| Date: | 03/20/2009 |
|---|---|
| Organization: | Massachusetts Department of Revenue |
| Regulatory Authority: | Massachusetts General Laws |
| Official Version: | Published by the Massachusetts Register |
830 CMR: DEPARTMENT OF REVENUE
830 CMR 63.00: Taxation of Corporations
830 CMR 63.00 is amended by adding the following section:
830 CMR 63.30.3: Entity Classification under St. 2008, c. 173
(a) Statement of Purpose. Chapter 173 of the Acts of 2008, (the "Act"), has changed the way unincorporated businesses are classified and treated for purposes of the Massachusetts corporate excise and personal income taxes, resulting in general conformity with federal entity classification and filing rules, effective with the first taxable year beginning on or after January 1, 2009. By the Act, Massachusetts adopts the federal "check-the-box" rules, which permit unincorporated businesses generally to elect how they will be classified.
Under the federal check-the-box rules, unincorporated businesses with two or more members are allowed to elect to be taxed either as corporations or as partnerships. Also, unincorporated associations with a single member may elect to be taxed as corporations or they may elect to be disregarded as an entity separate from their owner, thus being treated as a branch or division of their owner for tax purposes. Pursuant to the Act, an entity's federal check-the-box election or default federal classification will also apply for Massachusetts personal income tax and corporate excise purposes; no separate Massachusetts election is required or permitted.
The check-the-box rules have applied in Massachusetts to limited liability companies (LLCs) since 1997. Thus, the statutory change pursuant to the Act will apply particularly to partnerships and to corporate trusts. Formerly, partnership status for purposes of M.G.L. c. 62, § 17 (and related personal income tax and corporate excise provisions) has been generally determined by evaluating various legal and factual characteristics of the entity. "Corporate trusts" - that is, business trusts, or certain other entities (such as partnerships) with transferable shares, as defined in M.G.L. c. 62, § 1(j) - have been subject to the rules at M.G.L. c. 62, § 8. Because federal law has no separate tax classification for corporate trusts, the recent legislation repeals the specific Massachusetts rules that applied to the taxation of corporate trusts.
All federal S corporations are now subject to the entity level tax that applies to S corporations in Massachusetts under M.G.L. c. 63, § 32D, notwithstanding the entity's legal form of organization. Formerly, a qualified federal Subchapter S corporation subsidiary (QSUB) was subject to an entity level tax separate from its parent. The Act changes this, and a QSUB is now evaluated together with its parent in determining the parent S corporation's Massachusetts tax liability.
This regulation addresses the statutory changes and the effect they will have on an entity's status and returns, both in the transitional year and in future years. It explains the tax consequences of the classification changes, which generally would result in a deemed incorporation, reorganization or liquidation depending on the circumstances. Under the Act's transition rule authority effective as of July 3, 2008, the regulation also describes consequences of transactions, distributions, and other events occurring on or after July 3, 2008, and prescribes methods by which tax-free earnings and profits of corporate trusts are taxed to entities or successors or to their direct or indirect owners, partners, or beneficiaries. Finally, the regulation states the rules for changes to the estimated payment obligations of an affected entity and its shareholders or members.
This guidance does not address every issue related to Massachusetts' conformity with federal entity classification; special adjustments or tax consequences not specifically considered in this document may be required in particular cases in order to achieve Massachusetts tax treatment and consequences consistent with the legislative changes effected by the Act and the rules and principles described in this regulation.
(b) Outline of Topics. 830 CMR 63.30.3 is organized as follows:
(1) Statement of Purpose; Outline of Topics; Effective Date
(2) Definitions
(3) Entity Classification under the Act
(4) Tax consequences of reclassification under new statute
(5) Changes in estimated tax payment responsibilities
(c) Effective Date. Except to the extent otherwise indicated herein, (i) entity classification rules, as established in this regulation, apply to taxable years beginning on or after January 1, 2009; and (ii) transition rules contained herein, including without limitation rules governing the consequences of certain transactions, distributions, and other events occurring on or after July 3, 2008 and the methods for taxing tax-free earnings and profits of corporate trusts, apply as provided herein on and after July 3, 2008. This regulation supersedes all prior public written statements to the extent it is or may be inconsistent with any such prior statement or portion thereof.
For the purposes of 830 CMR 63.30.3, the following terms shall have the following meanings, unless the context requires otherwise:
Act, Chapter 173 of the Acts of 2008.
Business corporation, any corporation, or any 'other entity' as defined in section 1.40 of chapter 156D, whether the corporation or other entity may be formed, organized, or operated in or under the laws of the Commonwealth or any other jurisdiction, and whether organized for business or for non-profit purposes, that is classified for the taxable year as a corporation for federal income tax purposes.
Corporate trust,an entity that was taxable under the former M.G.L. c. 62, § 8, repealed by the Act (effective for taxable years beginning on or after January 1, 2009), and defined as any partnership, association or trust, the beneficial interest of which is represented by transferable shares. This category often includes entities generally described as business trusts.
Disregarded entity, an entity that is disregarded as a separate entity from its owner for federal income tax purposes. Such an entity shall similarly be disregarded for purposes of this regulation, and without limitation, all income, assets, and activities of the entity shall be considered to be those of the owner.
Member, may include, without limitation, a partner in an entity that is organized as a partnership, including a limited partner in a limited partnership; a member of an LLC; a shareholder in a corporation or a corporate trust; or any other type of owner of an interest in an incorporated or unincorporated association the income of which is subject to taxation in Massachusetts.
Partnership, an entity that is classified for the taxable year as a partnership for federal income tax purposes, except as otherwise provided in this chapter.
Tax-free earnings and profits, earnings and profits that were considered tax-free earnings and profits under M.G.L. c. 62, section 8, as in effect on December 31, 2008, including such amounts that have accrued or may accrue under certain specific circumstances as described in 830 CMR 62.8.2(4)(b).
Under the Act, taxpayers who make, or have made, the entity classification election under the check-the-box rules using federal Form 8832 will apply that classification to their Massachusetts filing status. Taxpayers who do not make or have not made a federal election will have a default federal classification that will apply in Massachusetts. The detailed rules for federal entity classification, applicable to M.G.L. c. 62 and c. 63, are found at 26 CFR 301.7701-1 - 301.7701-3.
Generally, under the federal default rules that apply in the absence of an affirmative election on Form 8832, an entity that is eligible to choose its entity classification and does not do so is treated, in the case of a domestic (that is, U.S.) eligible entity, (i) as a partnership if it has two or more members, or (ii) as disregarded as an entity separate from its owner if it has a single owner. A foreign (non-U.S.) eligible entity is treated as a partnership if it has two or more members and at least one member does not have limited liability, a corporation if all members (whether one or more) have limited liability, or disregarded as an entity separate from its owner if it has a single owner that does not have limited liability. See 26 CFR 301.7701-3(b).
The Act revises various Massachusetts definitions of a business entity. For purposes of M.G.L. c. 63, the introductory clause to the corporate excise provisions at M.G.L. c. 63, § 30, is revised to state that ". . . the terms "business corporation," "disregarded entity," and "partnership," defined in paragraphs 1, 2 and 16 of [M.G.L. c. 63, § 30], shall, unless otherwise provided, also have the following meanings and effect for all purposes of this chapter." This section clarifies that the use of these terms is consistent throughout the corporate excise provisions in M.G.L. c. 63, including in the context of financial institutions, under M.G.L. c. 63, §§ 1 - 7, insurance companies, under M.G.L. c. 63, §§ 20 - 29E, and utility corporations, under M.G.L. c. 63, § 52A.
(a) Corporations, generally
Pursuant to the Act, entities that are treated federally as corporations must generally file in Massachusetts either as business corporations taxable under M.G.L. c. 63, § 39, or under other more specific sections of chapter 63 based upon the classification of the entity. For example, business corporations that are financial institutions are taxable under M.G.L. c. 63, §§ 1 - 7. Business corporations that are federal S corporations are subject to tax as S corporations under M.G.L. c. 63, § 2B or 32D (and are also subject to the corporate excise non-income measure and minimum tax under M.G.L. c. 63, § 39). Business corporations that are insurance companies are taxable under M.G.L. c. 63, §§ 20 - 29E, and business corporations qualifying as utility corporations are taxable under M.G.L. c. 63, § 52A.
