| Date: | 01/02/2003 |
|---|---|
| Organization: | Massachusetts Department of Revenue |
| Referenced Sources: | Massachusetts General Laws |
Personal Income Tax
I. Introduction.
Effective for tax years beginning on or after January 1, 2002, the Massachusetts Legislature enacted changes regarding the income tax treatment of capital gains and losses under chapter 62 of the General Laws. See St. 2002, c. 186, and St. 2002, c. 364. The purpose of this Technical Information Release (TIR) is to explain the new law and how it affects the treatment and reporting of capital gains and losses for the 2002 tax year.
II. Law Changes.
A. Part C Income; Tax Rate for Transactions Completed on or after May 1, 2002.
Under prior law, Part C gross income was defined to include all Part C capital gains. Part C capital gains were long-term gains from the sale or exchange of capital assets (except collectibles) divided into six classes based on the holding period:
|
Prior Law Holding Period (in years) |
Class |
Tax Rate |
|
More than one but not more than two |
B |
5% |
|
More than two but not more than three |
C |
4% |
|
More than three but not more than four |
D |
3% |
|
More than four but not more than five |
E |
2% |
|
More than five but not more than six |
F |
1% |
|
More than six |
G |
0% |
Also under prior law, Part C capital losses were losses from the sale or exchange of capital assets divided into the above six classes based on the above holding periods. After reducing Part C gross income by Part C capital losses and other applicable deductions and exemptions to arrive at Part C taxable income, the classes of Part C taxable income were taxed at six different rates, as shown above. See 830 CMR 62.4.1.
Effective for tax years beginning on or after January 1, 2002, in place of the six categories of gain based on six defined holding periods, Part C gross income is defined as any gains from the sale or exchange of capital assets (except collectibles) held for more than one year. St. 2002, c. 186, § 6, amending G.L. c. 62, § 2(b)(3). The new capital gains tax law replaces the multiple tax rates for Part C taxable income with the single rate provided for Part B taxable income (5.3% for 2002), but only for transactions completed on or after May 1, 2002. St. 2002, c. 186, § 14, amending G.L. c. 62, § 4(c).
The new capital gains tax law provides that, to the maximum extent possible, all transactions that are completed prior to May 1, 2002, shall be aggregated and taxed under the procedures and rates in place prior to the changes in law,[ 1] and that all transactions completed on or after May 1, 2002, shall be aggregated and taxed under the procedures and rates established by such changes in law. St. 2002, c. 186; St. 2002, c. 364.
B. Part C Deductions.
Effective for taxable years beginning on or after January 1, 2002, for capital gains transactions completed on or after May 1, 2002, the deductions against Part C gross income to compute Part C adjusted gross income are allowed in the following order. Any amounts subtracted cannot reduce Part C adjusted gross income below zero.
1. Losses from the sale or exchange of capital assets held for more than one year ("Part C long-term capital losses"), including those carried forward from prior periods. G.L. c. 62, § 2(e)(1). If, on April 30, 2002, a taxpayer has any unused net long-term capital losses (from the classes taxed under prior law at the rates 5% - 0%), the aggregate amount of such net losses shall be taken into account after April 30, 2002 as a loss on the sale or exchange of a capital asset held for more than one year. G.L. c. 62, § 2(e)(N).
2. The excess, if any, of Part A net short-term capital losses remaining after application against Part A income. G.L. c. 62, § 2(c)(2)(a).
3. Excess Part B adjusted gross income deductions (remaining after application against Part A income) are deducted against the amount of Part C gross income that is effectively connected with the active conduct of a trade or business of the taxpayer. G.L. c. 62, § 2(e)(2). Excess Part B deductions cannot be applied to increase the amount of any net capital losses.
After reducing any Part A net short-term capital gains, any excess net long-term capital loss is carried forward to any succeeding taxable year. G.L. c. 62, §§ 2(c)(2)(b); 2(e)(1).
Part C taxable income is computed by applying the deductions and exemptions against Part C adjusted gross income allowable under G.L. c. 62, § 3.
