| Date: | 03/29/1990 |
|---|---|
| Organization: | Massachusetts Department of Revenue |
| Referenced Sources: | Massachusetts General Laws |
Personal Income Tax
Introduction
The income tax provisions of Chapter 62 of the Massachusetts General Laws have been amended by St. 1989, c. 287, §§ 18, 19. These provisions, effective for taxable years beginning on or after January 1, 1989 and before January 1, 1991, impose a temporary increase in the rate of tax for Part B taxable income for those two tax years. However, certain items of income, classified under the amendment as Part C income, are exempt from those temporary increase provisions.
The purpose of this Technical Information Release (TIR) is to address various issues concerning the income tax treatment of Part C income for the tax years indicated above. In particular, this TIR clarifies the meaning of Part C income and provides rules and examples for calculating and offsetting Part B and Part C losses, excess deductions, and exemptions.
1. Part B and Part C Income Distinguished
For taxable years commencing on or after January 1, 1989 and before January 1, 1991, "Part B taxable income" shall not include unemployment compensation, alimony, Massachusetts bank interest, rental income from real estate, pension and annuity income or IRA/Keogh distributions. During this two-year period, income received from those sources will be classified as "Part C taxable income" and will be taxed at the rate of five percent. For taxable years commencing on or after January 1, 1989 and before January 1, 1990, "Part B taxable income," as defined by St. 1989, c. 287, § 19, will be taxed at the rate of 5.375%. For taxable years commencing on or after January 1, 1990 and before January 1, 1991, "Part B taxable income," as defined by St. 1989, c. 287, § 19, will be taxed at the rate of 5.75%.
The relevant provisions of St. 1989, c. 287, §§ 18, 19, are summarized below:
A. Effective Dates:Taxable years beginning during calendar years 1989 and 1990.
B. Types of Income:
Part A: Capital gains, dividends, and interest (other than interest includible in Part C income).
Part B: Wages, self-employment income, business, profession and farm income, S corporation distributions, royalties, trust income, gambling winnings, rental income from personal property, and all other taxable income not specifically included in Part A or Part C income.
Part C: Unemployment compensation, alimony, Massachusetts bank interest, rental income from real estate, pension and annuity income, and IRA/Keogh distributions.
The following examples illustrate the differences between Part B and Part C income under these provisions:
Example 1: Taxpayer Lambert is an accountant who owns and rents out two triple decker houses. For taxable years 1989 and 1990, Lambert reports ten thousand dollars of income from the rental of this real estate. He also has $2,500 of income from Massachusetts bank interest. Lambert should report the income from these sources as Part C income, taxable at a rate of five percent. Lambert also has $36,000 in wages for each of those years. He must report the $36,000 in wages as Part B income, taxable at a rate of 5.375% in 1989, and 5.75% in 1990.
Example 2: Taxpayer Williams is a sole proprietor engaged in the business of selling and renting power tools. For the 1989 taxable year, Williams received a total of one hundred thousand dollars of income from the rental of power tools. Additionally, he received $5,000 in gambling winnings from the Massachusetts lottery. Williams must report the income from these sources as Part B income, taxable at a rate of 5.375%. He also received $4,800 of rental income from the rental of a two-family house that he owns. He must report the $4,800 income received from the rental of the real estate as Part C income, taxable at a rate of 5%.
C. Summary of Rates:
Type of Received During Received During
Income Taxable Year Taxable Year
Beginning in 1989 Beginning in 1990
______ _________________ _______________
Part A 10% 10%
Part B 5.375% 5.75%
Part C 5% 5%
2. Rules for Offsetting Part B and Part C Losses
A. Part B Losses
A taxpayer incurring a loss with respect to any item of Part B (5.375% or 5.75%) income, as defined in St. 1989, c. 287, § 19, must apply this loss first against other types of Part B income. If, after applying this loss there is a net loss with respect to Part B income, the taxpayer then may apply the net loss against Part C (5%) income.
B. Part C Losses
A taxpayer incurring a loss with respect to any item of Part C (5%) income, as defined in St. 1989, c. 287, § 19, must apply this loss first against other types of Part C income. If, after applying such a loss, there is a net loss with respect to Part C income the taxpayer may apply the net loss against Part B (5.375% or 5.75%) income.
The following example illustrates the application of this section:
Example 3: During calendar year 1989, Taxpayer Davis, a full year Massachusetts resident, had $50,000 in Part B business income. He also received $10,000 in rental payments related to the rental of a house that he owned, but his expenses related to the rental of the house (mortgage payments, property taxes, etc.) totaled $25,000, resulting in a $15,000 rental loss for the year. Under St. 1989, c. 287, §§ 18, 19, Part B (5.375% or 5.75%) income is taxed after any Part C (5%) losses have been subtracted from it. Davis must calculate his total income in 1989 as follows:
1. First, Davis must reduce the amount of his $10,000 Part C rental income by the $25,000 of the deductions related to this rental income, to arrive at $15,000 net loss as his Part C income from his real estate rental activity.
2. Second, Davis may reduce the amount of his $50,000 Part B business income by the amount of his $15,000 net loss to arrive at $35,000 of taxable Part B income.