Consistent with the definition of "business corporation," the Act similarly defines "corporation" for purposes of the definition of "financial institutions" that are subject to the financial institutions excise, M.G.L. c. 63, §§ 1 - 7, by adding the following sentence:
"The term 'corporation' as used in this definition shall mean any corporation, or any 'other entity' as defined in section 1.40 of chapter 156D, whether the corporation or other entity may be formed, organized, or operated in or under the laws of the commonwealth or any other jurisdiction, that is classified for the taxable year as a corporation for federal income tax purposes." M.G.L. c. 63, § 1, as amended by St. 2008, c. 173, § 28.
Under federal entity classification rules, entities that are formed in any state as a corporation, and certain foreign entities that are treated as "per se" corporations, must file as a corporate taxpayer, and are not allowed to elect their classification under the check-the-box rules. See Treas. Reg. §§ 301.7701-2, 301.7701-3(a). In addition to classification under the check-the-box rules, certain specialized federal classifications also apply in Massachusetts. For example, certain publicly traded partnerships are treated for federal purposes as corporations, IRC § 7704, generally including all publicly traded partnerships unless 90% or more of the gross income of the entity consists of certain qualifying income (generally, investment-type income). See IRC § 7704, Treas. Reg. §§ 1.7704-1, 1.7704-3. Another example of special federal treatment is the case of a partnership that if considered as a corporation could qualify as a Regulated Investment Company under IRC § 851; such an entity is exempt from the corporate filing requirement if it meets certain conditions. IRC § 7704(c)(3). In addition, following federal tax treatment, a real estate investment trust (REIT) may own a "qualified REIT subsidiary." Such subsidiary is not treated as a separate corporation for federal purposes and will also not be treated as a separate corporation for Massachusetts purposes; and following federal treatment, the REIT will treat all of the subsidiary's assets, liabilities and items of income, deduction, and credit as its own. See IRC § 856(i).
The Act provides the following rules for calculating basis that apply to all taxpayers subject to taxation under M.G.L. c. 63. St. 2008, c. 173, § 46, adding M.G.L. c. 63, § 31M. The section reads in its entirety:
Section 31M. In determining gross income under this chapter, if the federal gross income includes any item of gain or has been reduced by any item of loss, with respect to property, then the federal gross income shall be increased by the excess of the federal adjusted basis of the property over the Massachusetts adjusted basis of the property, and shall be decreased by the excess of the Massachusetts adjusted basis of the property over the federal adjusted basis of the property, so that the gain or loss realized for Massachusetts purposes takes into account all applicable differences in the Massachusetts and federal tax rules over the life of an asset that should, in principle, give rise to differences in basis. The Massachusetts adjusted basis of property shall be the federal adjusted basis, except that (i) any federal adjustment resulting from provisions of the Code that were not applicable in determining Massachusetts gross income at the time the federal adjustments were made shall be disregarded; and (ii) adjustments shall be made for any item that was applicable in determining Massachusetts gross income but that was not so applicable in determining federal gross income and for which a federal adjustment would be allowed under the Code if the item had been applicable in determining federal gross income. Without limitation of the foregoing, the federal basis of shares in a business corporation that was formerly treated as a corporate trust or of shares in a successor of that entity shall be reduced in computing Massachusetts adjusted basis to take into account any tax-free earnings and profits accumulated by the former corporate trust.
Among other things, the last sentence of these basis adjustment provisions provides a method of ensuring that in the case of an entity that is treated under the new rules as a corporation but that was previously taxed as a corporate trust under M.G.L. c. 62, § 8, any accumulated tax-free earnings and profits of such corporate trust are recognized and taxable no later than when the shares of the successor corporation are sold or otherwise transferred. This basis adjustment is discussed further in sections 830 CMR 63.30.3(4)(a) and (b) , below, in connection with various transactions or deemed transactions involving corporate trusts (or their successor entities) and the shareholders or other members thereof.
(b) S corporations and QSUBs
Prior to adoption of the Act, an entity could be treated as an S corporation for federal tax purposes, but be treated as a partnership, corporate trust, or financial institution for Massachusetts tax purposes. Pursuant to the Act, a federal S corporation will in every case also be an S corporation for Massachusetts purposes, taxable under M.G.L. c. 63, § 2B or 32D, notwithstanding its form of organization, and its shareholders will be taxable in accordance with M.G.L. c. 62, § 17A. No separate Massachusetts election is necessary or allowed. The Act creates a new taxing structure for financial institutions that are S corporations, M.G.L. c. 63, § 2B. See St. 2008, c. 173, § 32.
Massachusetts formerly subjected QSUBs to separate entity-level tax, both for income and non-income measure purposes. However, under the Act, an S corporation must take into account its QSUB's income, loss, deductions, and credits in determining its net income as may be subject to tax under M.G.L. c. 63, §§ 2B or 32D, as amended by St. 2008, c. 173, §§ 32, 50, 53. In determining the non-income measure of the corporate excise under c. 63, § 39, the S corporation parent will take into account the QSUB's property for purposes of measuring its tax liability. There is no longer a separate income or non-income measure for the QSUB, and the QSUB is no longer considered a separate entity for any corporate excise purpose. Accordingly, the S corporation, rather than a QSUB, will in every case also be responsible for the minimum tax under c. 63, § 39, where applicable.
(c) Partnerships
The Act adds a definition to the general definitions section of the personal income tax law at M.G.L. c. 62, § 1, which makes partnership status in Massachusetts conform to the entity's federal status:
(p) "Partnership", an entity that is classified for the taxable year as a partnership for federal income tax purposes, except as otherwise provided in this chapter. St. 2008, c. 173, § 11.
M.G.L. c. 63, § 30.16, as amended by St. 2008, c. 173, § 42, adds a similar definition of partnership to the corporate excise provisions, at M.G.L. c. 63, § 30. See St. 2008, c. 173, § 42.
Prior to adoption of the Act, the term "partnership" was not defined in M.G.L. c. 62 (or for purposes of applying the provisions of M.G.L. c. 63). By the new definition, an entity will be treated as a partnership for purposes of the Massachusetts personal income tax and corporate excise provisions if it elects partnership treatment for federal tax purposes, or meets the default category for partnership treatment under federal rules, notwithstanding its organization in Massachusetts as a partnership, corporate trust, limited liability company, or any other unincorporated form of association.
(d) Corporate trusts
The Act eliminates the separate taxation rules for corporate trusts. See St. 2008, c. 173, § 16 (removing a reference to corporate trusts in the tax rates described at M.G.L. c. 62, § 4); St. 2008, c. 173, § 19 (repealing M.G.L. c. 62, § 8, the taxation provisions applicable to corporate trusts); St. 2008, c. 173, § 22 (repealing M.G.L. c. 62, § 19, which stated that corporate trusts were not taxable as partnerships); St. 2008, c. 173, §§ 23, 25 (repealing filing requirements for corporate trusts). However, the Act preserves certain attributes of corporate trusts to be used in calculating the future tax liabilities of their owners or successors. For example, the Act preserves the accounting for tax-free earnings and profits that were accumulated by corporate trusts under prior law. The Act authorizes the Commissioner to adopt rules to prescribe methods by which such earnings and profits shall be taxed to the entities or their successors or to their direct or indirect owners, partners, or beneficiaries. See St. 2008, c. 173, § 96, by § 102 made effective on enactment, which states that "[f]or the purposes of modifying the tax treatment of corporate trusts to create general conformity with federal classification rules and insuring that any tax-free earnings and profits accumulated by an entity formerly treated as a corporate trust shall be subject to tax under chapter 62 or chapter 63 of the General Laws, the commissioner of revenue may adopt reasonable rules, by regulation or otherwise, to determine the methods by which previously untaxed amounts shall be taxed to the entity, its successor, or its direct or indirect owners, partners or beneficiaries." See also St. 2008, c. 173, § 46, adding M.G.L. c. 63, § 31M (last sentence providing for basis adjustment in shares of business corporation that was treated as corporate trust under prior law). The rules for the accounting and taxation of such tax-free earnings and profits are described in 830 CMR 63.30.3(3)(d) and in various portions of 830 CMR 63.30.3(4).
