Directive  Directive 14-4: Massachusetts Income Tax and Corporate Excise Deductions Where Federal Law Allows a Credit in Lieu of Deduction

Date:	12/16/2014
Organization:	Massachusetts Department of Revenue
Referenced Sources:	Massachusetts General Laws

Personal Income Tax

I.  Introduction and Summary  

Massachusetts and federal tax statutes sometimes differ in their treatment of deductions and credits.  With respect to both corporate entity-level taxation under the corporate excise under G.L. c. 63, and personal income taxation under G.L. c. 62, Massachusetts law generally bases the business expense deduction on the federal business expense deduction that is allowable under Internal Revenue Code (IRC or Code) §§ 62(a), 162.^[1]  Under some provisions of the Code, a taxpayer that has a business expense is allowed to take a credit for that expense instead of taking a business deduction.  In many cases Massachusetts does not offer a state credit that corresponds to the federal credit, as in the case of the federal credit in lieu of deduction for small employer health insurance premiums paid.^[2] 

The question presented is whether a taxpayer filing in Massachusetts may take the business expense deduction that would have been allowed federally had the taxpayer not instead taken the federal credit.  This Directive explains that, unless specifically permitted by Massachusetts statute, a taxpayer may take a business expense deduction in Massachusetts only if and to the extent the deduction is actually taken at the federal level.  If a taxpayer takes a federal credit in lieu of a federal deduction, the amount that would otherwise have been allowed as a federal deduction is no longer allowable and may not be deducted as a business expense for Massachusetts taxation purposes.

II.  Issue

In calculating its corporate excise under G.L. c. 63, or the personal income tax liability under G.L. c. 62, does Massachusetts permit a taxpayer to take a business expense deduction where the taxpayer has not taken a federal business expense deduction for that amount, in order instead to take a federal credit?  

III.  Directive

In calculating its corporate excise under G.L. c. 63, or the personal income tax liability under G.L. c. 62, Massachusetts law generally permits a taxpayer to deduct a business expense only when that expense is actually deducted for federal purposes.  In circumstances where a taxpayer does not take part or all of a federal business expense deduction, taking instead a federal credit, Massachusetts law allows a business expense deduction, under G.L. c. 62 or c. 63, only in an amount equal to that part of the expense that the taxpayer actually deducts as a business expense for federal purposes.  Exceptions to this general rule exist only where a Massachusetts statute specifically allows a taxpayer both a credit and a deduction related to the same expense.

IV.  Discussion

Massachusetts law allows a taxpayer to deduct certain business expenses for both corporate excise and personal income tax purposes, and generally ties the state business expense deduction, with modifications, to the federal business expense deduction.  See G.L. c. 63, §§ 1 “net income,” 30.4, G.L. c. 62, § 2(d)(1).  In some cases, a taxpayer does not take a federal business expense deduction because federal law gives taxpayers a credit instead, and does not allow the taxpayer to take a business expense deduction for some or all of the credit amount.^[3] 

Net income under the Massachusetts corporate excise is federal gross income minus certain deductions, among them, the allowable federal business expense deduction, as it may be modified for state purposes.  G.L. c. 63, §§ 1 “net income,” 30.4.^[4]   With respect to the income of an individual taxpayer, including distributive share income on which S corporation shareholders pay an income tax under G.L. c. 62, net income is also generally calculated by taking into account the allowable federal business expense deduction.^[5]  Because of the direct statutory link between the state deduction and the allowable federal business expense deduction, where the taxpayer does not take a federal deduction there is also no Massachusetts business expense deduction.  By taking the federal credit in lieu of deduction, the portion of the federal deduction the taxpayer is denied is no longer allowable for federal purposes.^[6]    

There are instances where the Massachusetts legislature by statute has allowed a taxpayer to take a business expense deduction for which there is a federal credit and no corresponding deduction at the federal level.  For example, Massachusetts law has allowed a corporation to deduct the portion of wages or salary that is used to calculate the federal work opportunity credit under IRC § 51.  G.L. c. 63, § 30.4.  Another example, part of the life sciences initiative passed in 2008, when specifically granted the benefit by the Massachusetts Life Sciences Center, Massachusetts law permits a corporation that takes the federal credit for clinical testing expenses in the pharmaceuticals industry (the “orphan drug” credit, see IRC § 45C) to deduct the amount of the credit from the Massachusetts corporate excise, again despite the fact that there is no federal deduction for that amount.  G.L. c. 63, § 38V.  

