In Peterson v. Commissioner of Revenue, 444 Mass. 128 (2005) (" Peterson II"), the Supreme Judicial Court concluded that the new capital gains tax rate of 5.3% (generally applicable to all capital gains with holding periods exceeding one year) is effective January 1, 2002. As a result of Peterson II, taxpayers with capital gain transactions reported for the period between January 1, 2002 and April 30, 2002 may have underpaid their Massachusetts personal income tax.
In response to Peterson II, as discussed below in Section VIII, there are several legislative proposals currently pending that may affect the amount of tax liabilities for 2002. However, the Department must issue assessments for the 2002 tax year prior to the expiration of the statute of limitations on assessment.  Accordingly, the Department will begin issuing notices of intention to assess in response to Peterson II including interest calculated from the original statutory due date of the 2002 return, as described below. The Department does not currently have the authority to waive interest. This legal authority may be provided only by enactment of new legislation by the state Legislature.
This Technical Information Release explains how, absent further legislation, the Department will administer the recalculation of 2002 tax liabilities required by Peterson II. As explained below, the Department will notify taxpayers of additional tax resulting from Peterson II based on records compiled from their previously filed 2002 tax returns.
- Peterson I
For years prior to 2002, where a capital asset was sold after a holding period of more than one year, the Massachusetts personal income tax law in G.L. chapter 62 provided six categories of capital gain based on six defined holding periods and taxed at six different rates (ranging from 5% down to 0%).
Effective for tax years beginning on or after January 1, 2002, the Legislature enacted changes regarding the income tax treatment of capital gains and losses under chapter 62. St. 2002, c. 186, and St. 2002, c. 364. This legislation set May 1, 2002 as the effective date for increasing the rate of taxation to 5.3% for long-term capital gains from sales or exchanges occurring on or after that date. Subsequently, the Supreme Judicial Court held that the May 1, 2002 effective date violated article 44 of the Amendments to the Massachusetts Constitution. Peterson v. Commissioner of Revenue, 441 Mass. 420 (2004) (" Peterson I"). In Peterson I, the Court ruled that the uniformity requirement of article 44 requires that "a single tax rate must be applied to income from the same class of property received during the period specified by the Legislature for measuring income." May 1, 2002 was stricken as the effective date, and the case was remanded for a determination of whether the effective date of the rate increase should be January 1, 2002, or January 1, 2003.
Before the Peterson I litigation was concluded, the Legislature enacted a second set of provisions to address the effective date of the new capital gains tax rate. St. 2004, c. 149, §§ 413, 414 (the "2004 Act"). Section 414 of the 2004 Act shifted the effective date for the tax rate change back to January 1, 2002. However, section 413 of the 2004 Act provided: "Notwithstanding any general or special law to the contrary the commissioner of revenue shall not adjust the tax liability with respect to capital gains for the period January 1, 2002 to April 30, 2002 for any taxpayer who, before the effective date of this act, paid that liability in full for capital gains realized between January 1, 2002 and April 30, 2002, inclusive."
The plaintiffs in Peterson I amended their complaint and sought a declaratory judgment that sections 413 and 414 of the 2004 Act were unconstitutional.
- Peterson II
On April 26, 2005, in Peterson II, the Supreme Judicial Court ruled that the new capital gains tax rate of 5.3% is effective January 1, 2002. In reaching its decision, the Court considered the legislative history, including the "fiscal crisis" that in part prompted the original legislation. The Court concluded, among other things, that it would be illogical, given those circumstances, for the Legislature to pass a tax increase but delay its implementation until the next year, January 1, 2003.
The Court held that section 413 and section 414 of the 2004 Act were severable and that, while section 414 setting the rate at 5.3% for 2002 is valid, the exemption at section 413 for capital gains realized between January 1, 2002 and April 30, 2002 is not. The Court stated that "the exemption provided by section 413 does not qualify as a 'reasonable exemption' under art. 44, but is instead an impermissible deviation from the art. 44 requirement of uniformity." Id.