1. Taxation of and required accounting for tax-free earnings and profits of corporate trusts. In particular, the Act provides that any tax-free earnings and profits accumulated by an entity formerly treated as a corporate trust that was in existence and treated as a corporate trust on or after July 3, 2008 shall be subject to tax under chapter 62 or 63 of the General laws. St. 2008, c. 173, § 96. See St. 2008, c. 173, § 96 (by § 102 made effective on enactment). To assist in achieving this legislative directive, the Commissioner will require all such former corporate trusts or their successors to file an accounting of all tax-free earnings and profits that have been earned, accumulated, or distributed by the corporate trust. This rule applies to any entity subject to treatment as a corporate trust under M.G.L. c. 62, § 8 at any time on or after July 3, 2008, including any successor to such a corporate trust in the case of entities that reorganized (or whose businesses were otherwise transferred directly or indirectly to a successor) on or after July 3, 2008. The Department will issue guidance as to the form, method, and due date for furnishing this accounting. Corporate trusts that are publicly traded and that qualify for one or more taxable years as regulated investment companies (RICs) or as real estate investment trusts (REITs) under the Code are only required to perform this accounting for such taxable years to the extent they have undistributed earnings and profits in such taxable years. RICs or REITs that have annually distributed all earnings and profits to shareholders and that therefore have no accumulated tax-free earnings and profits are exempt from filing the accounting statement, provided that such entities file with the Commissioner a statement identifying themselves and attesting to their qualification for this exemption.
The accounting shall be broken down by year, showing the tax-free earnings and profits attributable to each year, the Massachusetts apportionment percentage of the trust for that year (to be used by non-residents in calculating their tax liabilities, as set forth below), and noting for each entry under what regulatory category (namely, 830 CMR 62.8.2(4)(b)(1), (2), (3), or (4)) the earnings are derived. The accounting must show for each year the beginning balance of tax-free earnings and profits, any accruals to and any distributions from such tax-free earnings and profits during the year, and the ending balance for the year. The former corporate trust or successor thereto must report to its members their proportionate share of tax-free earnings and profits, broken down by taxable year. With respect to members that were residents of Massachusetts for all or a part of any tax year in which such tax-free earnings and profits were accrued, the report must show any income taxes paid by the corporate trust to other states with respect to such earnings and profits. With respect to members that were non-residents for all or a part of any tax year in which tax-free earnings and profits were accrued in the categories described in 830 CMR 62.8.2(4)(b)(1), (2) or (4), the report must include the apportionment percentage of the corporate trust for that year. Non-residents are not taxable on tax-free earnings and profits that accrued in the category described in 830 CMR 62.8.2(4)(b)(3).)
2. a. Distributions out of tax-free earnings and profits taxed as dividend income. All distributions made on or after July 3, 2008 by any entity (including C corporations, S corporations, partnerships, disregarded entities, or any other form of entity), or a successor thereto, that at any time on or after July 3, 2008 was in existence as a corporate trust, shall be deemed to be dividends, taxable as dividend income, to the extent there are remaining tax-free earnings and profits that have not been subject to Massachusetts taxation, and any distributions shall be deemed to have been paid first out of any tax-free earning and profits of the paying entity. Such distributions shall be recognized as income by the recipient in the taxable year of the recipient in which they are distributed by such corporate trust. Such treatment as dividend income shall not be required to the extent that such tax-free earnings and profits have already been required to be taxed as dividend income pursuant to other rules described in this regulation.
The entity paying such dividends must notify the recipient that the dividends are deemed to represent taxable dividend income derived from tax-free earnings and profits. Massachusetts resident taxpayers are allowed a credit for income taxes paid to other jurisdictions on dividends received out of tax-free earnings and profits of such a corporate trust. See M.G.L. c. 62, § 6(a), as amended by St. 2008, c. 173, § 17.
Non-resident members must report such taxable dividends as Massachusetts source income to the extent of any tax-free earnings and profits apportioned to Massachusetts that accrued in the categories described in 830 CMR 62.8.2(4)(b)(1), (2) or (4). In determining a non-resident's share of tax-free earnings and profits apportioned to Massachusetts, the member shall apply the apportionment percentage of the former corporate trust attributable to any year the member was a non-resident in which such tax-free earnings and profits were accrued under 830 CMR 62.8.2(4)(b)(1), (2) or (4). Non-residents who were residents during any year the former corporate trust accumulated tax-free earnings and profits must report as Massachusetts source income all distributions out of all such tax-free earnings and profits without apportionment, but are entitled to the credit for taxes paid to another jurisdiction in the manner of a resident for that year. Note that all tax-free earnings that are taxable to non-residents remain taxable indefinitely, wherever and for however long the non-resident continues to receive such distributions/dividends.
b. Special rule for publicly traded RICs and REITS. Deemed or actual distributions from publicly traded RICs and REITs are not treated as Massachusetts source income to non-residents for purposes of this section to the extent that the actual or deemed distributions are attributable to periods when the distributing entity was a publicly traded RIC or REIT.
3. Deemed distributions of tax-free earnings and profits upon reclassification, reorganization, or disposition of corporate trust. To ensure that all tax-free earnings and profits are properly subject to Massachusetts taxation under the Act, the reclassification of a corporate trust by operation of the Act, or a change in classification of the corporate trust (or a successor) occurring as a result of any form of reclassification, reorganization, or disposition, by any transaction or deemed transaction occurring on or after July 3, 2008, to a different type of status for Massachusetts tax purposes (partnership, corporation, or disregarded entity), shall result in a deemed distribution to all members of any tax-free earnings and profits of such corporate trust or any successor thereto, taxable to the members as dividend income. See 830 CMR 63.30.3(3)(d)4, below, regarding an exception to such treatment in the case of corporate successors. All members (resident and non-resident) must recognize such income as dividend income on their first return due (i) after the close of the corporate trust's last taxable year ending on or after December 31, 2008, or (ii) where a corporate trust was the subject of a reclassification, reorganization, or disposition on or after July 3, 2008 and before a change in classification that would occur by operation of the Act, after such reclassification, reorganization, or disposition. Thus, in the case of a corporate trust filing a calendar year return and with shareholders also filing calendar year returns, deemed distributions due to untaxed earnings and profits of the corporate trust occur on 12/31/2008 and are recognized by shareholders on their calendar 2008 return. The rules described in 830 CMR 63.30.2(3)(d)2.a regarding a potential credit for resident shareholders for income taxes paid to other jurisdictions and regarding the potential application of apportionment rules for non-resident shareholders shall apply to these deemed distributions of taxable dividend income as well.