C. Part A Deductions; $2,000 Limit on Deduction of Capital Losses against Part A Interest and Dividends.
The new capital gains tax law does not change the definition of Part A income. Part A gross income consists of interest (except interest from Massachusetts banks), dividends, gains from the sale or exchange of capital assets held for one year or less, and long-term gains from collectibles.[ 2] The tax rate on Part A taxable income consisting of short-term capital gains and long-term gains on collectibles is 12%.[ 3] The tax rate on Part A taxable income consisting of interest and dividends is the rate provided for Part B taxable income (5.3% for 2002). G.L. c. 62, § 4(a).
For taxable years 1996 - 2001, after Part A gross income was reduced by any excess Part B deductions, there was no dollar limit on the deduction of net capital losses (short-term and long-term) against Part A income consisting of dividends and interest.
Effective for taxable years beginning on or after January 1, 2002, the new capital gains tax law establishes a limit of $2,000 for the deduction of net capital losses against Part A income consisting of interest and dividends. G.L. c. 62, § 2(c)(2). Thus, beginning with taxable year 2002, no more than $2,000 of Part A interest and dividends can be offset by the aggregate of net short-term and net long-term capital losses. The deductions against Part A gross income to compute Part A adjusted gross income are allowed in the following order. Any amounts subtracted cannot reduce Part A adjusted gross income below zero.
1. Excess Part B adjusted gross income deductions are deducted against any item of Part A gross income (short-term capital gains, capital gains on the sale of collectibles, and interest and dividends) that is effectively connected with the active conduct of a trade or business of the taxpayer. G.L. c. 62, § 2(c)(1).
2. Part A short-term capital losses, including those carried over from prior years, are applied against Part A capital gains (short-term capital gains and capital gains on the sale of collectibles[ 4]). G.L. c. 62, § 2(c)(2)(a). A Part A short-term capital loss is a loss from the sale or exchange of a capital asset held for one year or less.
3. The excess, if any, of the Part A net capital loss for the year over the Part A capital gain for the year, but not more than $2,000, is applied against Part A interest and dividends. G.L. c. 62, § 2(c)(2)(a).
4. Part C long-term capital losses remaining after application against Part C long-term capital gains are used against Part A capital gains. G.L. c. 62, § 2(c)(2)(b).
5. The excess, if any, of the Part C long-term capital losses are applied against Part A interest and dividends, but the aggregate amount of the deductions for short-term and long-term capital losses against Part A interest and dividends cannot exceed $2,000. G.L. c. 62, § 2(c)(2)(b) and (c)(4).
After reducing any Part C net long-term capital gains, any excess net short-term capital loss is carried forward to any succeeding taxable year. G.L. c. 62, § 2(c)(2)(a).
Part A taxable income is computed by applying the deductions and exemptions against Part A adjusted gross income allowable under G.L. c. 62, § 3.
Example. In taxable year 2002, a taxpayer has $10,000 in dividend income. After offsetting any short-term capital gains with short-term and long-term capital losses, the taxpayer has $1,000 in net short-term capital losses and $4,000 in net long-term capital losses. The taxpayer deducts the $1,000 short-term capital loss and $1,000 of the long-term capital losses against the $10,000 dividend income. The resulting Part A taxable income of $8,000 is taxed at 5.3%. For taxable year 2003, the taxpayer will carry forward $3,000 in unused long-term capital losses.[ 5]
D. Certain Capital Losses Disallowed.
The new capital gains tax law did not change the rules prohibiting the deduction of certain capital losses. Capital losses that are disallowed as a deduction under Code § 165(c) (losses on personal use property), § 262 (personal expenses) or § 267 (losses between related parties) are not deductible for Massachusetts state tax purposes. G.L. c. 62, § 1(m). For example, losses on the sale or exchange of collectibles that are held for personal use are not deductible.
E. Transition Rules Needed to Effectuate the May 1, 2002 Date.
Since the new law provides for midyear changes in the tax rate for Part C income, the following transition rules are applicable for taxable year 2002.