II. Recalculation of 2002 Tax Year
As a result of the Peterson II decision, taxpayers with capital gain transactions reported for the period between January 1, 2002 and April 30, 2002 may have underpaid their Massachusetts personal income tax. Taxpayers whose returns for the 2002 tax year must be recalculated due to net capital gains during the first four months of 2002 include taxpayers who filed a Schedule D with Form 1, Form 1 NR/PY, Form 2, Form 3F or Form 3M.
In general, any taxpayer subject to the Massachusetts personal income tax who paid tax at a rate lower than 5.3% on net capital gains during the first four months of 2002 owes additional tax. The additional tax is calculated at a rate based on the difference between the 5.3% rate and the rates in effect before Peterson. The amount of additional tax owed for net capital gains during the first four months of 2002 depends on the rate of tax (ranging from 5% down to 0%) that was imposed on such net gains as reported on the 2002 return (Schedule D, Part 3, lines 23A - 23F). Absent further legislation,  the Department will administer the recalculation required by the Peterson II decision as follows.
General Laws c. 62C, § 26(b) authorizes the Commissioner to assess additional taxes within three years from the date the tax return was filed, or required to be filed, whichever occurs later. Generally, the Commissioner must first give notice of his intention to the person to be assessed, and "after the expiration of thirty days from the date of such notification, the [C]ommissioner shall assess the amount of tax remaining." Id. After an internal assessment is completed, the Commissioner will give written notice to the taxpayer of the amount of the assessment and the amount of any balance due. G.L. c. 62C, § 31.
Peterson Notices. In the case of any taxpayer with net capital gains from transactions reported for the period between January 1, 2002 and April 30, 2002, inclusive, the Department will mail the taxpayer a Notice of Intent to Assess ("NIA"). The NIA serves as notification to a taxpayer under G.L. c. 62C, § 26(b) that the Commissioner intends to make a deficiency assessment after thirty days based on the recalculation required by the Peterson II decision. The Peterson NIA will apply the rate of 5.3% to net capital gains reported on a taxpayer's personal income tax return for the period January 1 - April 30, 2002 (Schedule D, Part 3, lines 23A-23F). A taxpayer may confer with the Commissioner or his duly authorized representative as to the proposed assessment; the taxpayer's appeal rights are explained in the NIA instructions.
Taxpayer Verification. Taxpayers who receive a Peterson NIA should verify the amount of net gain reported in each rate class (ranging from 5% down to 0%) and notify the Department of any errors. In reviewing the 2002 returns filed by affected taxpayers, the Department has found that, in some instances, the amount of net gains previously taxed at 0% (Schedule D, Part 3, line 23F) was incorrect due to a tax preparer software error.  If a taxpayer's previously filed return shows an incorrect amount of net capital gain on Schedule D, Part 3, line 23F (net capital gains previously taxed at 0%), the recalculation required by Peterson will not be accurate. In such a case, the taxpayer must provide the Department with the corrected amount of net capital gain.
After thirty days from the issuance of the Peterson NIA, the Commissioner will proceed, in accordance with applicable procedures, to assess the tax remaining due including statutory interest and will issue a Notice of Assessment ("NOA") to the taxpayer.
Payment. The amount of the balance due from a taxpayer generally must be paid on or before the thirtieth day from the date of the issuance of the NOA. As explained below in Section III, the taxpayer's failure to pay the balance due by the due date will subject the taxpayer to the imposition of additional charges for interest and penalties.
III. Interest and Penalties
Interest. Interest on unpaid tax for tax year 2002 generally accrues from the statutory due date of April 15, 2003.  G.L. c. 62C, § 32.
Penalty for Failure to Pay a Tax When Due. A taxpayer who owes additional tax based on the Peterson II decision generally will not be assessed the penalty at G.L. c. 62C, § 33(b) for failure to pay such additional tax at the original due date. The § 33(b) penalty applies in instances where the taxpayer has reported a certain amount of tax on a return but has failed to pay the full amount shown. Thus, if a taxpayer timely filed the applicable 2002 return and reported and paid the tax in full based on the personal income tax law prior to Peterson II, the penalty at G.L. c. 62C, § 33(b) will not apply.