4 . a. Exception for corporate successors to corporate trusts. A statutory exception to the immediate recognition of dividend income on account of tax-free earnings and profits exists where a corporate trust is reclassified by operation of the Act as a corporation for Massachusetts tax purposes or reorganizes such that it is taxable in Massachusetts as a corporation. In such a case, the corporate trust or its successor must report to its shareholders their proportionate share of tax-free earnings and profits remaining after accounting for any taxation of tax-free earnings and profits that occurred on or after July 3, 2008. Shareholders of the successor corporation must reduce their Massachusetts basis in their corporate shares to the extent of their proportionate share of any such remaining tax-free earnings and profits. M.G.L. c. 63, § 31M. The preceding rule applies also to non-residents to the extent they would be taxable in the event of distributions of such tax-free earnings and profits under the rules described in 830 CMR 63.30.3(3)(d)2. To the extent a shareholder's proportionate share of tax-free earnings and profits exceeds the Massachusetts basis in the shares of the successor corporation, that shareholder must recognize the income as dividend income on that shareholder's first return due (i) after the close of the corporate trust's last taxable year ending on or after December 31, 2008, or (ii) where a corporate trust reorganized into an entity taxable in Massachusetts as a corporation on or after July 3, 2008 and before a change in classification that would occur by operation of the Act, after such reorganization. To the extent the shareholder pays Massachusetts tax on any tax-free earnings and profits on account of which it had reduced its basis in shares as provided in this paragraph, the shareholder may reverse such basis reduction and adjust its basis in shares upwards to reflect the dollar amount of such tax-free earnings and profits that were taxed. All tax-free earnings and profits that are required to be reflected in an adjustment to shareholder basis as described above remain taxable as dividend income upon a subsequent distribution, see 830 CMR 63.30.3(3)(d)2, or disposition of shares by the shareholder, see 830 CMR 63.30.3(3)(d)6, and shall be subject to the rules described in 830 CMR 63.30.3(3)(d)2.a regarding a potential credit for resident shareholders for income taxes paid to other jurisdictions and regarding the potential application of apportionment rules for non-resident shareholders.
b. Special rule for certain corporate successors to corporate trusts qualifying as regulated investment companies or real estate investment trusts. Corporate trusts that are publicly traded and that qualify as of July 3, 2008 as regulated investment companies (RICs) or as real estate investment trusts (REITs) under the Code and that are succeeded by a corporate taxpayer under the Act are allowed the following special treatment with respect to dispositions of shares of such corporate trust or corporate successor occurring on or after July 3, 2008 and before the first taxable year beginning on or after January 1, 2009. In such cases, a shareholder is not required to reduce Massachusetts basis in such shares under the general rule at 830 CMR 63.30.3(3)(d)4.a., on account of tax-free earnings and profits, provided and to the extent that such tax-free earnings and profits are currently distributed by the RIC or REIT for its taxable year in which derived. All undistributed earnings and profits of the REIT or RIC are subject to treatment under the general rules at 830 CMR 63.30.3(3)(d).
5 . Shareholder election to be taxed on deemed distribution of proportionate share of tax-free earnings and profits in lieu of reducing basis in shares. In lieu of making the basis reduction in shares described in 830 CMR 63.30.3(3)(d)4, a shareholder may elect to pay Massachusetts tax on a deemed distribution of all of the proportionate tax-free earnings and profits attributable to such shareholder in accordance with the rules described in 830 CMR 63.30.3(3)(d)3.
6. Disposition of shares of a corporate trust or of a corporate successor to corporate trust on or after July 3, 2008. A member of a corporate trust (or of a corporate successor thereto in a situation where a shareholder of such successor is required to reduce Massachusetts tax basis in the shareholder's shares of the corporate successor to account for tax-free earnings and profits of a former corporate trust, as described in 830 CMR 63.30.3(3)(d)4) is required to recognize taxable dividend income, to the extent of any tax-free earnings and profits, upon the disposition in any manner (direct or indirect, whether otherwise taxable or tax-free) on or after July 3, 2008 of any shares or other interest in such corporate trust or corporate successor. Such dispositions would include, without limitation, dispositions by gift or deemed dispositions in a liquidation of the corporate trust or corporate successor (whether shares are transferred, relinquished, or canceled). Where the disposition is of shares of a corporate successor to the corporate trust, such recognition of dividend income shall be limited to the extent of any basis reduction required to be made on account of such earnings and profits. The rules described in 830 CMR 63.30.3(3)(d)2 regarding a potential credit for resident shareholders for income taxes paid to other jurisdictions and regarding the potential application of apportionment rules for non-resident shareholders shall apply to taxable dividend income required to be recognized under this paragraph. Dispositions that are subject to tax as described in this paragraph shall include all direct or indirect dispositions on or after July 3, 2008, including, without limitation, by sale, exchange, liquidation, gift, bequest, or other transfer. Indirect dispositions by a member shall be deemed to occur, without limitation, when a corporate trust or a corporate successor issues or transfers shares or other ownership interests that have the effect of reducing the ownership interest of such member. See 830 CMR 63.30.3(3)(d)4.b. above for special rule for certain dispositions of shares of certain corporate trusts or corporate successors qualifying as RICs or REITs.
It is the intent of this regulation, and of 830 CMR 63.30.3(3)(d) in particular, to effectuate the purpose of the Act to ensure that all tax-free earnings and profits are subject to Massachusetts taxation to the extent permitted by law. Nothing in this document should be construed to provide a limitation on the taxation of tax-free earnings and profits, or to provide a means of postponing or avoiding the taxation of tax-free earnings and profits.
Example (3)(d)
HoldCo is a calendar-year entity organized in Massachusetts as a Massachusetts business trust with transferable shares. As of July 3, 2008, HoldCo is treated for Massachusetts taxation purposes as a corporate trust subject to taxation under M.G.L. c. 62, § 8. HoldCo has assets worth $100M. It has 100,000 outstanding shares, held by 5 shareholders. HoldCo is treated for federal purposes as an S corporation. On September 1, 2008, the shareholders of HoldCo agree to cause HoldCo to issue non-voting shares, representing 50% of the ownership interest of HoldCo, and to cause such shares to be contributed to HoldCo Foundation, a tax-exempt charitable foundation.
HoldCo has $5M of tax-free earnings and profits, based on the properly-completed accounting of tax-free earnings and profits that HoldCo is required to submit to DOR. As discussed above, any direct or indirect transfer of an interest in a corporate trust will trigger the taxable recognition of tax-free earnings and profits as dividend income to the shareholders. Thus, the shareholders must collectively recognize 50% of the total tax-free earnings and profits as taxable dividend income (the 50% figure representing the percentage of the value of the business that was transferred to the charitable foundation) on their first tax return due after the close of HoldCo's 2008 taxable year. Any resident shareholders may claim a credit for income taxes paid to other jurisdictions on the tax-free earnings and profits taxed to them as dividend income. Any shareholder that is a non-resident for taxable year 2008 must recognize taxable dividend income under the rules described in 830 CMR 63.30.3(3)(d)2 that apply in the event of distributions of such tax-free earnings and profits.
HoldCo becomes a corporation for Massachusetts tax purposes by operation of the Act as of the close of 2008, and the shareholders must use the remaining tax-free earnings and profits attributable to them to reduce their Massachusetts tax basis in shares of the successor corporation; any tax-free earnings and profits in excess of basis must be recognized immediately as taxable dividend income. Any non-residents must adjust their Massachusetts basis in shares to account for the remaining tax-free earnings and profits for which they are subject to Massachusetts tax under the rules described in 830 CMR 63.30.3(3)(d)2, 4.
(e) LLCs
Massachusetts previously adopted the federal entity classification rules as to LLCs in 1997. However, the Act repeals the specific statutory provisions that subjected only LLCs to the federal check-the-box rules, since these provisions are no longer necessary in light of the general applicability of the federal classification rules. See St. 2008, c. 173, § 20 (repealing references in the partnership taxation provisions at M.G.L. c. 62, § 17 that included LLCs and made the statute applicable to LLCs that were federally treated as partnerships, and that also stated that a disregarded LLC was to be disregarded as an entity separate from its member). The removal of the LLC-specific references has no effect on the taxation of LLCs, and LLCs will continue to be subject to the check-the-box rules as fully adopted in Massachusetts by the Act.
(f) "Disregarded" entities
Pursuant to the Act, Massachusetts conforms to the federal principle that an entity with a single member that is disregarded under federal law as a separate taxable entity is treated as a branch or division of its owner. In the absence of an affirmative election to be a disregarded entity, this is also the default position for an unincorporated association with a single member that makes no election under Treas. Reg. 301-7701-3, except in the case of a foreign (non-U.S.) entity with a single member that has limited liability. See Treas. Reg. 301.7701-3(b).
