When I was a kid, growing up in my patched up Toughskins, riding my hand me down Huffy bike, delivering eighty newspapers a day to folks in town, I had a lot of time to think and dream. I remember the idea of becoming a millionaire. It was once lauded as one of the greatest achievements a human could make in his or her life. Claiming this title was a sign that you’d made it in life and were set financially. People admired and envied millionaires, assuming that their lives were perfect in every way – and if they weren’t, money would fix it. Of course, we know that isn’t necessarily accurate, but nonetheless I think we can agree that money offers us choices that we may not otherwise have in our lives.
However, these days it seems as if becoming a millionaire is no longer enough. Apparently, being a millionaire is the new middle class, and in order to become truly elite, one must earn far more. Don’t get me wrong, a million dollars is not petty cash by any means. But with continued inflation, rising health care and retirement costs, increasing home prices and the general price increase of just about everything these days, a million dollars isn’t life-changing money.
Last fall on Election Day, Massachusetts voters approved Ballot Question 1, the so-called “Millionaires Tax” by a close margin of 52% for and 48% against. What this means is that, as of the January 1, 2023 tax year, the state will impose an additional 4% state income tax on a Massachusetts residents’ annual taxable income in excess of $1 million. 4% may not seem like a lot to some folks, but consider that 4% of $1million dollars is $40,000!
The tax revenue anticipated by this extra 4% tax, estimated at $1 to $2 billion annually, is supposed to be used for public education (including public colleges and universities) and transportation, repair and maintenance to roads, bridges, and public transportation. And with our time together this week, let’s take a closer look at the likely effects of this tax and ways to help mitigate it.
According to the state, this tax is no reason for alarm, as it’s expected to affect less than 1% of Massachusetts residents. But consider the fact that Massachusetts has the second highest average annual wage in the US, coming in at $93,675 vs the United States’ average of $69,392, this will affect more people than you might think₁. Sure, higher income here in our great state is a good thing. But consider also the fact that a typical home in Massachusetts costs almost $612,000, which is 143% of the typical home in the US. In fact, our state has some of the country’s most expensive housing costs which takes a big bite out of our bigger incomes₂.
The new law states that if your income from any source, including wages, interest, dividends, income from the sale of a home or business, and long and short-term capital gains, exceeds $1 million, the portion in excess of $1 million will be taxed at 9%, which reflects the current Massachusetts income tax of 5% plus the additional 4% tax on any income over $1 million. And because Massachusetts taxes short term capital gains at 12%, the effective new tax rate on this income will be 16%.
So how might this play out for those so-called “middle-class” residents? Well, let’s say you sell your fairly typical Massachusetts home. Our housing prices could easily push you into the $1 million income bracket for that year due to the capital gains on the home sale. You won’t pay capital gain tax on the entire sale price of your home, but rather on the selling price minus your “basis” in your home, but this could be a sizable figure depending on how long you’ve owned the home and what price you’re able to sell it for. Also, homeowners do have a capital gain exclusion that they can shield from taxes of $250,000 for a single individual and $500,000 for a married couple. You’ll want to review the conditions required to realize this exclusion for sure.
Luckily, there are strategies you can use to help you minimize or avoid the additional 4% tax. For example, you might consider spreading out your income across multiple taxpayers. If as a couple you have substantial unearned income, that income could be spread between the spouses to ensure that each makes full use of the first $1,000,000 of income that is free of the additional tax.
You can also spread your income across multiple years by using an installment sale to spread a large investment gain over multiple years if, say, you are planning to sell an asset that has a significant unrealized appreciation.
Another tactic, on the more extreme side, is to move out of state. If you’re not domiciled here, then most income will not be subject to this tax. Obviously, there is a lot involved in this decision beyond this tax but if you’re already considering a move across state lines for other reasons, this may help sway your decision.
There are numerous other strategies as well, too complex to go into detail here – but just know that if you may get hit with this new tax, you have options. Don’t let this new tax discourage you from becoming a Massachusetts Millionaire!
And as always – be vigilant and stay alert, because you deserve more!
Have a great week.
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield, MA. Insurance offered through its affiliate, CutterInsure, Inc.
We do not offer tax or legal advice. Jeff can be reached at jeff@cutterfinancialgroup.com. This information is intended to provide general information. It is not intended to offer or deliver investment advice in any way. Information regarding investment services is provided solely to gain a better understanding of the subject of the article. Different types of investments involve varying degrees of risk, including the potential for loss. Therefore, it should not be assumed that future performance of any specific investment or investment strategy will be profitable. Insurance product guarantees are backed by the financial strength and claims-paying ability of the issuing company. Market data and other cited or linked-to content is based on generally available information and is believed to be reliable. Cutter Financial does not guarantee the performance of any investment or the accuracy of the information contained in this article. Cutter Financial will provide all prospective clients with a copy of Cutter Financial’s Form ADV 2A, Appendix 1, applicable Form ADV 2Bs and Form CRS as well as the firm privacy policy. Please contact us to request a free copy via .pdf or hardcopy. 1. https://tinyurl.com/yrf5ab8s 2. https://tinyurl.com/434je6bt