Where there is no statutory authorization for a taxpayer to take a business deduction that is not taken federally, the taxpayer may not take the deduction at the state level.  Examples of this rule include, without limitation:  the small business health care insurance premiums expenses credit in lieu of the usual deduction for certain wages or salaries, at Code section 45R (see IRC § 280C(h)); the credit for expenditures to provide access to disabled individuals, at Code section 44;  the credit for a portion of employer social security taxes paid with respect to employee cash tips, at Code section 45B;  the small employer pension plan startup costs credit, at Code section 45E; and various credits the taking of which result in a reduction in an otherwise allowable federal deduction, as set forth in Code section 280C.  In such situations, the Massachusetts business deduction is allowed only to the extent that the taxpayer takes a federal business expense deduction.

 

/s/Amy Pitter
Amy Pitter
Commissioner of Revenue
 

AP:MTF:dt

December 16, 2014

DD 14-4

[1]  See G.L. c. 63, § 1, definition of “net income,” (defining the net income of a financial institution as “gross income . . . less the deductions, but not the credits allowable under the provisions of the Internal Revenue Code” ), G.L. c. 63, § 30.4 (defining the net income of a business corporation as “gross income less the deductions, but not the credits, allowable under the provisions of the Federal Internal Revenue Code . . . ).  See also G.L. c. 62, § 2(d)(1) (defining Part B adjusted gross income  to be gross income less “the deductions allowable under section sixty-two” of the Code, with exceptions not relevant here.)

[2]  As part of the federal health insurance law of 2010, known as the Patient Protection and Affordable Care Act of 2010, a small employer has the option of taking a credit in lieu of a business deduction for a portion of the health insurance premiums the employer pays on behalf of its employees.  P.L. 111-148 (2010).  See “Employee Health Insurance Expenses of Small Employers” credit, IRC § 45R.  The portion of such expense that is not reimbursed through the credit is allowed as a business expense deduction for both federal and state purposes, and is not at issue in this Directive.  If taken as an allowable business deduction for federal purposes, the same amount is allowed to the employer as a business deduction for Massachusetts purposes.  IRC § 280C(h), G.L. c. 63, §§ 1, “net income,” 30.4; G.L. c. 62, § 2(d)(1). 

[3] For example, the deduction for wages an employer pays is generally allowed as a trade or business expense deduction under IRC §§ 62(a), 162.   This federal deduction is denied for the portion of wages or salaries that are equal to the sum of certain federal credits, including the small employer health insurance premiums credit.  IRC § 280C.

[4]  The Massachusetts net income figure for corporate excise purposes is derived through the following statutory mechanisms.  For business corporations subject to the excise at G.L. c. 63, § 39, and for the entity-level tax of S corporations subject to the rate under G.L. c. 63, § 32D,  net income is “gross income less the deductions, but not the credits, allowable under the provisions of the Federal Internal Revenue Code, as amended . . . .”   Financial institutions subject to the excise at G.L. c. 63, §§ 2 – 2B are taxable on net income, defined as “gross income . . . less the deductions, but not the credits allowable under the provisions of the Internal Revenue Code, as amended . . . . “

[5]  For individual taxpayers, including shareholders in an S corporation taxable on their distributive share of the S corporation’s income, the adjusted gross income is determined under G.L. c. 62, § 2(d)(1), and is the federal gross income figure (as modified under G.L. c. 62, § 2(a), (b)), less a number of deductions, among them the general federal business expense deduction allowable under IRC § 62.  Partners in a partnership are subject to tax on their distributive share of the income received or earned by the partnership, with the income, loss, deductions and credits computed in the same manner as in the case of an individual under G.L. c. 62, with certain modifications not relevant here.  G.L. c. 62, § 17.

[6] There is an economic basis for this statutory link:  if a taxpayer takes a federal credit instead of a business expense deduction, the taxpayer has effectively been reimbursed for the expense.  The expense has been recovered through the reduction in tax afforded by the federal credit.   Once reimbursed, the taxpayer has had no real expense.  Thus, there is nothing to deduct at the state level.