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September 1, 2005
1000’s To Get Assessed Additional Tax for 2002 Tax Year
A recent court case (Peterson v. Commissioner of Revenue) has produced an unexpected result for many Massachusetts taxpayers. Before you get too worried, this only will apply to you if you answer yes to the following three questions:
I. Did you file a 2002 Massachusetts income tax return?
II. Did have a capital gain?
III. Was the date of the capital gain between January 1, 2002 and April 30, 2002.
Let’s go back in time to 2002 and look at how taxes were computed on capital gains. Massachusetts had the silliest method of computing taxes on gains. For long-term capital gains occurring between January 1, 2002 and May 1, 2002 there were six categories and six different tax rates ranging from zero to 5 percent. They just couldn’t say, take the federal amount and multiply it by 5%! So, like I was saying, there were numbers everywhere, it took about 4 pages to figure out what the tax was.
In 2002 Governor Romney got a tax increase through the legislature that became effective on May 1, 2002. From that date forward Massachusetts went back to a single tax rate on long-term capital gains of 5.3%, based upon the same amount of the gain as reported for Federal income tax purposes.
The Peterson case said that there needed to be some consistency in how capital gains are taxed and that you can’t change the rates in the middle of the year. So at this point the Peterson’s were winning their case. What happened next not only backfired on the Peterson’s, but on all the other taxpayers in Massachusetts. On April 26, 2005, in Peterson II, the Supreme Judicial Court ruled that the new capital gains tax rate of 5.3% is effective January 1, 2002. In reaching its decision, the Court considered the legislative history, including the "fiscal crisis" that in part prompted the original legislation. The Court concluded, among other things, that it would be illogical, given those circumstances, for the Legislature to pass a tax increase but delay its implementation until the beginning of the next year.
For those of you who had gains prior to May 1, 2002, the worst case is that you would owe 5.3% of the gain as additional tax. Let’s take a look at an example:
EXAMPLE: “Bob” sells a rental property that he had owned for quite some time. Bob had paid $100,000 for the property and it is now fully depreciated. His only cost remaining is $15,000 that was allocated to the land. He sold the property on April 15, 2002 for $300,000
On Bob’s original 2002 Massachusetts income tax return, Bob reported the gain of $285,000 and because he had owned it over 6 years, he paid zero tax. Now Bob is looking at of $15,105 ($285,000 x 5.3%=$15,105).
Next week, I’ll talk about a few pending Bills in the legislature that could eliminate these back taxes as well as the interest and penalties associated with these back taxes. There is also a Bill that would change the effective date of the tax increase from January 1, 2002 to January 1, 2003. This means that instead of getting a bill for past due income taxes, many will be entitled to a refund based upon long-term capital gains reported from May 1, 2002 to December 31, 2002. I’ll also give you an update on upcoming hearings that are being held by the legislature on several Bills that affect the elderly.
This article gives general information and not specific advice on individual matters. Persons wanting individualized advice on matters discussed should contact an advisor experienced in those matters. To the extent this article provides information on legal matters, it is based on law in effect in Massachusetts on the date of posting (laws in effect in other states are often quite different).
Ronald H. Surabian is a CPA and attorney who works at the Elder Law Center in Saugus, Massachusetts. He also holds masters in accounting and a masters in tax law. He currently serves on the board of directors of the Massachusetts Chapter of the National Academy of Elder Law Attorneys. If you have any questions please call me at the Elder Law Center, One Essex Street, Saugus, MA 01906 (781)233-4444. To view this or any prior article, please visit our web site at www.elderlawcenter.org