To effectuate this change, the Act adds the following definition to the personal income tax provisions and the corporate excise provisions:
"Disregarded entity", an entity that is disregarded as a separate entity from its owner for federal income tax purposes. Such an entity shall be similarly disregarded for purposes of this chapter; and, without limitation, all income, assets, and activities of the entity shall be considered to be those of the owner. M.G.L. c. 62, § 1(q), as amended by St. 2008, c. 173, § 11, and M.G.L. c. 63, § 30.2, as amended by St. 2008, c. 173, § 38.
In the case of a disregarded entity, the owner includes all the income, losses and attributes of the disregarded entity in its own tax calculations. For personal income tax and corporate excise purposes, the disregarded entity has no separate identity, although in most other respects the entity continues to be regarded as a separate legal entity, with its own obligations and privileges.
With respect to the treatment of a qualified REIT subsidiary, see 830 CMR 63.30.3(3)(a).
(a) General principles and transitional rules
The new check-the-box conformity rules require specific changes in the way that many affected taxpayers will calculate their tax liabilities. Borrowing from the federal rules at 26 CFR 301.7701-3(g), and subject to certain modifications as noted in this regulation, 830 CMR 63.30.3(4) describes general principles and transitional rules that govern the Massachusetts tax effects to an affected entity or its successors, and to the entity's or successor's partners, shareholders, or other owners, that result from a change in entity classification.
Section 96 of the Act, effective on date of enactment, July 3, 2008, grants broad authority to the Commissioner to "determine reasonable transition rules for entities, including but not limited to corporate trusts and qualified subchapter S subsidiaries, and the successors, direct or indirect owners, partners or beneficiaries of those entities, whose tax classification shall be altered by this act. These transition rules may include provisions for nonrecognition of gain or loss in the event of a conversion of an entity's Massachusetts tax status resulting from this act, with corresponding adjustments to basis or other tax attributes if and as determined by the commissioner to be appropriate." In addition, M.G.L. c. 63, § 31M, added by the Act and quoted above in 830 CMR 63.30.3(3)(a), provides for a basis adjustment to shares in a corporation that was formerly subject to tax as a corporate trust to account for tax-free earnings and profits.
Except as otherwise indicated, the Massachusetts tax consequences described in this regulation apply both in the case of reclassifications of entities that occur by operation of the Act and in the case of reclassifications that follow from transactions or deemed transactions initiated by entities or successors, or their members, on or after the effective date of the Act (July 3, 2008) and prior to the time at which a change in classification would otherwise occur by operation of the Act. Such consequences would include, among other things, the recognition of gain to an entity that has been treated as a corporation for Massachusetts tax purposes and is deemed to liquidate, whether by reason of its change of classification pursuant to the Act or, for example, in a transaction or transactions that result in a conversion into a different form of entity or in the termination of status as a corporation for Massachusetts tax purposes. To the extent rules or principles are not otherwise described in this regulation, the Massachusetts tax consequences of reclassifications pursuant to the Act and of transactions and deemed transactions that result in a change in the entity classification will generally be determined by applying federal rules and principles, including those related to income recognition and basis adjustments, as adjusted so as to be consistent with the rules and principles described in this regulation and as otherwise needed to take account of Massachusetts statutory and other modifications.
Entities and their successors and members that are the subject of, or involved in, an entity reclassification in Massachusetts, whether pursuant to the Act or as a result of a transaction or deemed transaction occurring on or after July 3, 2008 and prior to the time at which a change in classification would otherwise occur by operation of the Act, may need to determine the tax basis in their assets or their shares or other ownership interests, and make certain other calculations and adjustments, in a manner that differs from their federal tax reporting in determining their Massachusetts income tax and corporate excise liabilities. As noted, entities that were formerly taxable in Massachusetts as corporations and, as a result of the Act, will be taxable under a different classification will be deemed to liquidate, which will generally require recognition of gain or loss to the corporation for Massachusetts tax purposes. Such gain or loss must be reported on the closing return of the liquidating corporation. In some cases, there could be other tax consequences to the liquidating entity, such as recapture of a previously-taken benefit for which the taxpayer is ineligible under its new classification. For example, an entity that was classified as a manufacturing corporation and was eligible to receive the Investment Tax Credit under M.G.L. c. 63, § 31A, will be ineligible to receive that credit if its new classification is as a partnership. Thus, the liquidating entity will be subject to the recapture provisions described in M.G.L. c. 63, § 31A; any recapture must be reported on the closing return of the liquidating corporation.
The specific transition rules described in 830 CMR 63.30.3(4)(a)1-7 apply to entities whose Massachusetts entity classification changes pursuant to the Act as of the commencement of an entity's first taxable beginning on or after January 1, 2009. These rules will also apply to entities that change their form or classification on or after July 3, 2008 and prior to the time at which a change in classification would otherwise occur by operation of the Act, and in that context they should be applied in a manner that treats the change in entity classification, and the resulting consequences, as taking effect at the pertinent time of reclassification (rather than necessarily as of the first taxable year beginning on or after January 1, 2009 as in the statutory reclassifications described in 830 CMR 63.30.3(4)(a)1-7. Note, however, the special rules regarding accounting for and reporting of tax-free earnings and profits of former corporate trusts, as described in 830 CMR 63.30.3 (3)(d)1. The rules regarding tax-free earnings and profits of former corporate trusts apply to any such entity that was or would have been treated as a corporate trust at any time on or after July 3, 2008, to successors of such corporate trusts regardless of the form of organization of the successor, and to the owners or members of such corporate trusts or their successor entities, and regardless of whether the trust terminates by an affirmative action of the entity or by operation of the Act.
1. Change from a partnership to a corporation
An entity that formerly was treated as a Massachusetts partnership under M.G.L. c. 62, § 17 and now will be treated as a corporation under M.G.L. c. 63 is deemed to contribute all of its assets and liabilities to the corporation in exchange for stock in the corporation. Immediately thereafter, the partnership is deemed to liquidate by distributing the stock of the corporation to its partners. The deemed contribution of assets and liabilities to a corporation will be treated for Massachusetts tax purposes in accordance with the federal rules that would apply to such a transaction if it were also occurring federally - for example, in determining the extent of any recognition of gain or loss upon the contribution and the resulting basis in the assets of the corporation. See, e.g., IRC § 351, 357, 362. Similarly, the deemed liquidation of the partnership will be treated in accordance with the federal rules that would apply to such a transaction if it were also occurring federally - for example, in determining the extent of any recognition of gain or loss upon the deemed distribution of stock of the corporation to the partners in the deemed liquidation of the partnership, and the resulting basis of the partners in the stock of the corporation. See, e.g., IRC § 731, 732.
2. Change from a corporate trust to a corporation
a. General transition rules. An entity that formerly was treated as a corporate trust under M.G.L. c. 62, § 8 as of July, 3, 2008, but that will be treated as a M.G.L. c. 63 corporate taxpayer for tax years beginning on or after January 1, 2009, will be generally treated as having been party to a tax-free reorganization for Massachusetts tax purposes. The corporate trust will not generally be considered to recognize gain or loss due to the reclassification of the corporate trust as a corporation, and the basis in assets of the former corporate trust will carry over to the successor corporation. The 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, reduced as follows: shareholders of such entities that have any tax-free earnings and profits must reduce the Massachusetts tax basis in the shares of the successor corporation by the dollar amount of tax-free earnings and profits attributable to the shares to the extent those earnings and profits have not been previously taxed to the entity or its shareholders. With respect to non-resident individual shareholders, the basis reduction for such tax-free earnings and profits shall be made after proper apportionment to Massachusetts under rules described in 830 CMR 63.30.3(3)(d)2, 4. See generally St. 2008, c. 173, §§ 46 (as codified at M.G.L. c. 63, § 31M), 96, 102. As noted in 830 CMR 63.30.3(3)(d)5, a shareholder may elect to be taxed on such tax-free earnings and profits in lieu of making such basis reduction. The holding period for shareholders in the shares of the corporation will be a continuation of their existing holding period in the shares of the corporate trust, and will not recommence with the conversion. At the time of any distribution to shareholders or of any shareholder's direct or indirect disposition of the shares of the successor corporation, whether, for example, by sale or redemption of individual shares, by liquidation of the entire corporation, or by any tax-free disposition (including by gift), such shareholder must recognize taxable dividend income for Massachusetts tax purposes, to the extent of any of such basis reduction reflecting the tax-free earnings and profits, whether or not there is federal income recognition. The dividend income is Massachusetts source income to the non-resident shareholders as described in 830 CMR 63.30.3(3)(d)2.The shareholders of an entity that formerly was treated as a corporate trust under M.G.L. c. 62, § 8, but which has been a corporation for federal tax purposes will often have a Massachusetts basis in their shares that differs, possibly significantly, from their federal basis. This may be particularly the case where the corporate trust was an S corporation for federal tax purposes. Where the required reduction in basis to reflect tax-free earnings and profits would exceed the available Massachusetts tax basis, the excess must be taken into account as dividend income under the rules described in 830 CMR 63.30.3(3)(d).
