This Technical Information Release ("TIR") explains amendments to the personal income tax, tax administration, the sales tax, and the estate tax contained in chapter 186 of the Acts of 2002, An Act Enhancing State Revenues ("the Act"), enacted on July 25, 2002. [1] The pertinent effective dates for the various provisions of the Act are set out below. A separate TIR is forthcoming that will provide additional details on the income tax treatment of capital gains and losses. Also, the Act changed certain provisions governing the taxation of cigarettes and cigars that are explained in TIR 02-15.

. Provisions Affecting the Personal Income Tax

A. Tax Rates (Part A, Part B, and Part C Income)

Part A Income. Part A gross income consists of interest (except interest from Massachusetts banks [2]), dividends, gains from the sale or exchange of capital assets held for one year or less, long-term gains from collectibles, and pre-1996 gains reported on the installment method. The tax rate on Part A taxable income consisting of short-term capital gains and long-term gains on collectibles is 12%. The tax rate on Part A taxable income consisting of interest and dividends is the rate provided for Part B taxable income (5.3% for 2002). G.L. c. 62, § 4(a).

Part B Income. Part B gross income consists of all income, including wage income, that is neither Part A nor Part C income. For tax years beginning on or after January 1, 2002, the tax rate on Part B taxable income remains at 5.3%. St. 2002, c. 186, § 13, amending G.L. c. 62, § 4(b). The scheduled tax rate reduction to 5.0% in 2003 has been repealed. Depending on economic conditions, the tax rate on Part B taxable income may decrease for future tax years.

Part C Income; Tax rate for transactions completed on or after May 1, 2002. In place of the existing six categories of gain based on six defined holding periods and taxed at six different rates (ranging from 5% down to 0%), the Act defines Part C gross income as gains from the sale or exchange of capital assets (except collectibles) held for more than one year. [3] St. 2002, c. 186, § 6, amending G.L. c. 62, § 2(b)(3). Effective for tax years beginning on or after January 1, 2002, the Act changes the multiple tax rates for Part C taxable income to the single rate provided for Part B taxable income (5.3% for 2002), but only for transactions completed on or after May 1, 2002. St. 2002, c. 186, § 14, amending G.L. c. 62, § 4(c).

Part C Income; Tax rates for transactions completed before May 1, 2002. The Act provides that, to the maximum extent possible, all transactions that are completed prior to May 1, 2002, shall be aggregated and taxed under the procedures and rates in place prior to the changes in law set forth in the Act, and that all transactions completed on or after May 1, 2002 shall be aggregated and taxed under the procedures and rates established by such changes in law. [4] St. 2002, c. 186, § 32.

B. Election to Pay 5.3% Tax At Higher Rate

Recent legislation provides that the personal income tax forms must provide an election to voluntarily pay tax at a rate of 5.85% on taxable income that would otherwise be taxed at a rate of 5.3%. The election to pay tax at the rate of 5.85% does not apply to items of income taxed at 12% (short-term capital gains and gains on collectibles). St. 2002, c. 300, § 44.

C. Personal Exemption Amounts

The personal exemption amounts are reduced, effective January 1, 2002, as follows: for a single person or a married person filing a separate return, from $4,400 to $3,300; for a head of household, from $6,800 to $5,100; for a husband and wife filing a joint return, from $8,800 to $6,600. Depending on economic conditions, these exemption amounts may increase for future tax years. St. 2002, c. 186, §§ 10 - 12, amending G.L. c. 62, § 3.

