Six strategies to limit the Massachusetts millionaires tax and others like it

In 2023, Massachusetts imposed a new 4% surtax on income over $1 million. This is in addition to Massachusetts’ existing 5% income tax. As a result, Massachusetts taxpayers who earn more than $1 million in a year will face a total tax rate of 9% on the portion of their income that exceeds the threshold.

At 9%, Massachusetts joins the ranks of California, New York and New Jersey as states with the highest top state income tax rates. For residents of these states, one or more of the strategies below may help to limit your state income tax bill, especially if you’re approaching a significant one-time event like selling a business or property.

1. Spread your income across multiple tax years

A basic strategy to limit the hit of top state tax rates is to spread your income across multiple tax years. This is especially true when there’s a big jump at a certain dollar amount, as is now the case in Massachusetts with the $1 million threshold.

If your income is being pushed over the threshold in a single year, or if your income is lumpy and varies above and below the threshold, your goal should be to spread the income out and avoid the lumps that push you to the top rate.

This is typically done by deferring income or accelerating deductions. For example:

• You may defer income by postponing the sale of a business or a property to a year when you have less other income or choose an installment sale instead of a lump sum payment.
• You may delay the receipt of bonuses or commissions if your income for the year is already high.
• You might maximize contributions to retirement plans or deferred compensation plans if you’re not doing so already.
• You might accelerate charitable deductions.
• You may consider large purchases that can be depreciated or expensed.
• If you are at least 70 ½ years old, you can use a QCD (Qualified Charitable Distribution) to give up to $108,000 from your IRA directly to an eligible charity without paying taxes on it. This is a good option if you want to reduce your taxable income.

Of course, it may not always be feasible to defer income or accelerate deductions. Spreading out your income needs to be coordinated with your cash flow, liquidity and investment plans.

2. Harvest your capital losses

Another strategy to avoid top tax rates is to realize your losses. Capital losses can be realized by selling investments that have declined in value, such as stocks, bonds, mutual funds or ETFs. You can also realize losses by selling real property or business interests.

You should work with your accountant to understand whether your potential losses qualify as short-term or long-term and optimize the offset of your capital gains. If you have losses remaining after offsetting all capital gains, those excess losses can only be used to reduce up to $3,000 of ordinary income per year. Any remaining losses can be carried forward to future years.

You also should be aware of the wash sale rule, which disallows the deduction of losses if you buy substantially identical securities within 30 days before or after the sale.

3. Give to charity

As mentioned before, charitable contributions can be a way to accelerate deductions and smooth your income over multiple years. You can also consider making a large gift to charity in a year when you have a large income event, such as a sale of a business or property.

For example, let’s say you’re selling your interest in a business for $2,000,000, having invested $500,000 in it. That’s $1,500,000 of income. If you’re a Massachusetts resident, under the new tax $500,000 of that, along with any other income you may have in that year, will be subject to the new 4% surtax and therefore a total 9% state income tax.

But let’s say you have an outstanding pledge to give $1,000,000 to a charity at your death. You can fulfill half or more of that pledge in the year of the sale, avoid the 4% surtax, and have the satisfaction of seeing your pledge fulfilled during your life.

Close attention is needed to charitable deduction rules of your state. For example, in Massachusetts, there has been no charitable contribution deduction for many years, but new legislation added a deduction in 2023 just in time for the millionaires tax.

If you don’t have immediate charitable goals, you may consider a gift to a private foundation or donor advised fund, enabling you to receive a current charitable deduction for your gift with the ability to advise the fund on grants to other charities stretched out over future years.

You could also consider a charitable remainder trust if you plan to sell appreciated property. With a charitable remainder trust, you give the property to the trust and receive back an annuity interest. The annuity allows you to spread the capital gain from the sale of the property over multiple years and defer the tax. You also receive a current charitable deduction for the remainder interest that goes to charity.

You will want to work with your accountant to confirm your deduction amounts and limits when dealing with charitable vehicles like donor advised funds, private foundations and charitable trusts.

4. Turn off grantor trusts

Speaking of trusts, you can also look at income you are reporting from any irrevocable grantor trusts.

With an irrevocable grantor trust, you continue to be treated as owning the trust property for income tax purposes even though you’ve gifted the property out of your estate. This can be a good estate tax strategy, since the continued income tax liability is a means to limit the size of your estate and maximize the amount that goes to your beneficiaries.

But if the income from a grantor trust is pushing you into a top tax bracket, it can make sense to run the numbers and decide if your family would be better off by having the trust pay its own taxes. Most grantor trusts provide a way for the grantor to stop being treated as the income tax owner of the trust property.

Grantor trusts also typically provide the ability to swap assets in and out of the trust. Before you stop paying tax on the trust property, you can use this power to optimize the income-producing assets in the trust as opposed to your estate.

5. File separate returns

While married couples tend to live in the same state, that is not always true. If you and your spouse are spending time in multiple states, you might work with your accountants to understand your options to file separate returns at the state level and avail yourselves of tax laws in the different states.

You can expect the tax authorities to give this situation close attention, but this may make sense if one spouse is retired or a homemaker and living in a state like Florida or New Hampshire with no income tax, while the other spouse is continuing their career and living in the high tax state. If spouses are filing separate returns, it may be possible to reallocate ownership of your income-producing assets between you to reduce the overall state tax burden.

If you and your spouse live in the same state, you have the option to file your federal and state tax returns as “Married Filing Separately.” This may not be the most favorable choice for your federal taxes, but it could save you money on your state taxes if you are subject to the millionaires tax. You should consult with your accountant to compare the benefits and drawbacks of filing jointly or separately before you prepare your tax return.

6. Move

Of course, the easiest answer to avoiding high state income taxes is to move to a low- or no-income tax state. Florida, New Hampshire, Nevada, Texas, Washington and a few other states do not impose a state income tax.

If you move, you want to make sure you satisfy the residency requirements of your new home state. You also want to make sure you properly sever and monitor your ties to the former state. Please see our articles on How Changing States Changes Your Income Taxes and Hotel California: Can You Really Never Leave?

If taxes are part of your motivation to move, make sure you take into account your full tax picture. Along with income taxes, consider estate taxes. Seventeen states and the District of Columbia have an estate or inheritance tax, and the rules vary. For example, Massachusetts has a 16% estate tax that applies to assets over $2 million, which is up from $1 million thanks to a new law even more recent than the millionaires tax.

Let us help

The Massachusetts millionaires tax will have a significant impact on high-income taxpayers in the state. However, there are strategies that can help limit the effect of the new tax and other high state income taxes. Our wealth advisors can you help identify the strategies that may make sense for you and work with your other advisors to put your plans in place.