Distributions from S corporation successor to corporate trust. Distributions to shareholders of an S corporation that is a successor to a corporate trust shall be deemed to be paid first from previously undistributed tax-free earnings and profits of the corporate trust, to the extent that they have not yet been taxed to the shareholders, and thus shall be treated as taxable dividend income to the shareholders. Any further distributions shall be deemed to be first from (a) any accumulated S corporation income attributable to an S corporation that was a predecessor to a QSUB owned by the corporate trust, where such S corporation income had been previously taxed under M.G.L. c. 62 to the predecessor S corporation shareholders, and then from (b) previously undistributed earnings and profits of the corporate trust, until all such earnings and profits of the corporate trust are exhausted. See DOR Directive 04-2 (Feb. 13, 2004). The rules in Directive 04-2 are modified by this regulation. This regulation requires that any distributions be treated as first paid out of any tax-free earnings and profits of the corporate trust that has not yet been taxed to the shareholders, and provides that such distributions shall be taxed to the shareholders as taxable dividend income.
Distributions of previously undistributed earnings and profits of the corporate trust will not reduce the shareholders' Massachusetts tax basis in their S corporation shares. Distributions other than those out of earnings and profits of the corporate trust will be governed by existing S corporation rules.
For special rules that apply to QSUBs of former corporate trust parents, see 830 CMR 63.30.3(4)(a)7.
Treatment of capital loss carryover attributable to the corporate trust. To the extent an entity taxable as a corporate trust under the former M.G.L. c. 62, § 8, but taxable as a federal S corporation, has any ongoing capital loss carryforward, such amounts are not carried forward to its successor entity. However, a shareholder in such former corporate trust at the time of its conversion into an S corporation for Massachusetts tax purposes may take a proportionate share of such capital loss carryforward for Massachusetts tax purposes for the tax year beginning on or after January 1, 2009, provided that the shareholder held such proportionate interest in the corporate trust's shares on July 3, 2008.
b. Estates that include an interest in a former corporate trust. Respecting the statutory intent to ensure Massachusetts state-level taxation of tax-free earnings and profits of a former corporate trust, the following rule applies to estates or other persons ("holders having an IRC § 1014 basis") that own an interest in a corporate trust or its successor where the shares or other interests in the corporate trust or successor were or are subject to inclusion in the estate of a decedent shareholder or other owner or beneficiary of the corporate trust or successor. The basis in such shares, derived after application of IRC § 1014, must be reduced in the hands of the estate or other holder having an IRC § 1014 basis by the amount of tax-free earnings and profits of the former corporate trust attributable to that holder's interest, to the extent such tax-free earnings and profits have not been subject to Massachusetts tax in the hands of the trust or its shareholders or other owners or beneficiaries. To the extent of any such basis reduction on account of such tax-free earnings and profits, gain is to be recognized by the estate or other holder having an IRC § 1014 basis upon sale, transfer, or distribution of shares by such holder, including by gift or distribution to heirs and without regard to whether any disposition would otherwise be taxable or tax-free for Massachusetts tax purposes. These rules apply to all items counted as part of the estate, even if those items are not in the control of the estate or its fiduciary.3. Change from a corporation to a partnership
An entity that was formerly treated as a Massachusetts corporation under M.G.L. c. 63 but for tax years beginning on or after January 1, 2009 will be treated as a partnership under M.G.L. c. 62, § 17 and c. 63, § 30, is deemed to distribute all of its assets and liabilities to its shareholders in liquidation of the corporation, and immediately thereafter, the shareholders are deemed to contribute all of the distributed assets and liabilities to a newly formed partnership. Generally, this liquidation will result in recognition of gain or loss for; Massachusetts tax purposes at the corporate level, which must be reported by the corporation on its final Massachusetts return. See generally IRC § 336. Note that any gain must be reported even though this deemed liquidation will not result in the recognition of any federal gross income. In the event that a part of such deemed liquidation could qualify as a tax-free liquidation under the provisions of IRC § 332 and 26 CFR 301.7701-3(g)(2) if a federal election were being made under 26 CFR 301.7701-3 that resulted in the classification as a partnership of an entity previously treated as a corporation for federal income tax purposes, such provisions may apply in this context for Massachusetts tax purposes as well.
As to the shareholders of the corporation that will be now treated as a partnership, ordinarily the application of federal rules to the deemed liquidation of the corporation in these circumstances would also require the recognition of gain or loss to shareholders, and a resulting change in the basis of the former corporation's assets that the shareholders are deemed to contribute to the partnership. However, to provide as much consistency in asset basis as possible between Massachusetts and federal law, the Department has determined that in these circumstances the shareholders will not recognize gain or loss upon the deemed liquidation of the corporation, and the shareholders will take a Massachusetts tax basis in the assets received upon the deemed liquidation equal to the corporation's Massachusetts tax basis in such assets immediately prior to its deemed liquidation. The shareholders will then be deemed to transfer those assets to the partnership under the federal rules applicable to such a transaction, see, e.g., IRC §§ 721-723, with the partnership generally taking the same basis in the assets that the transferor shareholders had and with the shareholders now having a basis in their interests in the successor partnership consistent with their basis in the assets deemed to be transferred. The holding period for partners in their partnership interests will be a continuation of the existing holding period in their shares of the former corporation, and will not recommence with the conversion. The holding period for the partnership in the assets of the former corporation will be deemed to include the corporation's former holding period in its assets.
4. Change from a corporate trust to a partnership
An entity that was formerly treated as a corporate trust under M.G.L. c. 62, § 8, but for tax years beginning on or after January 1, 2009 will be treated as a partnership under M.G.L. c. 62, § 17 and c. 63, § 30, will be generally treated as having been party to a tax-free reorganization for Massachusetts tax purposes. The corporate trust will not generally be considered to recognize gain or loss due to the reclassification of the corporate trust as a partnership; however, all tax-free earnings and profits of the former corporate trust must be recognized as taxable dividend income to the partners on their first return after the conversion. With respect to the treatment of tax-free earnings and profits, to both resident individual partners and non-resident individual partners, see in 830 CMR 63.30.3(3)(d). The basis in assets of the former corporate trust will carry over to the successor partnership. The holding period for the partnership in the assets of the former corporate trust will be deemed to include the corporate trust's holding period in its assets. The shareholders of the former corporate trust will have a Massachusetts tax basis in their interests in the successor partnership equal to the basis they previously had in the shares of the corporate trust.
Distributions to partners shall be deemed to be paid first from previously undistributed earnings and profits of the corporate trust (both tax-free earnings and profits that were taxed to the partners upon the conversion to the partnership, and earnings and profits that were taxed to the corporate trust), until all such earnings and profits are exhausted; such distributions will not reduce the partners' Massachusetts tax basis in their partnership interests. After exhaustion of earnings and profits attributable to the former corporate trust, subsequent distributions of the successor partnership will be governed by ordinary partnership rules.
