| Date: | 05/03/2010 |
|---|---|
| Organization: | Massachusetts Department of Revenue |
| Referenced Sources: | Massachusetts General Laws |
Corporate Excise/Personal Income Tax
Introduction: As a result of St. 2008, c. 173 (the Act), Massachusetts business entity classification for income tax and corporate excise purposes now generally conforms to federal entity classification under the so-called check-the-box rules. See 830 CMR 63.30.3. A result of this conformity is that there are no longer special taxation provisions for corporate trusts. This Directive explains the calculation of a non-corporate shareholder's [1] basis in the shares of an entity that for any tax year was subject to tax in Massachusetts as a corporate trust under the now-repealed G.L. c. 62, § 8 where the entity has undistributed earnings that were taxed to the corporate trust under that section.
Issue: What is the basis of a non-corporate shareholder in shares of an entity that for any year was taxed in Massachusetts as a corporate trust under the now-repealed G.L. c. 62, § 8 and has undistributed earnings that were taxed to the trust under that section?
Directive: For any shares that a non-corporate shareholder holds in an entity that for any tax year was taxed in Massachusetts as a corporate trust under the now-repealed G.L. c. 62, § 8, the non-corporate shareholder's basis in such shares may be adjusted by adding the shareholder's proportionate or allocable share (based on the extent and terms of that shareholder's equity investment) of the net accumulated earnings of the entity that were previously taxed in Massachusetts under G.L. c. 62, § 8 but were never distributed to shareholders. "Net accumulated earnings" are the accumulated earnings of the entity that were reported on a Massachusetts tax return, apportioned or allocated to Massachusetts, and taxed under G.L. c. 62, § 8, as reduced by losses of the entity, if any, in a year that the entity was treated as a corporate trust under G.L. c. 62, § 8, to the extent that any such losses were apportionable or allocable to Massachusetts.
This Directive only applies with respect to non-corporate shareholders who were shareholders during the period when the entity was taxed as a corporate trust and with respect to that shareholder's share of previously taxed net accumulated earnings of the corporate trust during the period of the shareholder's ownership. No addition to basis may be made for any earnings of the former corporate trust that were not taxed in Massachusetts under former G.L. c. 62, § 8, or that were tax-free earnings and profits, as set forth in 830 CMR 62.8.2, or that have been distributed to the shareholder or any other shareholder. The adjustment authorized in this Directive may not be made if any other adjustment or modification has been or is made to the shareholder's basis that duplicates or otherwise corresponds to the adjustment described herein.
Corporate shareholders, namely shareholders that are taxable under Chapter 63 of the General Laws, do not make the adjustment authorized in this Directive for non-corporate shareholders. Rather, basis in shares of the former corporate trust that are owned by a corporate shareholder is determined in accordance with 830 CMR 63.30.3 and is subject to the modifications set forth in 830 CMR 63.30.3(3), (4).
This Directive does not change the Massachusetts rule that prior to the elimination, pursuant to the Act, of the special corporate trust tax regime in G.L. c. 62, § 8, corporate trust shares for all shareholders were not allowed the adjustments to basis that are permitted under the federal S corporation laws and regulations. The specific basis adjustment rules in this Directive apply to non-corporate shareholders in corporate trusts generally, irrespective of whether the corporate trusts were federal S corporations during a period that the entity was treated as a corporate trust under former G.L. c. 62, § 8.
