Retroactively effective for tax years beginning on or after January 1, 1996, the Massachusetts legislature enacted changes regarding the income tax treatment of capital gains and losses under G.L. c. 62. See St. 1999, c. 127. The purpose of this Technical Information Release (TIR) is to explain the new law and how it affects the treatment and reporting of capital gains and losses for the 1999 tax year and for prior tax years back to 1996.
II. Law Changes
A. Short-Term Losses are Deductible Against Long-Term Gains
Prior law did not allow short-term losses to be deducted against long-term gains. Under the new law, short-term losses are first deducted against Part A income (short-term capital gains, capital gains on the sale of collectibles, and interest and dividends). Any remaining short-term losses are deductible against any long-term gains remaining after the netting of long-term gains against long-term losses. The short-term losses are deducted against the highest rate long-term gains through (in descending order) the lowest rate long-term gains. Any remaining short-term losses are carried forward to the next tax year.
G.L. c. 62, § 2(c)(2)(a), as added by St. 1999, c. 127, § 64.
B. Excess Part B Deductions Can Be Applied Against Long-Term Gains Effectively Connected With the Active Conduct of a Taxpayer's Trade or Business
Excess Part B adjusted gross income deductions are deducted against any Part A income (short-term capital gains, capital gains on the sale of collectibles, (1) and interest and dividends) that is effectively connected with the active conduct of a taxpayer's trade or business. Under the new law, any remaining excess Part B deductions can be deducted against any long-term capital gains effectively connected with the active conduct of a taxpayer's trade or business, after the netting of long-term gains against long-term losses and after deducting short-term losses. The excess Part B deductions are deducted against the highest rate long-term gains through (in descending order) the lowest rate long-term gains. Any remaining excess Part B deductions are not allowed to be carried forward to subsequent tax years.
G.L. c. 62, § 2(e)(I)(2), as added by St. 1999, c. 127, § 67.
C. Lower Rate Capital Losses Fully Offset Higher Rate Capital Gains
Under prior law, long-term gains were netted against long-term losses within each holding period (e.g., 5% long-term gains against 5% long-term losses). The net long-term gain or loss for each holding period was then multiplied by the applicable tax rate. For example, a taxpayer with a 5% $100 net long-term gain would have a $5 Part C tax. If the same taxpayer also had a 2% $100 net long-term loss, the $5 Part C tax would be reduced to $3. Notice that the $100 net long-term loss did not fully offset the $100 net long-term gain.
Under the new capital gains tax law, all net long-term gains eventually net against all net long-term losses, regardless of their respective holding periods.
The netting starts with the highest rate capital gain and flows down to the lowest rate capital losses. Applying the new law to the example above, the 5% net long-term gain would fully offset the 2% net long-term loss, resulting in zero Part C tax.
G.L. c. 62, § 2(e)(I)(1), as added by St. 1999, c. 127, § 67.
D. Long-Term Losses Can Be Applied Against Part A Interest and Dividends
Under prior law, net long-term losses within each holding period generated a credit based on the tax rate applicable to that holding period. The credit applied first to reduce the tax on long-term gains and then to reduce the tax on Part A capital gains. The credit was not allowed to reduce the tax on Part A interest and dividends.
Under the new capital gains tax law, net long-term losses are allowed as a deduction against all Part A income (including interest and dividends), but only after Part A income has been reduced by any excess Part B deductions and short-term losses.
G.L. c. 62, § 2(c)(2)(b), as added by St. 1999, c. 127, § 64.
E. Allocation of the 5.95% and 12% Tax Rates - Taxable Part A Income
Part A gross income consists of interest, dividends, short-term capital gains and gains on the sale of collectibles. Certain deductions, such as the deduction for short-term losses under G.L. c. 62, § 2(c)(2), reduce Part A gross income in determining Part A adjusted gross income. Other deductions, such as the excess exemptions deduction under G.L. c. 62, § 3(A)(b), reduce Part A adjusted gross income to arrive at Part A taxable income. These deductions apply to Part A income in the aggregate, with no differentiation between interest, dividends, short-term capital gains or gains on collectibles.
Effective for tax years beginning on or after January 1, 1999, a new tax rate of 5.95% is imposed on Part A taxable income consisting of interest and dividends. (2) The legislation enacting this new tax rate did not specify how the Part A deductions and exemptions should be allocated between the 5.95% Part A income and the 12% Part A income. As a result, the Department of Revenue issued TIR 98-8 to require that Part A exemptions and deductions be allocated on a prorated basis. However, the method of proration outlined in TIR 98-8 is inconsistent with the new capital gains legislation that employs a different ordering of capital gains and losses and deductions.
Therefore, Part A taxable income will be taxed at the rate of 5.95% to the extent it does not exceed Part A gross income consisting of interest and dividends (before any deductions or exemptions are applied). Any remaining Part A taxable income (i.e., any portion which exceeds Part A gross income consisting of interest and dividends), will be taxed at the rate of 12%. In effect, Part A deductions and exemptions are first allocated to 12% Part A income and then, if any deductions or exemptions remain, to 5.95% Part A income.
