Massachusetts uses LLP structure to avoid MBT problems.

• Author: Lerman, Jerry L.
• Position: State & Local Taxes

Massachusetts currently imposes a corporate-level tax, known as a "sting tax," on large S corporations. As result, S corporations with over $6 million in gross receipts are subject to tax of 3%-4.5% on taxable income, calculated as if the S corporation were a C corporation. This tax is in addition to the income tax due on each of the S shareholders' respective share of the corporation's income.

Many practitioners believe that this is an unfair burden and have developed strategies to avoid this entity-level tax, including the use of a Massachusetts Business Trust (MBT). However, over the last few years, they have discovered several problems with this structure.

Background

Letter Ruling 99-17, issued by the Massachusetts Department of Revenue (DOR), approved a reorganization in which an S corporation would be classified as a qualified subchapter S subsidiary (QSub) and would be a wholly owned MBT. According to the ruling, the reorganization would occur when the S shareholders formed an MBT, which would then elect S status. Although MBTs are S corporations for Federal tax purposes, they remain corporate trusts for Massachusetts purposes, and are not subject to the sting tax, but only to the favorable individual rate of 5.3%.

In the ruling, the operating corporation's shareholders would exchange their S stock for that of the MBT, which is an F reorganization. The operating S corporation would then make a QSub election. For Federal income tax purposes, this structure collapses into one entity, filing as an S corporation. However, it is two separate entities for state income tax purposes.

How MBT Taxation Works

An MBT is taxed as if it were a resident individual; in general, no state tax will be due on trust distributions to the extent they were previously taxed at the trust level. An MBT is not subject to any corporate-level tax. The existing operating S corporation continues to pay a corporate-level excise tax on the greater of the property measure of the corporate franchise of $2.60 per $1,000, or a $456 minimum. Thus, this type of reorganization eliminates the tax on large S corporations at the state level, while preserving the flowthrough nature of S corporations at the Federal level.

Problems with MBTs

Although the MBT structure has gained popularity over the last few years, it has several disadvantages. One involves out-of-state shareholders. A shareholder who is not a Massachusetts...