Discussion: This Directive sets forth rules for calculating a non-corporate shareholder's basis in shares of an entity that for any tax year was taxable as a corporate trust under the now-repealed G.L. c. 62, § 8. In reviewing the tax consequences of the Act on non-corporate shareholders, the Department of Revenue has determined that to avoid the possibility that the value of retained, previously taxed net accumulated earnings of a corporate trust could be subject to income tax again under Chapter 62 of the General Laws upon a sale or other taxable disposition of shares, the Department will allow an upward basis adjustment in shares of a corporate trust for non-corporate shareholders to the extent of the shareholder's proportionate or allocable share of net accumulated earnings that were taxed to the corporate trust under G.L. c. 62, § 8 during the period of the shareholder's share ownership and that have not been distributed to any shareholders. The basis as calculated in this Directive is the Massachusetts tax basis referred to in 830 CMR 63.30.3, subject to further adjustments provided therein or pursuant to other applicable rules. The upward adjustment to basis set forth in this Directive is not allowed for any earnings of the former corporate trust that were not taxed in Massachusetts under former G.L. c. 62, § 8, nor for the value of any tax-free earnings and profits, nor is it allowed for the value of any earnings that were taxed under G.L. c. 62, § 8 but were distributed to the shareholder (or any other shareholder) at any time prior to the shareholder's disposition of shares and while the entity is or was treated as a corporate trust. The upward adjustment to basis is also not allowed for shareholders that are subject to tax under Chapter 63 of the General Laws, that is, corporate shareholders. [2]
As a general matter, retained earnings will carry forward on the books of entities (and certain successors) that were formerly taxed as a corporate trust, after the elimination pursuant to the Act of the special corporate trust tax regime in G.L. c. 62, § 8. To the extent that a non-corporate shareholder has obtained an upward adjustment in share basis to account for net accumulated earnings that were taxed to the corporate trust as set forth in this Directive, such shareholder must account for all subsequent distributions of net accumulated earnings during the period that the entity was treated as a corporate trust under G.L. c. 62, § 8, by reducing basis in the amount of such distributions. [3] Once the corporate trust becomes treated for Massachusetts tax purposes as a corporation, partnership, or disregarded entity as the case may be, whether pursuant to the Act or pursuant to a prior conversion or reorganization, the regular tax rules applicable to such types of entities as classified for tax purposes, and to distributions therefrom, will apply. [4] For example, when a corporate trust becomes treated as a corporation pursuant to the Act, subsequent distributions will be treated as taxable dividends to the extent of earnings and profits and to such extent will not be accompanied by any downward basis adjustment. When a corporate trust becomes treated as a partnership, regular partnership tax rules would apply to distributions, e.g., in many cases treating distributions as non-taxable and resulting in a reduction in basis.
This Directive states rules that are separate and distinct from the rules in the entity classification regulation, 830 CMR 63.30.3, pertaining to the taxation of tax-free earnings and profits of the former corporate trust. See, for example, 830 CMR 63.30.3(3)(d) (generally requiring, upon termination of tax classification of an entity as a corporate trust, an immediate inclusion of taxable dividends in shareholders' income to the extent of tax-free earnings and profits of a former corporate trust; but in situations where a corporate trust becomes classified as a corporation for Massachusetts tax purposes, providing generally for a downward basis adjustment in shareholders' shares of former corporate trust to account for such tax-free earnings and profits). Thus, those taxpayers who are allowed a downward basis adjustment in shares of a successor corporation to account for tax-free earnings and profits of the "outgoing" corporate trust (in lieu of immediate taxation of such tax-free earnings and profits as a dividend) will use as their basis from which to take such downward adjustment their share basis as adjusted in accordance with this Directive to reflect any undistributed previously taxed net accumulated earnings of the corporate trust that were attributable to their shares. In such cases, this Directive supplements the transition rule in 830 CMR 63.30.3(4)(a)(2)(a), which states that "[t]he shareholders of the former corporate trust will have a Massachusetts tax basis in the shares of the successor corporation equal to the basis they previously had in the shares of the corporate trust."
It should be noted that shareholders of those corporate trusts that, prior to their reclassification pursuant to the Act, were S corporations for federal income tax purposes were not permitted to adjust basis in the manner that they adjusted basis federally. The basis adjustment rules in this Directive apply to shareholders in corporate trusts generally, irrespective of whether such an entity was a federal S corporation during a period that the entity was taxable in accordance with former G.L. c. 62, § 8.
