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Massachusetts’s TCJA Guidance Stirs State Constitutional Question

Posted on Aug. 13, 2019

A Massachusetts technical release on the reporting of deemed repatriated income has raised the question whether some guidance puts the state on shaky constitutional grounds.

An August 8 technical information release (TIR 19-11), which replaces previous guidance, outlines the impact of the fiscal 2018 and fiscal 2019 supplemental budgets on the tax treatment and reporting of deemed repatriated income and global intangible low-taxed income under the Tax Cuts and Jobs Act.

TIR 19-11 explains that former Massachusetts guidance on reporting deemed repatriation income cited a federal statement — IRC 965 Transition Tax Statement — used for reporting deemed repatriated income for the 2017 tax year. However, the state Department of Revenue learned that the section 965 statement did not offer express guidance on reporting the foreign tax credit gross-up associated with deemed repatriated income, which may have led to varying reporting methods by taxpayers.

“For 2017 and 2018 tax years, Massachusetts gross income includes both (i) deemed repatriated income determined under code section 965 and (ii) the code section 78 gross-up associated with such deemed repatriated income,” the release states. “Taxpayers that have filed returns for 2017 or 2018 and have not included such code section 78 gross-up amounts should amend those returns.”

Sebastian Watt, a Philadelphia-based associate with Reed Smith LLP, explained that most states don’t tax the section 78 gross-up because it is “a deemed inclusion solely for the computation of the federal foreign tax credit.” A Reed Smith client alert released in April advised that for taxpayers electing to claim an FTC, their federal gross income must include the amount of foreign taxes paid on subpart F income, deemed repatriated income, or GILTI. This FTC gross-up is a “fictional inclusion” that is “required solely to calculate the federal limitation on the foreign tax credit,” according to the alert.

“By statute Massachusetts gross income is tied to federal gross income,” a DOR spokesperson told Tax Notes August 12. “Because the section 78 gross-up amount is included in federal gross income, it is also included in Massachusetts gross income.”

Deemed repatriated income and GILTI are treated as dividend income under chapter 63 of Massachusetts’s general laws, according to TIR 19-11, which notes that both are eligible for the state’s 95 percent dividends received deduction. The related FTC gross-up amount is likewise treated as dividend income and eligible for the 95 percent dividends received deduction, according to the technical information release, which cites the Massachusetts Supreme Judicial Court’s 1979 decision in Dow Chemical Co. v. Commissioner of Revenue.

However, Watt indicated that Massachusetts’s taxation of the remaining 5 percent of the gross-up could present a constitutional issue.

“Massachusetts may be on shaky constitutional grounds taxing the gross-up because it arguably isn’t ‘income’ the state’s allowed to tax under its constitution,” Watt told Tax Notes .

The Reed Smith client alert said the Massachusetts Supreme Judicial Court has interpreted article 44 of the Massachusetts Constitution, which authorizes lawmakers to “impose and levy a tax on income,” as restraining the state’s taxing authority. In its 2000 decision in Bill DeLuca Enterprises Inc v. Commissioner of Revenue, the court observed that “income as a subject of taxation imports an actual gain.”

“Because the gross-up is not actual income earned by a foreign corporation and is included in federal taxable income solely for the purpose of computing the federal tax credit, the gross-up arguably does not import ‘an actual gain’ that can be taxed by the Commonwealth,” according to the client alert.

However, it’s difficult to predict whether the issue could spark litigation, according to Watt. He noted that “the inclusion may be immaterial for most taxpayers after applying the 95 percent [dividends received deduction] and Massachusetts apportionment.”

'No Surprises' for Corporate Taxpayers

TIR 19-11 overall doesn’t stray much from earlier draft guidance.

“TIR 19-11 finalizes the Department of Revenue’s position on the Massachusetts treatment of several international provisions of the Tax Cuts and Jobs Act following supplemental budget bills,” Richard Call, a Boston-based partner with McDermott Will & Emery, told Tax Notes . “For corporate taxpayers, there are no surprises. There are no changes from prior drafts of the TIR.”

TIR 19-11 provides that deemed repatriated income and GILTI are not included in the apportionment factors of a business corporation or financial institution. The guidance explains that under Massachusetts’s general laws, section 38 of chapter 63, the sales factor of a business corporation carves out “interest, dividends and gross receipts from the maturity, redemption, sale, exchange or other disposition of securities.” Section 2A, as amended under the 2018 supplemental budget, also excludes from a financial institution’s receipts factor those “amounts included in federal gross income pursuant to code sections 951 and 951A.”

Call noted that the DOR made “wording changes” to clarify its position regarding passthrough entities for personal income tax purposes.

“An individual, including an individual that is a member of passthrough entity, with deemed repatriated income for tax years 2017 and 2018 is required to include such amounts (including any code section 78 gross-up associated with such income) in his/her Massachusetts income for the tax year ending on December 31, 2019,” according to the technical information release. The release's guidance on GILTI reporting for the tax year ending in December 2018 also includes the phrase “an individual that is a member of a passthrough entity.” 

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