Example: A taxpayer has $500 of Part A gross income consisting of $300 of interest and dividends and $200 of short-term capital gains. The taxpayer has $100 of net long-term losses and $50 of excess exemptions. After applying losses and excess exemptions the taxpayer has $350 of Part A taxable income, of which $300 is taxed at 5.95% and $50 is taxed at 12%.
G.L. c. 62, § 4(a), as amended by St. 1998, c. 175, § 16.
III. Recalculation of Prior Tax Years
A. Abatement, Refund or Tax Credit
Taxpayers who have realized capital gains and losses in 1996, 1997 or 1998, may benefit from the new capital gains legislation. Taxpayers who recalculate their prior tax liability and derive a tax benefit from the new legislation, have the option of seeking an abatement or refund for the recalculated prior tax years, or they can take the tax benefit as a credit on their 1999 Massachusetts tax return. Any unused portion of the credit may be refunded or applied to the taxpayer's estimated tax for the tax year 2000.
A special tax booklet to aid taxpayers in their recalculations of prior tax years will be issued during the 1999 tax year filing season. The booklet will be available on DOR's website at www.mass.gov/dor and on the Fax on Demand system by calling (617) 887-1900. Taxpayers can also order the booklet by calling the Massachusetts Department of Revenue at (617) 887-MDOR or toll-free in-state at 1-800-392-6089.
B. Deadline for Recalculation of Previous Tax Years
Taxpayers who choose to recalculate their capital gains tax for previous tax years and obtain their capital gains tax benefit through the abatement option, must do so within the statute of limitations for abatements. For each tax year, the abatement must be filed " within three years from the last day for filing the return . . ., without regard to any extension . . ., within two years from the date the tax was assessed or deemed to be assessed, or within one year from the date that the tax was paid, whichever is later." G.L. c. 62C, § 37. For example, taxpayers who choose to recalculate their capital gains tax on their 1996 tax returns which were filed on or before April 15, 1997, will have until April 18, 2000 (3) to file for an abatement.
However, taxpayers who choose to recalculate their prior tax years' capital gains and claim their tax benefit as a credit on their 1999 tax return, may do so within the statute of limitations for their 1999 tax return. For example, taxpayers who recalculate their capital gains tax on their 1996 tax return and claim any resulting tax benefit as a credit on their 1999 tax year may do so even if they file for extension. The capital gains tax credit is treated as a 1999 tax credit, regardless of the fact that it is generated from a 1996, 1997 or 1998 recalculation of capital gains. The credit is claimed on line 36 of the 1999 Massachusetts Form 1 (or line 41 of the Form 1-NR/PY).
St. 1999, c. 127, §§ 278, 279, 280.
C. Long-Term Capital Gains Tax Credit Carryover
Under the prior law, long-term capital losses were converted into a long-term capital gains tax credit that could reduce long-term gains and Part A capital gains. For example, a taxpayer with $100 of Class B (tax rate 5%) and $100 of Class C (tax rate 4%) long-term capital losses would have a long-term credit carryover of $9. Any unused credit could be carried forward to the next tax year.
Taxpayers who choose not to recalculate their capital gains and losses for prior years, may convert their long-term credit carryover, if any, available under prior law into a Class B long-term capital loss by multiplying the credit by 20 and entering the result in line 7, column A of the 1999 Massachusetts Schedule D. In the case of the example above, the taxpayer would have a 1999 $180 Class B long-term loss carryover ($9 x 20). This option of converting a long-term loss credit carryover into Class B long-term capital losses is provided as an administrative convenience. However, in some cases, choosing this option may result in minimizing the tax effect of a taxpayer's carryover losses. A taxpayer may wish to recalculate his or her prior year capital gains and losses under the new law in order to maximize any carryover losses.
G.L. c. 62, § 4(c), as amended by St. 1999, c. 127, § 77.
This TIR modifies TIR 98-8, Massachusetts 1998 Reducing Income Taxes Act ("the Act").
Frederick A. Laskey
Commissioner of Revenue
December 29, 1999
1. A deduction equal to 50% of the long-term gains from the sale of collectibles is allowed against Part A income after any short or long-term losses have reduced Part A income. G.L. c. 62, § 2(c)(3).
2. Part A taxable income consisting of interest and dividends is taxed at the same rate as Part B income. The Part A and Part B income tax rate is scheduled to go down over the next three tax years. Part A interest and dividends and Part B income will be taxed at the rate of 5.85% for tax years beginning on or after January 1, 2000, 5.80% for tax years beginning on or after January 1, 2001 and 5.75% for tax years beginning on or after January 1, 2002. See St. 1999, c. 127, §§ 73, 74, 75.
3. Personal income tax returns are due on or before April 15th following the close of each tax year. For the 1999 tax year, the due date of April 15, 2000 falls on a Saturday. When the due date for filing tax returns falls on a Saturday, Sunday or legal holiday, the filing may be made on the next succeeding business day. Because the Monday following April 15, 2000 is a legal state holiday, the due date for filing 1999 personal income tax returns is April 18, 2000. G.L. c. 62C, § 6(a); TIR 84-3, Saturday, Sunday and Holiday Due Dates.