Examples
Example 1. Business Trust X has been in existence in Massachusetts since 2005 and prior to 2009 was taxed as a corporate trust. Its taxable year is the calendar year. Business Trust X is classified as a corporation for federal income tax purposes. Prior to tax year 2005, Shareholder A (a non-corporate shareholder) had a Massachusetts basis in shares of Business Trust X of $2,000. In tax year 2005, Business Trust X has income of $1,000 attributable to Shareholder A (based on A's proportionate holding of Business Trust X's stock). Business Trust X has no tax-free earnings and profits. $700 of the $1,000 of Business Trust X's income was taxable to the trust and distributed to Shareholder A, and was not taxable to Shareholder A in accordance with former G.L. c. 62, § 8(c). The remaining $300 of the $1,000 of income attributable to Shareholder A was taxed to Business Trust X in Massachusetts, but was retained by Business Trust X. For simplicity of illustration, assume Business Trust X has earnings and distributions of an identical pattern to those in 2005 for tax years 2006 - 2008. At the close of tax year 2008, the basis in shares for Shareholder A is calculated as follows:
Basis of Shareholder A's shares, at beginning of 2005: $2,000
Amount of net accumulated earnings retained by
Business Trust X and taxed to Business
Trust X in accordance with G.L. c. 62, § 8:
Tax year 2005 $300
2006 $300
2007 $300
2008 $300
$1,200
Shareholder A's Massachusetts tax basis
at the close of tax year 2008, assuming none
of the net accumulated earnings taxed to Business
Trust X have been distributed to Shareholder A: $3,200
Thus, the Massachusetts tax basis of Shareholder A's shares at the close of 2008, when Business Trust X was reclassified as a corporation pursuant to the Act [5], is also $3,200.
Example 2. Under the "Exception for corporate successors to corporate trusts," at 830 CMR 63.30.3(3)(d)(4), a shareholder in a corporate trust that becomes classified as a corporation for Massachusetts tax purposes (and shareholders in certain corporate successors to corporate trusts) will generally reduce the shareholder's basis in shares by the shareholder's proportionate share of any remaining tax-free earnings and profits. [6] Business Trust Y has been in existence in Massachusetts since 2005 and prior to 2009 was taxed as a corporate trust. Its taxable year is the calendar year. Business Trust Y is classified as a corporation for federal income tax purposes. Prior to tax year 2005, Shareholder B (a non-corporate shareholder) had a Massachusetts tax basis in shares of Business Trust Y of $2,000. In years 2005 through 2008, Business Trust Y has income of $1000 per year attributable to Shareholder B (based on B's proportionate holding of Business Trust Y's stock). Of that $1,000 of income per year, $200 per year constitutes tax-free earnings and profits attributable to Shareholder B, and $800 per year constitutes earnings that were taxed to Business Trust Y in accordance with G.L. c. 62, § 8. Business Trust Y made no distributions in any of the years from 2005 through 2008. Consequently, Business Trust Y had $800 of accumulated tax-free earnings and profits attributable to Shareholder B and $3,200 of net accumulated taxed earnings attributable to shareholder B on December 31, 2008. Under the Act, the Business Trust Y was reclassified as a corporation for Massachusetts tax purposes for the tax year beginning January 1, 2009.
As of the beginning of 2009, Shareholder B's Massachusetts tax basis in shares of Business Trust Y is calculated as follows:
Basis of Shareholder B prior to 2005: $2,000
Increases
Taxed E&P yet to be distributed:
2005 $800
2006 $800
2007 $800
2008 $800
Total Increase $3,200
Basis reflecting Increases $5,200
Decreases
Undistributed Tax-Free E&P on 12/31/08:
2005 $200
2006 $200
2007 $200
2008 $200
Total Decrease $800
Adjusted Basis $4,400
Note that these rules with regard to basis and adjustments also apply in the case of certain corporate trusts that reorganized into entities taxable as a corporation before the change in classification would occur by operation of the Act. See 830 CMR 63.30.3(3)(d)(4).
/s/Navjeet K. Bal
Navjeet K. Bal
Commissioner of Revenue
NKB:MTF:dt
May 3, 2010
DD 10-2