The House last week passed, despite the governor’s veto, a change in state tax law to allow the owners of partnerships and S corporations to avoid the federal limit on state and local tax deductions, but the Pioneer Institute said Monday the change will not be enough to avoid compounding effects if voters next year approve a surtax on household income above $1 million.
The 2017 federal tax law capped state and local tax (SALT) deductions at $10,000, increasing the liability on higher earners and property owners in Massachusetts and other states with relatively high taxes and property values. In a whitepaper published Monday, Pioneer said the cap “will greatly exacerbate the adverse effects” of a proposed 4 percent state surtax on household income greater than $1 million, a proposal the organization has long opposed.
“After the authors of the proposed graduated tax in Massachusetts submitted their proposal for legislative approval in 2017, the federal government placed a $10,000 limitation of deductibility of state and local taxes on federal tax returns. This unforeseen change in the federal tax code had the effect of turning what would have been a 58 percent increase in average state income tax payments among Massachusetts millionaires, from $160,786 to $254,355, into what is essentially a 147 percent increase when the federal SALT limitation is included in the calculation,” the Pioneer report concluded. “This substantial change should be taken into consideration by voters when they contemplate approving the surtax proposal.”
The state budget approved this summer included a provision to allow the Department of Revenue to implement an optional pass-through entity excise in the amount of personal income tax owed on a member’s flow-through income and a corresponding tax credit equal to 90 percent of the member’s portion of the excise. Gov. Charlie Baker vetoed the provision in favor of his own proposal to return 100 percent of the excise to the taxpayer but the House last week overrode his veto (H 4009) and the Senate could follow suit.
But Pioneer said Monday that a workaround, with a credit at either 90 percent or 100 percent, would “not diminish the amount of surtax payments Massachusetts taxpayers will owe DOR if state voters approve the graduated income tax.”
“It appears that neither the [workaround] tax credit nor the taxpayer’s state tax liability are relevant to the proposed constitutional amendment because the additional 4 percent surtax is charged by calculating the total amount of annual taxable income, not the amount of taxes due on that income,” Pioneer said.
Roughly 55,500 Massachusetts personal income tax filers would benefit from a pass-through entity (PTE) tax workaround and could save up to an average of $20,158 in federal taxes annually, DOR estimated in a March report.
The Senate as early as Thursday could complete the override initiated by the House last week.