3. Rules for Offsetting Excess Deductions
Generally, similar to the rules for applying losses as described in section 2, above, a taxpayer having deductions allowed under G.L. c. 62, § 2(d) (e.g. alimony, employee business expenses, etc.) must take them first against Part B (5.375% or 5.75%) income. However, the interest deduction allowed by G.L. c. 62, § 3(B)(a)(6) may be applied only against Massachusetts bank interest (Part C income). St. 1989, c. 287, § 19. A taxpayer having any of those deductions remaining after applying such deductions against Part B income may apply these excess deductions against Part C (5%) income. The excess of these deductions over Part B and C income then may be offset against Part A income to the extent allowed by G.L. c. 62, § 2(c)(1) or I.R.C. Section 469(d)(1)(B). There is no change under St. 1989, c. 287 in the way such excess deductions may be applied against Part A income. Thus, these deductions may be applied against Part A income to the extent that the Part A income is either 1) effectively connected with the active conduct of a trade or business of a taxpayer, or 2) allowed to be offset under the passive loss rules of I.R.C. Section 469(d)(1)(B).
The following examples illustrate the application of this section:
Example 4: Taxpayer Harris, a full year Massachusetts resident for calendar year 1990, receives the following sources of income for the year: $15,000 in rental income from real estate, $2,000 in Massachusetts bank interest, and $5,000 in lottery winnings for the year. Harris has $17,000 of Part C income, taxed at a 5% rate, and $5,000 of Part B income, taxed at a 5.75% rate, for the year. In 1990, Harris pays $7,500 to his former spouse as alimony. His $7,500 alimony payment must be claimed as a deduction, first against Part B income, and then, to the extent any amount remains unused, from 5% income. Accordingly, Harris must calculate his 1990 income as follows:
1. Harris must apply his $7,500 alimony deduction first against his Part B lottery winnings, ($7,500 from $5,000 equals $2,500 as an excess deduction).
2. Then, Harris applies the $2,500 excess deduction against his Part C income of $17,000, ($17,000 - $2,500 equals $14,500 remaining as Part C income).
Example 5: Taxpayer Martin, a full year Massachusetts resident during 1989, opened her own novelty store in 1989. By the end of the year, Martin's business had incurred net losses amounting to $25,000. She also had the following sources of income and losses for the year: $15,000 in wages from part-time employment, $5,000 in rental income from Massachusetts real estate that she actively managed, a $20,000 capital gain received upon selling some property that was effectively connected with the active conduct of her trade or business, and $2,000 in losses related to another Massachusetts property that she also actively managed.
Business losses are classified as Part B (5.375%) losses under the new tax classification system. Wages are classified as Part B income. Rental income from real estate is taxed at the 5% rate as Part C income. Losses related to the rental of real property are Part C losses. Capital gains are considered Part A income and are taxed at the 10% rate. The new law allows any excess of Part B loss over Part B income to offset Part C income. It further allows the excess of Part B and C deductions over Part B and C income as a deduction against Part A income to the extent that the Part A income is either 1) effectively connected with the active conduct of a trade or business, or 2) allowed to be offset under the passive loss rules of I.R.C. Section 469(d)(1)(B). Accordingly, Martin must calculate her income as follows:
1. First, Martin should apply her $25,000 business loss (a Part B loss) against her $15,000 wages (Part B income) ($25,000 loss applied against 15,000 wages equals $10,000 as a Part B loss).
2. Second, Martin should offset her $2,000 loss from the rental of the Massachusetts property against the $5,000 income from rental of the other property ($5,000 - $2,000 = $3,000 Part C rental income).
3. Third, she should apply her $10,000 Part B loss against her $3,000 Part C rental income amount. ($10,000 Part B loss applied against $3,000 Part C income equals $7,000 as an excess deduction).
4. Fourth, Martin may apply this excess $7,000 deduction against Part A income that is effectively connected with the active conduct of her trade or business. (Here, the excess $7,000 deduction would be applied against her $20,000 Part A capital gain for a net capital gain of $13,000).
4. Rules for Offsetting Exemptions
Generally, after the deductions in Section 3 above have been taken, taxpayers must apply the exemptions allowed under G.L. c. 62, § 3(B) (e.g. personal exemption, exemption for blindness, etc.) against Part B (5.375%) income, with any excess exemption amounts then applied against Part C (5%) income, and lastly against Part A income, as provided and limited by the provisions of G.L. c. 62, § 3(A)(b). There is no change under St. 1989, c. 287 in the way excess exemptions may be applied against Part A (10%) income. (See DOR Directive 86-27).
5. Treatment of Part C Income for Purposes Other than Calculating Losses, Deductions, and Exemptions During Effective Dates of St. 1989, c. 287, §§ 18, 19
During the period in which the provisions of St. 1989, c. 287, sections 18, 19 are in effect, for purposes other than calculating losses, deductions and exemptions, Part B income as referred to in G.L. c. 62, includes both Part B income and Part C income, as defined in St. 1989, c. 287, §§ 18 and 19. Thus, for example, for purposes of determining and calculating items such as a taxpayer's no tax status, the credit for taxes paid to another jurisdiction, etc., Part B and Part C income are calculated together, without regard to their status as Part B or Part C income under the temporary income tax classification provisions of St. 1989, c. 287, § 19.
6. Effect of St. 1989, c. 287, §§ 18, 19 on Part B and Part C Income On or After January 1, 1991
The provisions of St. 1989, c. 287, §§ 18, 19, are effective for taxable years commencing on or after January 1, 1989, and before January 1, 1991. After this date, unless otherwise provided by law, all income now classified as Part B income (5.375% or 5.75%) and Part C income (5%) will again be classified as Part B income only, taxable at a single rate of five percent.
Stephen W. Kidder
Commissioner of Revenue
TIR 90-2
March 29, 1990