5. Change from a corporation to a disregarded entity
An entity that was formerly treated as a Massachusetts corporation under M.G.L. c. 63 but for tax years beginning on or after January 1, 2009 will be treated as a disregarded entity under M.G.L. c. 62, § 1 and c. 63, § 30, is deemed to distribute all of its assets and liabilities to its shareholder in liquidation of the corporation. Generally, this liquidation will result in recognition of gain or loss for Massachusetts tax purposes at the corporate level, which must be reported by the corporation on its final Massachusetts return. See generally IRC § 336. Note that any gain must be reported even though this deemed liquidation will not result in the recognition of any federal gross income. In the event that such deemed liquidation could qualify as a tax-free liquidation under the provisions of IRC § 332 and 26 CFR 301.7701-3(g)(2) if a federal election were being made under 26 CFR 301.7701-3 that resulted in "disregarded entity" classification of an entity previously treated as a corporation for federal income tax purposes, such provisions may apply in this context for Massachusetts tax purposes as well.
As to the corporation's shareholder, ordinarily the application of federal rules to the deemed liquidation of the corporation in these circumstances would also require the recognition of gain or loss to the shareholder, and a resulting change in the basis of the former corporation's assets in the hands of such shareholder. However, to provide as much consistency in asset basis as possible between Massachusetts and federal law, the Department has determined that in these circumstances the shareholder will not recognize gain or loss upon the deemed liquidation of the corporation, and the shareholder/owner will take a Massachusetts tax basis in the assets received upon the deemed liquidation equal to the corporation's Massachusetts tax basis in such assets immediately prior to its deemed liquidation. The holding period for the shareholder in the assets will be deemed to include the corporation's former holding period in its assets.
6. Change from a corporate trust to a disregarded entity
An entity that was formerly treated as a corporate trust under M.G.L. c. 62, § 8, but for tax years beginning on or after January 1, 2009 will be treated as a disregarded entity under M.G.L. c. 62, § 1 and c. 63, § 30, will be treated as having been liquidated for Massachusetts purposes. Under these transition rules, the corporate trust will not generally be considered to recognize gain or loss on the deemed liquidation due to the reclassification of the corporate trust as a disregarded entity; however, all tax-free earnings and profits of the former corporate trust must be recognized as taxable dividend income to the shareholder or other owner on such owner's first return after the conversion. With respect to the treatment of tax-free earnings and profits, to an individual resident or non-resident owner, see 830 CMR 63.30.3(3)(d). The basis in assets of the former corporate trust will carry over to the shareholder/owner. The holding period for the shareholder in the assets will be deemed to include the corporate trust's former holding period in its assets.
7. Transition rules with respect to QSUBs
Formerly, a QSUB was subject to an entity-level tax separate from its parent. The Act changes this, and a QSUB's income, assets, and other attributes are now taken into account by the QSUB's S corporation parent, together with the parent's income, assets, and other attributes, in determining the parent S corporation's Massachusetts tax liability. The Department will not consider this change in tax status of the QSUB to a fully disregarded entity to be a liquidation or other potentially taxable event. Thus, neither the QSUB nor its parent will recognize gain or loss as a consequence of the change in taxation of the QSUB. The basis in assets of the QSUB will carry over to the S corporation parent. The holding period for the S corporation parent in the assets will be deemed to include the QSUB's former holding period in its assets. For related provisions in the Act, see M.G.L. c. 63, § 32D, as amended by St. 2008, c. 173, §§ 50, 53. See also M.G.L. c. 63, § 2B, as inserted by St. 2008, c. 173, § 32. Any net operating loss or credit amounts that would have been carried forward by the QSUB will be considered as having been generated by and as available to the S corporation parent for purposes of M.G.L. c. 63, § 2B or 32D, to the extent the parent would be eligible for such carry forward or credit amount.
(b) Permanent rules applying to all chapter 63 taxpayers; changes to the dividends received deduction for dividends received from corporate successor to corporate trust on or after July 3, 2008
Before the enactment of St. 2008, c. 173, corporations were not allowed to take into account the dividends on shares of a corporate trust in calculating their dividends received deduction under M.G.L. c. 63, § 38(a)(1). With the elimination of separate tax provisions for corporate trusts, this clause becomes obsolete. However, the Act addresses the issue of dividends received by business corporations with respect to their ownership of shares of corporations that formerly were treated as corporate trusts under M.G.L. c. 62, § 8. The legislation provides that such dividends are not eligible for the dividends received deduction if the dividends represent tax-free earnings and profits, as defined in section 8 of chapter 62, as in effect on December 31, 2008. St. 2008, c. 173, § 57, repealing M.G.L. c. 63, § 38(a)(1)(i). See also St. 2008, c. 173, §§ 96, 102 (providing for transition rules effective July 3, 2008 to ensure the taxation of tax-free earnings and profits of corporate trusts under M.G.L. c. 62 and c. 63).
All dividends received by a corporation on or after July 3, 2008 from a corporate successor to an entity that was in existence as a corporate trust at any time on or after July 3, 2008 shall first be deemed to have been paid out of tax-free earning and profits of the paying entity, to the extent there are remaining tax-free earnings and profits that have not been subject to Massachusetts taxation, and to that extent shall be fully taxable as dividend income without regard to the dividends received deduction. A corporation that was previously a corporate trust, or a successor thereto, that is paying such dividends must notify the recipient of the extent to which the dividends are deemed to represent such tax-free earnings and profits. To the extent of such taxable dividends out of tax-free earnings and profits of a predecessor corporate trust, in a case where the recipient corporation's basis in the shares of the former corporate trust had been reduced (pursuant to M.G.L. c. 63, § 31M, added by St. 2008, c. 173, § 46) on account of the tax-free earnings and profits that are being distributed, the recipient corporation may readjust its basis in the shares of the payor upwards in the amount of tax-free earnings and profits distributed and taken into income.
The Department will issue regulations regarding the combined reporting obligations of certain corporations, as set forth in the Act. See St. 2008, c. 173, § 48, adopting M.G.L. c. 63, § 32B. These regulations will, among other things, set forth the rules for the elimination of certain dividends among members of the combined reporting group, as a general matter, and for an exception to such elimination in the case of dividends from a former corporate trust.
(c) Permanent rules applying to all chapter 62 taxpayers
1. Taxation of dividends received from corporate trust or successor
Before adoption of the Act, in determining Massachusetts gross income pursuant to chapter 62, taxpayers deducted from their federal gross income "dividends received from a corporate trust subject to taxation under [M.G.L. c. 62] to the extent that such dividends are exempt from taxation under [M.G.L. c. 62, § 8]." M.G.L. c. 62, § 2(a)(2)(D). This deduction has been revised in light of the repeal of M.G.L. c. 62, § 8, and as of taxable years beginning on or after January 1, 2009, the deduction from federal gross income will apply to "dividends received from a corporate trust subject to taxation under section 8, as in effect on December 31, 2008, to the extent that they are derived from earnings and profits previously taxed to the trust under said section 8, but only to the extent that the trust properly filed returns and paid all taxes due." M.G.L. c. 62, § 2(a)(2)(D), as amended by St. 2008, c. 173, § 14. See also St. 2008, c. 173, § 12, repealing M.G.L. c. 62, § 2(a)(1)(E), which formerly added to federal gross income to be used in calculating tax liability "[a]mounts excluded under Subchapter S of the [Internal Revenue] Code with respect to a federal S corporation which is subject to taxation under [M.G.L. c. 62] as a corporate trust." St. 2008, c. 173, § 13, repealing M.G.L. c. 62, § 2(a)(2)(B), which formerly deducted from federal gross income in calculating tax liability "[a]mounts included under Subchapter S of the [Internal Revenue] Code with respect to a federal S corporation which is subject to taxation under [M.G.L. c. 62] as a corporate trust."; St. 2008, c. 173, § 15, repealing M.G.L. c. 62, § 2(d)(1)(J), which formerly allowed as a deduction from Part B gross income "[a]ny deduction allowed by Subchapter S of the [Internal Revenue] Code with respect to a federal S corporation which is subject to taxation under [M.G.L. c. 62] as a corporate trust."