1. Unused Capital Losses From 2001 And First Four Months Of 2002.
If, on April 30, 2002, after netting Part C capital losses against capital gains within the six categories of gain and loss, a taxpayer has any unused Class B loss, Class C loss, Class D loss, Class E loss, Class F loss or Class G loss, the aggregate amount of such net losses is taken into account after April 30, 2002 as a loss on the sale or exchange of a capital asset held for more than 1 year. G.L. c. 62, § 2(e)(3).
Example (unused net losses from first four months of 2002)
A taxpayer has the following transactions before May 1, 2002:
5% long-term capital loss ($3,000)
4% long-term capital gain $4,000
1% long-term capital loss ($5,000)
0% long-term capital gain $2,000
The taxpayer also has the following transaction on or after May 1, 2002
5.3% long-term capital gain $4,000
First, the gains and losses from transactions completed before May 1, 2002, are offset using the applicable ordering rules of prior law, resulting in a $2000 net loss in the 1% category.[ 6] On May 1, 2002, the 1% net long-term capital loss of $2,000 is deemed to be a 5.3% long-term capital loss of $2,000 to be offset against the 5.3% long-term capital gain of $4,000, resulting in a net long-term capital gain of $2,000 that is taxed at the rate of 5.3%.
Example (unused prior year losses, unused net losses from first four months of 2002, and limit on losses to reduce Part A interest and dividends)
Short-term capital gain $4,000
Dividend Income $6,300
Prior year short-term unused losses ($1,000)
The following transactions before May 1, 2002:
5% long-term capital loss ($2,000)
4% long-term capital loss ($5,000)
2% long-term capital loss ($1,000)
First, the prior year short-term unused losses are offset against short-term capital gain, resulting in net short-term capital gain of $3,000. As of May 1, 2002, the sum of the long-term capital losses under the prior law becomes a net 5.3% long-term capital loss of $8,000, of which $3,000 is used to offset net short-term capital gain. This results in a net long-term capital loss of $5,000. The taxpayer deducts $2,000 of the long-term capital loss against the $6,300 dividend income, resulting in Part A taxable income of $4,300 which is taxed at the 5.3% rate. For taxable year 2003, the taxpayer will carry forward $3,000 in long-term capital losses.
2. Net Capital Gain before May 1, 2002; Net Capital Loss on or after May 1, 2002.
For taxable year 2002, any net long-term capital loss from a transaction completed in the last 8 months is used to offset any net long-term capital gain from a transaction completed in the first 4 months. This is so even if the long-term capital gain in the first 4 months is in the 0% category. The taxpayer cannot choose to carry forward the long-term capital loss in the last 8 months instead of using it to offset a 0% gain in the first 4 months. This result is consistent with the Department's regulations on capital gains at 830 CMR 62.4.1(6)(b)(2)(f) where taxpayers must offset 0% gains with any net capital losses from other rate categories.
Example (post-April 30, 2002, net long-term capital loss offsets pre-May 1, 2002, net long-term capital gain)
After offsetting various gains and losses, a taxpayer has the following net amounts:
Transactions before May 1, 2002, 4% net long-term capital gain $100,000
Transactions on or after May 1, 2002, 5.3% net long-term capital loss ($100,000)
The 5.3% net long-term capital loss of $100,000 and the 4% net long-term capital gain of $100,000 are offset, resulting in no taxable income in 2002.
Example (post-April 30, 2002, net long-term capital loss offsets pre-May 1, 2002, net long-term capital gain)
A taxpayer has a transaction before May 1, 2002:
0% long-term capital gain $120,000
Also, the taxpayer has a transaction on or after May 1, 2002:
5.3% long-term capital loss ($100,000)
The 5.3% long-term capital loss of $100,000 offsets $100,000 of the 0% long-term capital gain of $120,000, resulting in a long-term capital gain of $20,000, which is taxed at the 0% rate. The taxpayer must offset the 5.3% long-term capital loss against the 0% long-term capital gain. In this case, even though any amount of gain would be taxed at 0%, a taxpayer cannot opt to carry forward the long-term capital loss of $100,000 to 2003.
