts Schedule D, line 5, (together with current long-term gain on collectibles) and should be identified as "1996 gain from prior year installment sale." The amount of such gain is then reported on the 1996 Massachusetts Schedule B, Part 2, line 10, where it is included with capital gains on collectibles. The amount of such gain should be identified as "1996 gain from a prior year installment sale." The remainder of Schedules B and D should be completed as instructed, unless otherwise provided in this TIR.

Gains from prior year installment sales classified as ordinary income under the law in effect before St. 1994, c. 195 (e.g., I.R.C. Section 1231 gains) and that are included on the Massachusetts 1996 Schedule D, line 1, should be subtracted on Schedule D, line 4 ("Differences"). The amount of such ordinary income gains should be reported as "Other income" on the Massachusetts 1996 Form 1, line 9 or on Form 1-NR/PY, line 11. Such ordinary income gains should be included on Schedule X, line 3, and identified as "1996 gain from prior year installment sale."

5. Form 2: reporting amounts paid to or accumulated for nonresident beneficiaries; reporting short-term capital gains accumulated for an unascertained remainder. In general, all income received by a Massachusetts fiduciary or executor is included in Massachusetts gross income. G.L. c. 62, §2. However, a deduction is allowed with respect to certain amounts payable to or accumulated for nonresident beneficiaries. G.L. c. 62, § 3C(a)(1). The deduction is claimed on Form 2 by adjusting the 12 percent income amount reported on line 30. For purposes of line 30, notwithstanding the Form 2 instructions, modified gross income is the amount reported on line 29, reduced by the portion of such amount that is attributable to deductible amounts paid to or accumulated for nonresident beneficiaries. No amount of short-term capital gains accumulated for an unascertained remainder may be deducted in determining line 30 reportable amounts.

6. Form 3 and Schedule 3K-1: reporting of gains realized on sale, exchange or involuntary conversion of property used in a trade or business. In general, under the new law, long-term gains on the sale, exchange or involuntary conversion of property used in a trade or business (i.e. I.R.C. Section 1231 long-term gains) are included in 5 percent income. See proposed 830 CMR 62.4.1(2)-(4). Massachusetts 1996 Form 3 and Schedule 3K-1 do not adequately explain how to report such gains. Such gains should be included as a positive amount reported on Form 3, Part II, line 23, and identified as "long-term gains on the sale, exchange or involuntary conversion of property used in a trade or business." Such gains should also be included as a positive amount reported on Massachusetts 1996 Schedule 3K-1, line 21, and identified as "long-term gains on the sale, exchange or involuntary conversion of property used in a trade or business."

7. Shareholders of S corporations: reporting of certain flow-through long-term capital gains on sale, exchange or involuntary conversion of property used in a trade or business. I.R.C. Section 1231 long-term gains on the sale, exchange or involuntary conversion of property used in a trade or business are included in 5 percent income. See proposed 830 CMR 62.4.1(2)-(4). The full amount of the gain is a Massachusetts capital gain, notwithstanding the applicability of any federal recapture provision. The Massachusetts 1996 Schedule S and Schedule SK-1 do not adequately incorporate these rules. Notwithstanding any instructions to the contrary, taxpayers should take the following steps when completing Massachusetts 1996 Schedule S and Schedule SK-1:

Federal recapture amounts, to the extent included in Schedule S, line 13, should be subtracted as an adjustment on Schedule S, line 17 and identified as "federal recapture amount."

Federal recapture amounts subtracted on line 17 should be added to any other amounts reported on Schedule S, line 32 and identified as "federal recapture amount."

Schedule SK-1 should be completed using the Schedule S amounts, determined as provided above and identified as "federal recapture amount."

8. Shareholders of S corporations: where to report I.R.C. Section 1231 long-term capital gains. Under Massachusetts law, gains or losses on the sale or exchange of I.R.C. Section 1231 property are capital gains or losses. See proposed 830 CMR 62.4.1 (2)-(4). Schedule S incorrectly includes these amounts as ordinary income on line 14. These amounts should be omitted in the computation of Massachusetts ordinary income/loss and therefore should not be reported on line 14. For purposes of reporting 1996 Massachusetts section 1231 long-term capital gains from the sale of I.R.C. Section 1231 property, taxpayers should add the amount of such gain to amounts reported on the 1996 Massachusetts Schedule S, line 32, and Schedule SK-1, line 17. The remainder of Schedule S and Schedule SK-1 should be completed as instructed, unless otherwise provided in this TIR.


Mitchell Adams
Commissioner of Revenue

TIR 97-3

March 14, 1997