D. Conformity with Federal Law for Workplace Retirement Plans

Recently, the U.S. Congress made numerous changes to the Internal Revenue Code ("Code") provisions relating to qualified plans and other tax-favored retirement plans. For tax years beginning after December 31, 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") increases the federal income tax contribution limits for elective deferrals, provides catch-up contributions for those age 50 or older, increases portability between plans and accounts by expanding the rollover provisions, and makes several other changes related to retirement plans and accounts. See Public Law 107-16, enacted on June 7, 2001. Before the Act, the reference to the 1998 Code in the personal income tax at G.L. c. 62, § 1 prevented the adoption by Massachusetts of many of the EGTRRA provisions pertaining to retirement plans. [5]

Effective Date for Retirement Plan Conformity. Under the Act, Massachusetts retains the reference in chapter 62 to the 1998 Code for most income tax provisions, but adopts the current Code for the treatment of qualified plans and certain other tax-favored retirement plans. St. 2002, c. 186, § 1, amending G.L. c. 62, § 1. Effective for tax years beginning on or after January 1, 2002, the Act conforms the Massachusetts personal income tax to the following sections of the Code as amended and in effect for the taxable year ("current Code"): IRC §§ 72, 401 to 420 inclusive (but excluding §§ 402A and 408q), 457, 3401 and 3405.

Exclusions from Gross Income. As a result of the Act, all amounts of retirement plan contributions and distributions that are excluded from federal gross income under the sections of the current Code enumerated in the Act are excluded from Massachusetts gross income. In the case of contributions to and distributions from qualified plans, § 401(k) plans, § 403(b) plans, § 457 plans, SEPs (simplified employee pensions), and SIMPLE IRAs (savings incentive match plans for employees), the amount excluded from Massachusetts gross income is the amount excluded from federal gross income by the current Code. Thus, for these plans, Massachusetts conforms to federal law in the treatment of elective deferrals, catch-up contributions, and qualified rollovers of plan proceeds. [6]

Maximum Exclusion Amounts for Elective Deferrals
. For tax year 2002 and subsequent tax years, Massachusetts follows federal law in determining the amount of the maximum exclusion for elective deferrals for the following plans and accounts.

For contributions to a SIMPLE IRA governed by IRC § 408(p), the maximum exclusion from federal gross income in tax year 2002 is $7,000, with an additional exclusion of $500 allowed for age 50 catch-up contributions. The maximum applicable dollar amount of excludable salary deferrals will increase in subsequent tax years in accordance with the table provided in IRC § 408(p)(2)(E) and subsequent cost-of-living adjustments provided for therein. Also, the additional exclusion allowed for age 50 catch-up contributions will increase in subsequent tax years in accordance with the table at IRC § 414(v)(2) and subsequent cost-of-living adjustments provided for therein.

For contributions to a § 401(k), § 403(b), § 408(k) SEP or § 457 plan, the maximum exclusion from federal gross income in tax year 2002 is $11,000 (or other applicable amount determined by federal law), with an additional exclusion of $1,000 allowed for age 50 catch-up contributions. The maximum applicable dollar amount of excludable salary deferrals will increase in subsequent tax years in accordance with the tables at IRC §§ 402(g)(1) and 457(e)(15), as appropriate, and subsequent cost-of-living adjustments provided for therein. Also, the additional exclusion allowed for age 50 catch-up contributions will increase in subsequent tax years in accordance with the table at IRC § 414(v)(2) and subsequent cost-of-living adjustments provided for therein.

Employer's Deduction. The Act adopts the current Code at § 404 where employers taxed under chapter 62 are allowed a deduction for employer contributions to qualified plans and other retirement plans. In calculating adjusted gross income, Massachusetts generally allows the deductions available under § 404 of the Code. [7] G.L. c. 62, § 2(d)(1). However, under subparagraph (D) of that section, the § 404 deduction for contributions on behalf of Code § 401(c)(1) employees (sole proprietors and partners) is specifically disallowed. G.L. c. 62, § 2(d)(1)(D). [8]

E. Qualified Tuition Programs--Code § 529

The Act adds Code § 529 plans to the list of Code sections for which Massachusetts follows the current Code. St. 2002, c. 186, § 1, amending G.L. c. 62, § 1. As of January 1, 2002, Massachusetts is aligned with federal treatment of qualified tuition programs, including the substantial changes made to such plans under EGTRRA. EGTRRA amended Code § 529 to exclude earnings distributed from Qualified Tuition Programs ("QTPs") after 2001 from the beneficiary's federal gross income to the extent the distribution is used to pay for qualified higher education expenses. EGTRRA also eased rollover rules, expanded the definition of qualified distributions, and authorized educational institutions to establish and maintain QTPs.