Penalty for Underpayment of Estimated Tax. Under the provisions of G. L. c. 62B, there is no penalty for underpayment of estimated tax for tax year 2002 for additional tax due attributable to the Peterson II decision.
Penalty for Failure to Pay Deficiency Assessment. If a taxpayer does not pay the full amount due on a Notice of Assessment related to a deficiency assessment within 30 days of the notice, a penalty will be charged at the rate of ½% per month, or fraction thereof, of the unpaid tax. The total penalty charge cannot exceed 25% of the unpaid tax. G.L. c. 62C, § 33(c).
IV. Payment Agreements
In some hardship situations, taxpayers are unable to pay their full tax liability and are unable to borrow the full amount in order to do so. General Laws c. 62C, § 37B provides the Commissioner authority to enter into a written agreement with a taxpayer under which such taxpayer is allowed to satisfy liability for payment of any tax in installment payments if the Commissioner determines that such agreement will facilitate collection of the liability. See Administrative Procedure 631.3 and the Department's online payment agreement application for the requirements for a Payment Agreement. 
V. Liability of Estates and Distributees
In various circumstances, tax entities such as a trust or an estate that filed a 2002 return may no longer be in existence. Also, individuals who filed a 2002 return may have subsequently died. In such cases, the trustee or distributee of the terminated entity or the decedent's estate may owe additional tax based on the recalculation required by Peterson II.
For example, in situations where a net capital gain was reported on a 2002 Form 1, the gain was realized between January 1, 2002 and April 30, 2002, and the taxpayer has subsequently died, generally the Commissioner will assess the executor or other legal representative of the decedent's estate. The executor or legal representative is liable for a tax incurred by the decedent resulting from the decedent's receipt of taxable income during his lifetime to the extent that, after a demand for tax, the executor or legal representative has received or has in his possession money for payment of the tax. See G.L. c. 62, § 9 and Levin v. Commissioner of Corporations and Taxation, 349 Mass. 20 (1965). Executors of undistributed estates are cautioned to withhold funds for this tax liability before making distributions. Where the Commissioner cannot collect the assessment from the executor and, prior to April 26, 2005, the time for filing a claim under G.L. c. 197, § 9 expired and the estate was settled, the Commissioner may collect the tax from the heirs to the extent of distributions pursuant to G.L. c. 197, §§ 28 - 34.
VI. Installment Sales
If Massachusetts taxpayers use the installment method of reporting gains with respect to installment sales for federal income tax purposes, they may elect to use this method for Massachusetts personal income tax purposes as well. G.L. c. 62, § 63. A taxpayer must obtain the written approval of the Commissioner prior to the use of the installment method.
A. Installment Sales on or after January 1, 2002 and before May 1, 2002
Certain taxpayers used the installment method of reporting for federal purposes for eligible installment sales completed on or after January 1, 2002 and before May 1, 2002, but chose not to apply for the Massachusetts installment method based on the personal income tax law prior to Peterson II. Those taxpayers may now apply to the Commissioner for permission to use the installment method of reporting for Massachusetts purposes with respect to such transactions.  Taxpayers wishing to report income using the installment method must amend their tax returns for 2002 and subsequent affected years to report such transactions and all payments, gain, interest, and other items, consistent with the use of such method. Final approval to use the installment method is conditioned upon receipt of the amended returns for all applicable years and the posting of acceptable security to the extent required. See Administrative Procedure 201, Installment Sales, for the procedures to follow in posting security.
B. Installment Sales on or after January 1, 1996 and before January 1, 2002
If taxpayers previously received approval to use the installment method on a transaction that took place between January 1, 1996 and December 31, 2001, they should continue to report their gains from that sale at the tax rate in effect in the year of the sale. Any taxpayer who receives a Peterson NIA for the 2002 tax year which recalculates the gain from one of these sales at the 5.3% tax rate should contact the Department within 30 days of receipt of the NIA so the notice can be adjusted or canceled. For example, a taxpayer who had a 3% installment sale gain from a year prior to 2002 would have reported it as a 3% gain in 2002. The automated Peterson NIA will not routinely reflect the gain as installment gain from a prior-year transaction and will assess a deficiency at the difference between 3% and 5.3%, thus requiring a further adjustment to utilize the prior year's rate.
