Massachusetts imposes a corporate tax at a rate of 3% -
4.5% on taxable income of S corporations such as XYZ with more than $6
million of gross receipts. Under Massachusetts regulations, a
Massachusetts Business Trust (or corporate trust) that is an S
corporation for federal income tax purposes does not qualify for
treatment as an S corporation in Massachusetts and is, therefore, not
subject to the special Massachusetts tax on large corporations.
Instead, an MBT is subject to tax at the entity level as an individual
under the provisions of M.G.L. c 62, §8.
Under prior law, the Massachusetts personal income tax
relied on the definitions found in the 1986 Internal Revenue Code.
However, for the limited purpose of defining S corporations and
characterizing income as S corporation income, the Massachusetts
corporation regulations adopt the current Code. Massachusetts recently
incorporated into the Massachusetts personal income tax law the Code
as amended and in effect on January 1, 1998. As a result of this Code
update, Massachusetts has adopted many of the Federal tax law changes
that have been enacted by Congress in the past ten years.
Under recent federal tax law changes, S corporations are
allowed to own qualified subchapter S subsidiaries ("Q-Subs"). The
Q-Sub must be wholly owned by the S corporation parent and the parent
must elect Q-Sub treatment for its subsidiary. For Federal tax
purposes, the Q-Sub is not treated as a separate corporation. All of
the Q-Sub's assets, liabilities and items of income, deductions and
credits are treated as those of the S corporation parent. These items
then flow through to the shareholders. A subsidiary corporation that
meets the expanded definition of an S corporation for Federal tax
purposes will be eligible for S corporation treatment in Massachusetts
if it is otherwise eligible for such treatment under the S
In Massachusetts Technical Information Release (TIR
97-6), Massachusetts attempted to explain how the Federal tax law
changes affect eligibility for S corporation treatment under the
Massachusetts personal income and corporate excise tax statutes.
Because Massachusetts law makes no specific provision for a Q-Sub, the
DOR will look to the Internal Revenue Code to determine how the Q-Sub
is to be taxed. There is no provision in the Massachusetts corporate
excise statute that allows the Commissioner to disregard the existence
of a Q-Sub that falls within the definition of a foreign or domestic
corporation under M.G.L. c. 63, §30. The TIR indicated that a Federal S
corporation with a Q-Sub will be subject to the principals of the
corporate excise statute in the S corporation regulations.
It appeared, although not clear from the 1997 TIR, that
a Federal S corporation which is a Massachusetts Business Trust with a
wholly-owned Q-Sub would be subject to Massachusetts taxation as
The Q-Sub (subsidiary) would not itself subject to the
net income measure of the corporate excise since all of its income is
treated as that of the parent under the Code. The Q-Sub must file a
corporate excise tax return to report any corporate excise tax
attributed to its tangible property or taxable net worth and the
minimum corporate excise.
The Massachusetts Business Trust (parent) would report
all of the income of the Q-Sub and pay the tax at individual rates.
The MBT will be taxed at 5.95% for operating income, 5% for capital
gains, and 12% for dividends, but it would not be subject to the net
income measure of the S corporation tax. The special 3% - 4.5% tax on
large S corporations would not apply.
In Massachusetts Technical Information Release (TIR
99-17), issued on November 30, 1999, Massachusetts confirmed the above
analysis and ruled that the Q-Sub would not be subject to the net
income measure of the corporate excise since all of its income is
treated as that of the parent under the Code. The MBT will report all
of the income of the Q-Sub and pay the tax at individual rates. The MBT
will not be subject to the net income measure of the S corporation
To effectuate a restructuring of XYZ, the
corporation=s shareholders would organize a new entity, e.g., XYZ
Associates Trust ("XYZ Trust"), as a Massachusetts Business Trust. XYZ
Trust would elect treatment as an S corporation for Federal income
tax purposes. After creating XYZ Trust, the shareholders of XYZ would
then transfer their S corporation stock into XYZ Trust in exchange for
shares of stock representing the beneficial interest of XYZ Trust. XYZ
Associates Trust would then make an election to treat XYZ as its own
Q-Sub. Assuming a valid business purpose, the federal tax law will
recognize this transaction as a tax-free reorganization. For corporate
law purposes, the business continues to be operated out of XYZ, just
as before. XYZ Trust would file its own S election, file a Q-Sub
election, and file a "check the box" election to ensure classification
as a corporate entity.
Among the potential negative aspects of the plan are the
unavailability of Massachusetts tax losses to the shareholders of the
corporation (NOL's do not carry forward in a Business Trust), and the
possibility that out of state shareholders will be adversely affected
by the entity level tax in Massachusetts. The traditional aspects of
corporate law governing the relationship of officers, directors, and
shareholders would now be governed by the law applicable to
Massachusetts corporate trusts.