F. Charitable Contributions

The Act disallows a deduction for charitable contributions for taxable years beginning on or after January 1, 2002. A deduction for charitable contributions may become available in future tax years if the rate of tax on Part B income decreases to 5 percent. St. 2002, c. 186, § 9, amending G.L. c. 62, § 3B(a)(13).

Carryover. Under prior law, the charitable contributions deduction at G.L. c. 62, § 3B(a)(13) was effective for contributions paid on or after January 1, 2001. For taxable year 2001, certain taxpayers had excess charitable contribution amounts that could not be deducted in 2001, resulting in carryover amounts for 2002. Under the Act, these amounts cannot be deducted in 2002. However, the taxpayer is permitted to carry over, for up to five succeeding taxable years, charitable contribution deduction amounts that exceeded the amount allowable by Massachusetts in 2001. See 830 CMR 62.3.2 (6). Taxpayers will not be able to deduct these carryover amounts unless the charitable contributions deduction is restored by 2006.

G. Withholding and Estimated Tax Issues

The Department has issued new withholding tables effective immediately. The tables may be viewed on the DOR website, www.mass.gov/dor or obtained by calling Customer Service at (617) 887-MDOR or toll-free in Massachusetts, 1-800-392-6089.

It is possible that estimated payments made during the first two quarters of 2002 may be insufficient, either because the taxpayer 1) sold assets after May 1, 2002 but before the legislation imposing higher rates on capital gains had been enacted; or 2) relied on a deduction for charitable contributions made during the first half of the year, before the Act repealed the charitable contribution deduction for 2002. Taxpayers with underpayments of estimated tax as a result of the amendments made to chapter 62 may avoid any addition to tax for the portion of the underpayment attributable to the changes made by the Act if the estimated tax payment due on September 15, 2002 is increased by the amount of the underpayment from the previous two quarters. Such taxpayers should file form M-2210 with their income tax return, and check the box labeled "Adjustment for 2002 Act Enhancing State Revenues." In calculating their underpayment penalty, taxpayers may subtract from the underpayment amounts in the first two quarterly installments the amounts attributable to changes made by the Act and paid by September 15, 2002.

II. Provision Affecting Sales and Use Tax

Mobile Telecommunications Sourcing for Sales Tax Purposes

The Act conforms the Massachusetts sales tax on telecommunications services, G.L. c. 64H, § 1, to the Federal Mobile Telecommunications Sourcing Act, 4 U.S.C. §§ 116 - 126. St. 2002, c. 186, §§ 24 - 27. This federal law simplifies the taxation of wireless calls by requiring states that tax such calls (such as Massachusetts) to impose tax based only on the retail customer's "place of primary use," regardless of where a call originates or terminates. The "place of primary use," as defined by the federal law, is generally the residential street address or the primary business address of the customer. Thus, if a retail customer's "place of primary use" is in Massachusetts, all calls billed to that customer will be subject to Massachusetts sales tax. Both the new federal law and the new Massachusetts sales tax provisions apply to customer bills for wireless telecommunications services issued after August 1, 2002.

III. Provision Affecting Estate Tax

"Decoupling" the Massachusetts Estate Tax from the Federal Estate Tax

Recently, the U.S. Congress made numerous changes to the Code provisions relating to estate and gift tax. For the estates of decedents dying on or after January 1, 2002, EGTRRA, inter alia, phases out the amount of the allowable credit for state death taxes by 25% a year until the credit is eliminated in 2005. Because the Massachusetts estate tax, prior to the recent statutory amendments, equaled the amount of the allowable federal credit for state death taxes, this federal change meant that the Massachusetts estate tax would be phased out and eliminated unless legislative action was taken.

