Report says millions from new tax on high earners could be lost to loophole 

STATE BUDGET-WRITERS have begun planning to spend $1 billion in new revenue to fund education and transportation needs thanks to the so-called “millionaires tax” approved last year by voters. But a new report says Massachusetts could lose out on anywhere from $200 million to $600 million from the new tax on high earners unless legislators close a loophole in state tax law. 

The analysis from the left-leaning Massachusetts Budget and Policy Center said high-earning married couples could skirt the new tax by filing separate state tax returns, while still reaping the tax benefits that come from filing a joint return for federal taxes. 

The new state tax, also known as the “Fair Share Amendment” and approved narrowly by voters in November, imposes a 4 percent surcharge on all income over $1 million. But because the same $1 million threshold applies to both individual and joint filers, couples with combined income over $1 million might be able to avoid the surcharge by filing separate state tax returns.  

“Voters chose to make our tax system more fair, and nobody was expecting that there would be a backdoor loophole to reverse a significant part of that change,” said Phineas Baxandall, the policy director at MassBudget and author of the report. 

Unlike many other states, Massachusetts does not require married couples to file their state income tax returns consistently with their federal returns. That means a couple with a combined income of $2 million could file together federally, which usually confers clear tax advantages, but then file separate state tax returns. If they each earned $1 million they would avoid the new tax entirely. 

The MassBudget report says the state’s lack of a consistent filing requirement raises more than just the risk of legal tax avoidance. It says the situation could encourage illegal tax evasion by couples who not only file separate state tax returns but misreport the distribution of their income between the two filers in order to keep each return below or as close to $1 million as possible. 

The recent “consensus revenue” forecast issued by state leaders anticipates spending $1 billion in revenue from the new surcharge in fiscal year 2024, which begins in July, though the new levy may bring in even more, according to the Executive Office for Administration and Finance. State leaders are confident that there will be at least $1 billion in new surtax revenue, though their projection did not explicitly address the possibility of high earning couples switching their filing status to avoid the tax. The total revenue forecast for the coming fiscal year was $40.4 billion, which forms the basis for agreement on a state budget. 

MassBudget’s analysis of tax data, done with the Washington, DC-based Institute on Taxation and Economic Policy, concludes that the filing loophole could reduce revenue from the millionaires tax by up to one-fifth, or $200 million, based on the more conservative estimate of $1 billion generated by the tax. Based on other estimates projecting much higher potential revenue from the millionaires tax, the report said the amount lost to the tax filing loophole could be as great as $600 million. 

Law firms advising high earners are already jumping on the issue, with online guides from Ropes & Gray and Morgan Lewis recommending that married spouses file separate income tax returns.

“Filing separately could effectively shelter an additional $1 million and would not require the couple to file separately for federal income tax purposes,” reads a post on Morgan Lewis’s website. As a caveat, the post adds: “Note that this will work currently, but the legislature could change the law to close this loophole.”

Some members of the Legislature are looking to do just that. 

Lewis also filed two other bills that would ensure that revenue from the Fair Share Amendment would be kept in a separate trust and be marked exclusively for the transportation and education purposes listed on the ballot measure. In a recent MassINC Polling Group survey, two-thirds of voters said the income surtax proceeds should flow into a trust fund specifically for education and transportation.  

Lewis said he is “optimistic” about the chances for all three bills.