Breaking the Code: Updates to Massachusetts Conformity with the Internal Revenue Code
By: Matthew Knightly
The tax filing season is well underway. Ahead of the upcoming deadlines, we wanted to provide an update on recent Massachusetts conformity changes to the Internal Revenue Code.
A Massachusetts taxpayers’ gross income is generally based on the taxpayer’s Federal gross income under the Internal Revenue Code as of a specific date. Massachusetts personal income tax previously conformed to the internal revenue code as of January 1, 2005. The conformity date has now been updated to January 1, 2022.
We have highlighted a few of the key updates below.
Alimony Received and Paid
Under the Tax Cuts and Jobs Act of 2017, alimony payments received from a former spouse are not included in the recipient’s federal gross income. In addition, a taxpayer cannot deduct alimony payments to a former spouse from federal gross income. This is the case for any payments made pursuant to any divorce agreement or separation instrument executed after December 31, 2018.
Prior to the Code Update, Massachusetts conformed to the federal income tax treatment of alimony and separate maintenance payments under the 2005 Code. Therefore, a taxpayer who paid alimony to a former spouse could deduct the amount of such payments from Massachusetts gross income, and the recipient of such payments was required to include those payments in Massachusetts gross income.
As a result of the update, Massachusetts now conforms to the 2022 Code’s treatment of alimony and separate maintenance payments. Consistent with the federal rules Massachusetts now eliminates alimony payments as a deduction from, and inclusion in, Massachusetts gross income. This is the case for all payments made pursuant to any divorce or separation instrument executed after December 31, 2018. If payments are associated with any divorce or separation agreement executed prior to December 31, 2018, the payments will be factored into both Federal and Massachusetts gross income.
Partial Exclusion for Gains from Certain Small Business Stock
The IRS allows for the exclusion of gains from the sale or exchange of qualified small business stock held for more than 5 years. The exclusion applies to gains on qualified small business stock acquired on or after September 27, 2010. However, under the 2005 Code, only 50% of the gain was excluded.
Prior to the Code Update, Massachusetts applied the 50% federal exclusion for gains on qualified small business stock. As a result of the Code Update, Massachusetts conforms to the 100% exclusion with respect to sales or exchanges of qualified small business stock that occur on or after January 1, 2022.
In addition to the exclusion, Massachusetts taxes gain on the sale or exchange of certain small business stock at a reduced rate of 3%. The reduced rate continues to apply to gains that are not eligible for the full federal exclusion, if all the requirements for the reduced rate are met.
Only certain types of companies are considered qualified small businesses and therefore have gains eligible for qualified small business stock treatment. Firms in the technology, retail, wholesale, and manufacturing sectors are eligible as QSBS, while those in the hospitality industry, personal services, the financial sector, farming, and mining are not. Additionally, to qualify, the business’s assets cannot exceed $50 million on or after the issuance of the stock.
For the stock to be considered qualified small business stock, and associated gains be eligible for exclusion treatment, the following must apply:
The investor must not be a corporation.
The investor must have acquired the stock at its original issuance.
The investor must have purchased the stock with cash or property or accepted it as payment for services performed.
The investor must have held the stock for at least five years.
At least 80% of the issuing corporation's assets must be used in the operations of one or more of its qualified trades or businesses.
Investments in Qualified Opportunity Zones
The Internal Revenue Code allows taxpayers to defer gains on the sale of property for federal tax purposes to the extent gains are invested in a Qualified Opportunity Fund (“QOF”) within 180 days of the sale of the original property. A QOF is an investment vehicle organized for the purpose of investing in Qualified Opportunity Zone property.
The deferred gain is then recognized when there is an inclusion event (sale of part or all the investment). The amount of deferred gain subject to tax will be reduced if the interest in the QOF has been held for five years or more. If the interest in the QOF is held for ten years or more, increases in the value of the QOF are excluded from federal income when sold.
As a result of the Code Update, starting for the 2022 tax year, Massachusetts now conforms to the Internal Revenue Code as it relates to treatment of opportunity zones for qualified taxpayers.
Limitation on Excess Business Losses of Noncorporate Taxpayers
For taxable years beginning on or after January 1, 2021, and ending before January 1, 2027 (i.e., the 2021 through 2026 taxable years), noncorporate taxpayers are prevented from deducting excess business losses. Excess business losses include losses greater than $250,000 over gross business income. The excess business losses that are disallowed may be carried forward as net operating losses for federal income tax purposes.
Prior to the Code Update, Massachusetts did not conform to the excess business loss limitations because that section was not included in the 2005 Code. As a result of the Code Update, Massachusetts now conforms to the excess business loss limitations for tax years beginning on or after January 1, 2022.
A key distinction for Massachusetts, that differs from Federal treatment, is that losses disallowed due to the limitation may not be carried forward. Additionally, Congress extended the excess business loss limitation through the 2028 taxable year. Massachusetts, however, does not conform to the extension of the excess loss rules and will only apply in the state through the 2026 taxable year.
We will continue to monitor additional changes to Massachusetts conformity with the Internal Revenue Code and provide updates as they arise. Please reach out with any questions about your personal tax situation.
For more detail on the Massachusetts conformity changes, please see following link: Mass Department of Revenue - Conformity to Select Provisions of the 2022 Internal Revenue Code
To ensure compliance with the requirements imposed on us by IRS Circular 230, we inform you that any tax advice contained in this communication (including any attachments) is not intended to and cannot be used for the purpose of: (i) avoiding tax-related penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.