All dividends received on or after July 3, 2008 from an entity (whether classified as a corporation or otherwise) that was subject to treatment as a corporate trust at any time on or after July 3, 2008, or a successor thereto, are taxable to a recipient who is taxable under M.G.L. c. 62 unless they are derived from earnings and profits previously taxed to the corporate trust under said section 8 and the corporate trust properly filed returns and paid all taxes due. See St. 2008, c. 173, § 96. With respect to dividends paid out of tax-free earnings and profits accumulated by a corporate trust, Massachusetts resident taxpayers will be allowed a credit for income taxes paid to other jurisdictions on such dividends and non-residents are taxable as described and to the extent provided in 830 CMR 63.30.3(3)(d)2. See M.G.L. c. 62, § 6(a), as amended by St. 2008, c. 173, § 17.
2. Shareholders of an S corporation that was formerly taxed as a corporate trust
Before adoption of the Act, shareholders of a federal S corporation that was treated for Massachusetts purposes as a corporate trust taxable under M.G.L. c. 62, § 8 were not subject to tax on their distributive share of income. M.G.L. c. 62, § 17A. The Act repeals these provisions. Shareholders of S corporations are now subject to tax on their total distributive share of income, under M.G.L. c. 62, § 17A. In addition, all distributions from an S corporation to its shareholders are taxable as dividend income to the shareholders to the extent they are paid out of tax-free earnings and profits derived from a former corporate trust or successor. See 830 CMR 63.30.3(3)(d). Further rules applicable to the ordering and treatment of distributions from an S corporation that was formerly treated as a corporate trust are set out in 830 CMR 63.30.3(4)(a)2.a.
With respect to the treatment of capital losses attributable to corporate trusts that become S corporations after July 3, 2008, see 830 CMR 63.30.3(4)(a)2.a, last paragraph.
(a) General rules
A taxpayer whose filing status changes pursuant to the Act or this regulation from a M.G.L. c. 62 filer to a M.G.L. c. 63 filer, or vice versa, and where applicable its owners or members, are required to adjust their estimated tax payments accordingly. For tax years beginning prior to January 1, 2009, the effective date of the legislative changes, taxpayers subject to tax under M.G.L. c. 62 must continue to make payments of estimated tax if required to do so under M.G.L. c. 62B, §§ 13, 14 for that tax year. If the same entity, or successor, is classified as a corporation for tax years beginning on or after January 1, 2009, the entity shall be subject to the estimated tax payment rules set forth at M.G.L. c. 63B, as modified by certain transition rules, below. For tax years beginning prior to January 1, 2009, taxpayers subject to tax under M.G.L. c. 63 must continue to make payments of estimated tax if required to do so under M.G.L. c. 63B for that tax year. If the same entity, or successor, is classified as a partnership or as a disregarded entity to the extent owned by M.G.L. c. 62 taxpayers, for tax years beginning on or after January 1, 2009 the partners or other owners shall be subject to the estimated tax payment rules at M.G.L. c. 62B, §§ 13, 14, as modified by certain transition rules, below. Taxpayers are required to register with the Department under their proper classification at the beginning of their first taxable year on or after January 1, 2009.
The corporate estimated tax payment rules are found at 830 CMR 63B.2.2. Note that as a general rule, these tax payments are not of equal amount, and are front-weighted. This contrasts with the estimated tax filing rules under M.G.L. c. 62B, § 13 - 15, applicable to individuals, where the general rule requires four equal payments of the estimated tax due.
(b) Specific rules
One of the statutory methods for determining estimated tax payments, for both corporate excise and personal income tax purposes, is to base the payments on the prior year's tax due. See M.G.L. c. 62B, § 14(c), M.G.L. c. 63B, § 3(c). To account for differences in taxpayer classification, the following transition rules apply for estimated payments in the year of the change. Nothing in this regulation is intended to abridge the requirements imposed under 830 CMR 63B.2.2; in particular, rules applying to large corporations, as noted in 830 CMR 63B.2.2(8) apply to all entities affected by the Act.
1. Shareholders in a successor to a corporate trust
A shareholder in an entity that was formerly taxed at the entity level under M.G.L. c. 62, § 8, may now be taxable as a partner in a partnership or as an owner of a disregarded entity for tax years beginning January 1, 2009. In making estimated tax payments on account of their earnings from the partnership or disregarded entity, in cases where their "required annual payment" is based on the prior year formula set forth at M.G.L. c. 62B, § 14(c)(ii), resident shareholders must take into account their proportionate share of the former corporate trust's tax due for the prior tax year. Further, in such cases, non-resident shareholders must base their estimated tax payments for the first year of the change in filing status on the personal income tax rate as applied to their proportionate share of the former corporate trust's Massachusetts source income for the prior tax year.
2. S corporations and their shareholders
Pursuant to the Act, a federal S corporation is a Massachusetts S corporation, irrespective of its treatment under prior law. In some cases, the income of S corporation shareholders previously would not have included S corporation distributive share income for Massachusetts income tax purposes because the S corporation was previously taxed in Massachusetts only at the entity-level (e.g., as a corporate trust under M.G.L. c. 62, § 8, or as financial institution under M.G.L. c. 63, §§ 1 - 7), but the shareholders' estimated tax payments may nonetheless be based on the tax due from the preceding taxable year. In these cases, the shareholders must calculate their estimated taxes as they relate to the S corporation's income based on what the personal income tax for the preceding taxable year would have been with respect to the shareholder's distributive share of the entity's income, loss, deduction and credit if the entity been treated as an S corporation for Massachusetts tax purposes. Further, non-resident shareholders must use the apportionment percentage of the former corporate trust or financial institution for the preceding taxable year in calculating their estimated payments, to the extent required under M.G.L. c. 62B, § 14(c)(ii). The S corporation must provide its shareholders with all information necessary for shareholders to comply with these requirements.
Pursuant to the Act, S corporations and their QSUBs are no longer subject to separate taxation, and are evaluated together for income and non-income measure purposes. See M.G.L. c. 63, § 32D, as amended by St. 2008, c. 173, §§ 49 - 53. To ensure proper calculation of estimated tax payments required under M.G.L. c. 63B, to the extent the estimated payment of the entity is based on the prior year's tax due, according to the rules at 830 CMR 63B.2.2, the amount must be based on the sum of the tax due for the S corporation and its QSUBs for the preceding taxable year, as that term is defined at 830 CMR 63B.2.2(2). In many cases, estimated tax payments after the first of four required estimates must be based on the entity's actual circumstances during the current taxable year, according to the rule at 830 CMR 63B.2.2(8)(b)(1).
In addition to the preceding general rule, an S corporation that was formerly subject to taxation as either a corporate trust, under M.G.L. c. 62, § 8, or as a financial institution, under M.G.L. c. 63, §§ 1 - 7, must recalculate its tax due for the preceding taxable year as though the entity had been subject to taxation under M.G.L. c. 63, § 32D or 2B including the income of its QSUBs, to the extent the payment due is based on the income tax liability of the preceding taxable year.
3. C corporations
In some cases an entity the income of which formerly was subject to taxation under M.G.L. c. 62 is now subject to taxation under M.G.L. c. 63, as amended by St. 2008, c. 173 and therefore under the new statutory scheme must determine its estimated tax payment due under 830 CMR 63B.2.2. In these cases, to the extent the required annual payment is properly based on the tax due in the preceding taxable year, under 830 CMR 63B.2.2(8)(b), the entity must calculate its tax liability for the entity for the preceding year as if the entity had been subject to tax under M.G.L. c. 63. In many cases, payments after the first of four required estimates must be based on the entity's actual circumstances during the taxable year, according to the rule set forth at 830 CMR 63B.2.2(8)(b)(1).
RGULATORY AUTHORITY
830 CMR 63.30.3: M.G.L. c. 14 § 16(1); M.G.L. c. 62C, § 3; St. 2008, c. 173, §§ 11 - 17, 19 - 25, 28 - 32, 37, 38, 42, 46, 49-53, 57, 84, 85, 96.
REGULATORY HISTORY
Date of Promulgation: 3/20/09
