Directive Directive 19-1: Application of the Massachusetts Personal Income Tax Credit for Taxes Paid to Another Jurisdiction to the Connecticut Pass-through Entity Tax
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Massachusetts law generally provides for a credit (the “§ 6(a) credit”) against taxes imposed under chapter 62 on Massachusetts residents for taxes due any other state, territory or possession of the United States, or the Dominion of Canada or any of its provinces, on account of any item of Massachusetts gross income. G.L. c. 62, § 6(a). The amount of the credit is the lesser of (i) the tax due the other jurisdiction, or (ii) the amount of tax imposed by chapter 62 multiplied by a fraction, the numerator1 of which is the amount of Part A, B, or C income taxed in the other jurisdiction, and the denominator of which is the total Part A, B, or C income.2 Id. This directive is intended to provide guidance for individuals and other chapter 62 taxpayers with respect to the application of the § 6(a) credit to a new Connecticut tax on pass-through entities. 3
Generally, individuals and other chapter 62 taxpayers are eligible for the § 6(a) credit for taxes due in another jurisdiction on an item of Massachusetts gross income. Such taxpayers may also be eligible for the credit on their distributive share of taxes imposed on a pass-through entity, but only if certain criteria are met. These requirements prevent the § 6(a) credit from exceeding the amount of tax due to Massachusetts and ensure that taxpayers cannot claim a deduction and a credit with respect to the same item of income. Specifically, in order to qualify for the credit: (1) the pass-through entity must pay the tax during the taxpayer’s taxable year; (2) the tax must be measured by income earned by the entity, a distributive share of which is required to be included in the taxpayer’s Massachusetts gross income; (3) the entity may not deduct any portion of the tax from its income in computing net income available for distribution to such member; and (4) the tax must otherwise be allowable as a credit under the provisions of G.L. c. 62, § 6(a). See 830 CMR 62.17A.2(4)(g)2a,b. See also DOR Directive (DD) 08-6. The credit is not allowed for taxes such as excise or property taxes or for franchise taxes not in the nature of an income tax. DD 08-6.
II. SUMMARY OF CONNECTICUT LAW
Prior to enactment of the Connecticut legislation, pass-through entities were not subject to tax on their income in Connecticut. Instead, the members of a pass-through entity were required to pay tax on their distributive shares of the entity’s income. Pursuant to the new Connecticut law, effective for taxable years beginning on or after January 1, 2018, pass-through entities (partnerships, S corporations and certain LLCs) are subject to a “Pass-through Entity Tax (“PE Tax”).4 The new law provides members with a credit for the tax paid by the pass-through entity. Both resident and nonresident members can claim this credit on their Connecticut personal income tax and corporation business tax returns.5
The Connecticut statute states that the new tax is to be deducted from an entity’s gross income in computing the net income available for distribution.6 The statute also provides that a PE Tax credit, in the amount of 87.5% of the tax paid,7 is allowed to each member in proportion to their distributive share of taxable income, applied against their Connecticut income tax liability, provided the entity has paid such liability prior to the member claiming the PE Tax Credit.8 Any excess credit is treated as an overpayment and, provided the taxpayer does not have other tax liabilities or debts or obligations to the state of Connecticut, it will be refunded to the taxpayer claiming the credit.9 Members are responsible for any additional Connecticut tax due and not covered by the PE Tax paid by the entity.10
Is an individual or other chapter 62 taxpayer, who is both a Massachusetts resident and a member of a pass-through entity, eligible for the credit under G.L. c. 62, § 6(a) for the taxpayer’s distributive share of the Connecticut PE Tax paid by the pass-through entity?
An individual or other chapter 62 taxpayer who is both a Massachusetts resident and a member of an entity subject to the Connecticut PE Tax is eligible for the credit allowed under G.L. c. 62, § 6(a) for the taxpayer’s distributive share of the PE Tax paid by the pass-through entity. The credit is allowed only if the taxpayer adds back his or her pro rata share of PE Tax paid to the amount of distributive share income subject to tax in Massachusetts, and the requirements of G.L. c. 62, § 6(a) are otherwise met.
In general, members of a pass-through entity report their distributive share of pass-through entity income, losses, deductions and allowable credits on their state and federal returns as if such items were realized or incurred directly by the member in the manner in which realized or incurred by the pass-through entity. G.L. c. 62, § 17(c). In prior guidance, the Department applied this general rule in addressing the applicability of the credit under G.L. c. 62, § 6(a) to situations where a pass-through entity paid a tax and a member of the entity sought the credit for such tax paid.
For instance, in DD 08-6, the Department explained that where an entity-level income tax based on an item of Massachusetts gross income is paid in another state by a partnership or other pass-through entity and the requirements and limitations described in G.L. c. 62, § 6(a) and 830 CMR 62.17A.1(5)(e) are met, a credit may be allowed to the Massachusetts members under G.L. c. 62, § 6(a). DD 08-6 requires that the tax paid by the pass-through entity be an income tax based on an item of Massachusetts gross income for a taxpayer member to be eligible for the credit. The directive also requires that the tax be an income tax in nature that is imposed on the net income of the pass-through entity. Id. See also DD 08-7. Additionally, in order for a taxpayer member to claim the credit under G.L. c. 62, § 6(a) on account of tax paid by a pass-through entity, the entity may not deduct any portion of the tax from its income in computing its net income before distribution to members. DD 08-6.
Letter Ruling (LR) 87-10 addressed a transaction involving a Massachusetts resident partner in a Massachusetts limited partnership that had invested in a New Hampshire partnership. The New Hampshire partnership invested in New Hampshire real property and proposed to sell the property at a substantial gain. LR 87-10. New Hampshire imposed the New Hampshire Business Profits Tax on the net business profits of the New Hampshire partnership at the entity level. Id. The Department concluded that both the income and the tax payment were passed from the New Hampshire partnership through the Massachusetts partnership to the Massachusetts partners. Id. It followed that the partners could apply their distributive shares of the New Hampshire Business Profits Tax payment as credits against their Massachusetts income tax under G.L. c. 62, § 6(a). The Department further noted that if the partners used the New Hampshire Business Profits Tax as a credit, the partnership could not deduct the tax liability from its gross income in computing its distributable income. LR 87-10.
Applying the principals set forth in the guidance cited above, the Department concludes that Massachusetts resident members of pass-through entities subject to the Connecticut PE Tax are eligible for the credit under G.L. c. 62, § 6(a). However, to claim the credit, Massachusetts resident members must add back their pro rata share of PE Tax paid by the entity when determining their distributive share income subject to tax in Massachusetts. The amount of distributive share income and the amount of the PE Tax paid on behalf of a member should be reported on either Massachusetts Schedule 3K-1 (by partnerships) or Schedule SK-1 (by S corporations).11 The amount of Connecticut PE Tax must be added back and included in the income reported by the member on his or her Massachusetts tax return.
/s/ Christopher C. Harding
Christopher C. Harding
Commissioner of Revenue
September 19, 2019