Example (net short-term capital loss offsets pre-May 1, 2002, long-term capital gain; $2,000 limit on deduction of net losses against dividend income)
Dividend income $10,000
Transaction before May 1, 2002:
4% long-term capital gain $100,000
Transaction on or after May 1, 2002:
Short-term capital loss ($110,000)
The short-term capital loss completely offsets the long-term capital gain, resulting in a net short-term capital loss of $10,000. A short-term capital loss deduction of $2,000 is applied against the $10,000 dividend income, resulting in $8,000 dividend income to be taxed at the rate of 5.3%. The unused short-term capital loss of $8,000 is carried forward to 2003.
3. Real estate sales.
In the case of long-term capital gains from a real estate transaction where the purchase and sale agreement is dated before May 1, 2002, as well as a deposit paid by the buyer to the seller, the determination of the proper tax rate depends on when the transaction is completed.[ 7] If the transaction is completed before May 1, 2002, the rates in place prior to the changes in law apply (5% - 0%, depending on the holding period). If the transaction is completed on or after May 1, 2002, and before January 1, 2003, the amount of capital gain is taxed at the rate of 5.3%.
A review of the statute and case law indicates that, as a general rule, in determining whether a sale is complete for tax purposes for reporting gain or loss, courts have set the standard, with respect to real property, as the earlier of the passage of legal title (delivery of the deed) or the passage of the benefits and burdens of ownership. For filing purposes, taxpayers should use the date that the title passes as the date that the sale was completed. If the taxpayer believes that the sale was completed prior to the date title passes, the taxpayer should file an application for abatement which demonstrates that the benefits and burdens of ownership had passed prior to the passage of title.
III. Installment Sales Completed on or after January 1, 1996, and before May 1, 2002.
The new capital gains tax law provides in relevant part, "It is intended, to the maximum extent possible, that all transactions which are completed prior to May 1, 2002 shall be aggregated and taxed under the procedures and rates in place prior to the changes in law." St. 2002, c. 186, § 32. Where a capital asset was sold or exchanged in an installment sale completed on or after January 1, 1996, and before May 1, 2002, and the taxpayer elected to pay the personal income tax on capital gain attributable to such sale using the installment method pursuant to G.L. c. 62, § 63, the gains will be taxed under the rates in place prior to May 1, 2002.[ 8]
Example. In tax year 2001, a taxpayer realized a long-term capital gain upon the sale of a capital asset that had been held for more than four years but not more than five years (2% tax rate). The sale was an installment sale and payments are to be made in monthly installments over a five-year period. The taxpayer timely elected installment treatment to report the gain for Massachusetts income tax purposes. Gains from payments received in 2002 and subsequent tax years are taxed as long-term capital gains at the rate of 2%.
IV. Mutual Funds.
A. Capital Gain Dividends.
Where a taxpayer receives a distribution that is treated as a capital gain distribution under the Code, the distribution is included in Part C income. For taxable year 2002, where some of the transactions are completed before May 1, 2002, a mutual fund may (i) determine the amount of the capital gain dividend attributable to each class of Part C income and (ii) report such amounts to the taxpayer and the Commissioner not later than March 1 of the calendar year following the calendar year of the distribution. If the mutual fund does so, then the shareholders shall report the distribution on their personal income tax returns in the same manner. If the mutual fund does not do so for taxable year 2002, then the entire amount of the capital gain distribution is included in Part C gross income and taxed at the rate of 5.3%. See comparable rule for years prior to 2002 at 830 CMR 62.4.1(9).
B. Transition Rule.
The new capital gains rules, which eliminate the multiple rate structure for transactions completed on or after May 1, 2002, are applied based upon the date that a gain is realized by the investment company rather than the date that the gain is distributed to the fund's shareholders.
/s/Alan LeBovidge
Alan LeBovidge
Commissioner of Revenue
AL:DMS:ah
January 2, 2003
TIR 02-21