Reforming Massachusetts Corporate Excise Tax for S Corporations

Massachusetts policymakers should reform the Commonwealth’s corporate excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. to make it a simpler, more neutral revenue tool conducive to better economic growth. In our previous blog post, we looked at three provisions of the corporate excise taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. that impact C corporations and recommended that Massachusetts adopt a consistent corporate apportionmentApportionment is the determination of the percentage of a business’ profits subject to a given jurisdiction’s corporate income or other business taxes. U.S. states apportion business profits based on some combination of the percentage of company property, payroll, and sales located within their borders. formula, cap, or eliminate the capital stock tax, and eliminate the counterproductive throw-back rule. This blog post will address ways to make the corporate excise tax simpler and more neutral for S corps, which are also subject to the corporate excise tax.

Massachusetts’ corporate code should be cleaned up for S corporations by fixing the structure and rate schedule for the “stinger” tax Massachusetts levies on S corps. The stinger tax is an extra income tax that is layered on top of the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. and is paid only by S corporationAn S corporation is a business entity which elects to pass business income and losses through to its shareholders. The shareholders are then responsible for paying individual income taxes on this income. Unlike subchapter C corporations, an S corporation (S corp) is not subject to the corporate income tax (CIT). owners. In addition, the competitiveness and economic justification for having a stinger tax should be rethought given how rare it is for a state to impose such a tax. The tax code can also be made more neutral and competitive for S corporations by repealing or capping the Commonwealth’s capital stock tax, the same as we recommended in our previous blog post on C corporations.

Massachusetts’ corporate code creates an extra tax liability for S corporations that is unique compared to other states. S corporations are pass-through entities for tax purposes, and at the federal level and in the vast majority of states S corp owners are liable only to pay individual income tax on their share of earnings. For Massachusetts taxpayers (and S corp owners), the individual income tax rate is a flat rate of 5 percent. Massachusetts has an additional tax on S corp owners which ranges from 0 percent to 3.9 percent, depending on the industry of the business and its total revenues.

The detail on the S corporation rate structure is thus:

• 0 percent on net income subject to tax for S corporations with less than $6 million in revenue;
• 1.93 percent on net income subject to tax if total receipts are $6 million-$9 million; and
• 2.9 percent on net income subject to tax if receipts are $9 million or more.

For financial institutions that are S corporations, the rates are:

• 0 percent on net income subject to tax for S corporations with less than $6 million in revenue;
• 2.6 percent on net income subject to tax if total receipts are $6 million-$9 million; and
• 3.9 percent on net income subject to tax if receipts are $9 million or more.

This rate structure is nonneutral between industries, uncompetitive with other states, and based on business revenue triggers with little economic justification. Furthermore, it creates tax cliffs at $6 million and $9 million of business revenue. Once companies hit those revenue thresholds, they have a new tax that kicks in and is imposed on all previous income. Massachusetts would be better off with a single flat rate on all S corporation income regardless of industry or revenue level. Under current law, Massachusetts is almost certainly taxing some businesses with less profits at a higher rate than other businesses that generate more profits. Consider the following examples:

Business A has $5.5 million in receipts and 25 percent profit margins. Business A thus earns $1.375 million profit, on which it pays no corporate excise tax=$0 corporate excise tax liability.

Business B has $7.5 million in receipts and 15 percent profit margins. Business B thus earns $1.125 million profit, on which it pays a 1.93 percent corporate excise tax rate=$21,712.5 corporate excise tax liability.

Business C is a financial institution and has $12 million in receipts with 5 percent profit margins. Business B thus earns $600,000 profit, on which it pays a 3.9 percent corporate excise tax rate=$23,400 corporate excise tax liability.

This potential outcome makes little sense, but it is the product of a nonneutral tax code that discriminates between businesses based upon revenue levels and industrial classification rather than simply taxing all profits evenly.

Massachusetts lawmakers should rethink the wisdom of having this surcharge on S corporation income. While it is designed to bring the Commonwealth’s S corp rate approximately in line with the C corp rate, there is little economic justification for doing this given that C corps face different levels of taxation (entity level and personal level). And it leaves Massachusetts’ S corp tax code uncompetitive with other states, which generally avoid a similar surcharge. If Massachusetts is to maintain the additional tax, it should be at a flat rate on all S corp profits instead of varying rates based on total revenues and industrial classification.

Finally, Massachusetts’ capital stock tax is a disincentive for S corps to invest in the state, the same as it is for C corporations. Massachusetts should reduce, cap, or eliminate its anachronistic capital stock tax, which incentivizes profit-stripping over reinvestment in the Commonwealth and is particularly burdensome for smaller businesses and those with significant assets in-state but low profits. Of all the states that are not in the process of repealing their capital stock tax, Massachusetts has the third-highest rate (0.26 percent), behind Arkansas and Louisiana (0.3 percent each).

State Capital Stock Tax Rates, As of January 1, 2020

(a) Taxpayer pays the greater of corporate income tax or capital stock tax liability. (b) The tax will be phased out from 2021 to 2026. (c) Based on a fixed dollar payment schedule. Effective tax rates decrease as taxable capital increases. (d) The tax will be phased out from 2020 to 2024. (e) The rate is 0.15% for the first $300,000 of taxable capital. (f) Tax will be fully phased out before 2028. (g) Tax is being phased out; liability limited to liability in tax year ending Dec. 31, 2010. Note: Capital stock taxes are levied on net assets of a company or its market capitalization. Sources: State statutes; Bloomberg Tax.
State	Tax Rate	Max Payment
Alabama	0.18%	$15,000
Arkansas	0.30%	Unlimited
Connecticut (a, b)	0.34%	$1,000,000
Delaware	0.04%	$200,000
Georgia	(c)	$5,000
Illinois (d)	0.10%	$2,000,000
Louisiana (e)	0.30%	Unlimited
Massachusetts	0.26%	Unlimited
Mississippi (f)	0.23%	Unlimited
Nebraska	(c)	$11,995
New York (a,g)	0.05%	$5,000,000
North Carolina	0.15%	Unlimited
Oklahoma	0.13%	$20,000
South Carolina	0.10%	Unlimited
Tennessee	0.25%	Unlimited
Wyoming	0.02%	Unlimited

Massachusetts’ corporate excise tax should be redesigned to make it more efficient, streamlined, and conducive to economic growth. Along with reform to the tax provisions that affect C corporations, the Commonwealth should restructure the additional income tax levied on S corporations and reduce, cap, or eliminate its capital stock tax.

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