VII. Small Amounts Due (Not Exceeding $50)
General Laws chapter 62C, section 43 provides:
The commissioner is authorized to abate the unpaid portion of the assessment of any tax or any liability in respect thereof, if the amount due does not exceed fifty dollars and the commissioner determines, under uniform rules prescribed by him, that the administration and collection costs involved would not warrant collection of the amount due.
Due to the costs of administration and collection, the Commissioner will generally abate (rather than pursue collection of) assessments of additional 2002 tax resulting from Peterson II where the total amount due (including applicable interest and other outstanding tax balances) does not exceed $50. Accordingly, where the recalculation required by Peterson II results in a total liability of $50 or less (including interest) the Department does not expect to issue NIAs.
VIII. Proposed Legislation
As explained below, there are bills pending with the Legislature that address certain issues resulting from the Peterson II decision. Their description here reflects the applicable bill language at the time of issuance of this TIR and is subject to further legislative developments. In the event any additional legislation is enacted, the Department will provide further guidance to taxpayers.
H.B. 4165: An Act Amending the Taxation of Capital Gains. In Peterson II, the Supreme Judicial Court noted that it is "within the Legislature's power to amend the Act yet again, if it wishes, to set the effective date at January 1, 2003." This is the course proposed by the Governor. On June 10, 2005, Governor Romney filed legislation in response to the Peterson II decision that would set the effective date of the capital gains tax increase at January 1, 2003. This proposal would reinstitute the capital gains tax rates that existed during the first four months of 2002 (5% ranging down to 0% depending on the holding period) as the legal and enforceable tax rates applicable for that period. In addition, it would extend the applicability of those lower capital gains rates to all of calendar year 2002. Enactment of this legislation would eliminate the need for any deficiency assessments due to Peterson and would entitle certain taxpayers to refunds.
H.B. 4169: An Act Relative to the Tax Laws of the Commonwealth. Proposed legislation contained in this bill would generally provide that taxpayers would not be liable for interest or penalty charges with respect to any assessments as a result of the Peterson case, provided the additional tax is timely paid after such assessment. Under the proposed legislation, normal penalties and interest would accrue on unpaid taxes after such assessment. Also, the House and Senate proposals would permit a taxpayer to pay the liability in installments under rules to be developed by the Department.
In addition, H.B. 4169 contains a provision that, while not specific to anticipated Peterson assessments, will nevertheless have an impact with respect to many taxpayers. Under current law, General Laws chapter 62C, section 43 provides authority for the Commissioner to abate certain assessments where the total amount due does not exceed $50. See Section VII, above. The proposal would amend G.L. c. 62C, § 43 to increase the maximum amount from $50 to $100. If this legislation passes, the Commissioner will, for administrative convenience, abate anticipated assessments attributable to Peterson II where the taxpayer's total liability is $100 or less.
Commissioner of Revenue
November 9, 2005
 Although the statute of limitations for assessment of additional tax will not expire until April 15, 2006 (in certain cases, the statute will expire at a later date), as a practical matter the Department must begin mailing notification to affected taxpayers in time to allow for verification of the tax due and the processing of appeals.
 See Section VIII, Proposed Legislation.
 Before the Peterson case, an error in the amount of net gains reported on Schedule D, Part 3, line 23F (0% tax rate) did not affect the amount of tax. Where a net gain was previously taxed at a rate of 0%, the tax attributable to the net gain was $0 regardless of the amount of net gain.
 See TIR 05-10 and quarterly interest rate updates for specific rates in effect for each quarter.
 Before a payment agreement will be considered, the taxpayer must file all outstanding returns. Taxpayers should also know that a payment agreement extends the statute of limitations applicable to assessments for the term of the payment agreement.
 G.L. c. 62, § 63 provides that the Commissioner has the authority to consent to the revocation of a taxpayer's election with respect to use of the Massachusetts installment method of reporting.