The Massachusetts estate tax in G. L. c. 65C, § 2A, also known as the "sponge tax", is preserved by "decoupling" the Massachusetts estate tax from the federal estate tax. In other words, the reference point Massachusetts uses to tie itself to the Code for sponge tax purposes is a fixed date instead of a reference point that automatically incorporates any federal changes. Thus, due to the decoupling legislation, the Massachusetts sponge tax is now tied to the Code as in effect on December 31, 2000. See St. 2002, c. 186, § 28, as amended by St. 2002, c. 364, § 10.

As a result of these changes, the threshold amounts for filing Massachusetts and federal estate tax returns will be different for the estates of decedents dying on or after January 1, 2003. Massachusetts estate tax returns will be required when the gross estate plus adjusted taxable gifts, computed using the Internal Revenue Code in effect on December 31, 2000, exceeds the following amounts:

1. $ 700,000
2. $ 850,000
3. $ 950,000

2006 and thereafter $ 1,000,000

Beginning in 2003, some estates will file a Massachusetts estate tax return but no federal estate tax return, and some estates will pay a Massachusetts estate tax but no federal estate tax. Future changes to the federal estate tax law will not affect the Massachusetts estate tax law, as the reference for Massachusetts is the Internal Revenue Code in effect on December 31, 2000.

The Massachusetts sponge tax computation for deaths occurring in 2002 will be computed under current federal law that has a filing threshold of $1,000,000.

IV. Provision Affecting Tax Administration

Interest on Tax Refunds

For returns filed on or after January 1, 2002, and before January 1, 2005, taxpayers are eligible to receive interest on overpayments of tax when the Department pays a refund more than 120 days after a return's due date, or, if a return is filed after the due date, more than 120 days after the actual date of the return's filing. No interest is allowed on an overpayment if the tax refund is made within these 120-day periods. For returns that are filed after the due date, the 120-day period begins to run with the date of filing regardless of whether there is an extension; if a refund is made after the 120-day period, interest is allowed back to the date of filing. For returns filed on or after January 1, 2005, the 120-day period becomes a 45-day period. St. 2002, c. 364, § 14; St. 2002, c. 96, §§ 3, 10; amending G.L. c. 62C, § 40.

[1] In addition, this TIR explains certain provisions of St. 2002, c. 300, and St. 2002, c. 364.
[2] Also, interest from loans made in the course of business by persons subject to G.L. c. 140, §§ 70 - 85 is excluded from Part A income.
[3] As under prior law, capital gains on the sale or exchange of collectibles, as defined at IRC § 408(m), are included in Part A income.
[4] See the Department's regulation on Capital Gains and Losses at 830 CMR 62.4.1 for an explanation of the tax treatment of capital gains and losses for tax years beginning on or after January 1, 1996, and for transactions completed before May 1, 2002.
[5] TIR 02-6 and TIR 02-7 are hereby revoked and replaced. The consequences of nonconformity to federal law before the Act were explained in TIR 02-6, The Effect of Recent Federal Tax Law Changes to Retirement Plans; Contributions, Distributions and Rollovers, and TIR 02-7, Massachusetts Exclusion Amounts for Retirement Plan Elective Deferrals for Tax Year 2002. TIR 02-6 and TIR 02-7 were implicitly repealed by the Act on July 25, 2002 and are replaced by this TIR.
[6] For years when an individual receives plan distributions, Massachusetts allows a deduction for the portion of plan distributions that were previously subject to Massachusetts personal income tax. The distributions are deducted from Massachusetts gross income to the extent that the aggregate amount deducted equals the aggregate amount previously included in Massachusetts gross income. G.L. c. 62, § 2(a)(2)(F).
[7] For employers taxable on net income under G.L. c. 63, the definition of net income (including the deduction at IRC § 404) refers to the provisions of the current Code.
[8] See DD 01-7. Compare DD 99-4 and DD 01-4.

/s/Alan LeBovidge
Alan LeBovidge
Commissioner of Revenue

AL:DMS:ah
143411

November 6, 2002

TIR 02-18