On Jan. 3, Massachusetts amended regulations 830 CMR 62.5A.1(6) and 830 CMR 62.5A.1(11) to clarify the proper apportionment for pass-through entities for tax years beginning on or after Jan. 1, 2025. The apportionment amendment comes on the heels of H.B. 5077, which was enacted on Dec. 4, 2024 to provide an alternative methodology for companies with no sales factor or one which is “inapplicable.” Also, certain individual income tax exemptions from joint filings for married couples took effect for tax years beginning on or after Jan. 1, 2024.  

Background

In 2023, Massachussetts enacted a tax relief package that changed state apportionment rules from a three factor formula including property and payroll to a single sales factor effective for tax years beginning on or after Jan. 1, 2025. These rules were intended to apply to corporations and pass-through entities, but the application to pass-through entities was not explicit and began to raise questions amongst both taxpayers and practitioners. Thus, Massachusetts began its string of clarifying amendments.

H.B. 5077: Alternative apportionment

Pursuant to H.B. 5077, companies with an “inapplicable” sales factor are required to use property and payroll for apportioning income. A sales factor is “inapplicable” when:

• Both its numerator and denominator are zero;
• The denominator is less than 10% of one third (3.33%) of taxable net income; or
• It is otherwise determined by the Department of Revenue (Department) to be insignificant in producing income.

A sales factor with a zero numerator is not necessarily “inapplicable”; both the numerator and denominator need to be zero to automatically be “inapplicable”. If a sales factor with a zero numerator also meets the one-third test or is insignificant in producing income, then it could be deemed “inapplicable” and the alternative apportionment required. The Department recently amended the above-mentioned regulations clarifying the apportionment method for taxpayers with an “inapplicable” sales factor.

Pass-through entity apportionment – Single sales factor

Another amendment under these regulations clarifies that pass-through entities are, in fact, subject to the single sales factor rules. Based on this clarification, all multi-state pass-through entities and corporations are required to use single sales factor apportionment, unless the “inapplicable” rules under H.B. 5077 apply as discussed above. 

Taxpayers and practitioners should consider this change when filing quarterly estimates.

Individual returns – Exemptions for couples filing federal joint returns 

Effective for tax years beginning on or after Jan. 1, 2024, married individuals who file a federal joint federal return are required to file a Massachusetts joint return. The intent of the rule is to prevent federal joint filers from avoiding the $1 million surtax. However, the recent rule amendment provides certain exceptions that may be beneficial to clients, especially those subject to the surtax:

1. The married individuals' tax years do not begin on the same day;
2. The married individuals' tax years do not end on the same day except where such tax years end on different days solely because of the death of either or both;
3. Either married individual is not required to file a return according to G.L. c. 62C, §6(a) (generally, Massachusetts source income is less than $8,000); or
4. One or both married individuals is a nonresident and has items of income, exemptions or deductions unrelated to their Massachusetts income, and:

• If only one of the married individuals is a nonresident, the sum of the resident married individual's Massachusetts gross income and the nonresident married individual’s Massachusetts source income does not exceed the threshold in G.L. c. 62, §4(d) (generally, $1 million); or
• If both of the married individuals are nonresidents, the married individuals’ combined Massachusetts source income does not exceed the threshold in G.L. c. 62, §4(d) (generally, $1 million).

These exemptions are effective for tax years beginning on or after Jan. 1, 2024; therefore, taxpayers and practitioners should consider the various filing options before remitting extensions. Note that if married individuals do not file a joint return, each individual should assess their own Massachusetts reporting obligations pursuant to these amended regulations and file accordingly.

What does CohnReznick think?

The shift to a single sales factor apportionment formula will have a significant impact on many taxpayers. Both pass-through entities and corporations need to be cognizant of these apportionment changes as they file tax year 2025 estimates. Taxpayers and tax practioners should review the recently amended regulations providing guidance for alternative apportionment. Proper determination of the proper in-state sales factor is even more important now that it has become the sole methodology in apportioning income for Massachusetts tax purposes without the inclusion of payroll or property unless the new “inapplicable” sales factor rules apply. A revenue sourcing study for business entities may be worthwhile in light of these apportionment changes.

Married couples have a unique opportunity to mitigate the $1 million surcharge for state income tax purposes; however, the exemptions are extremely fact sensitive. They should consult their tax advisors before filing their 2024 federal or Massachusetts extensions to determine if any of these exemptions would be beneficial.