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state tax notes™
Spring Cleaning for the Massachusetts
Legislature and the DOR
by Matthew A. Morris
Matthew A. Morris is a partner
at Kerstein, Coren & Lichtenstein
LLP, Wellesley, Massachusetts. His
practice areas include federal and
state tax controversy resolution,
representation in federal and state
voluntary disclosure programs,
state sales and use tax controversies, tax planning, and estate planning. He can be reached at mmorris
@kcl-law.com.
Matthew A. Morris
In this article, Morris examines three problematic issues
— lien subordination, discharge of indebtedness income
relating to the sale of a principal residence, and the lack of
guidance on passive foreign investment company income for
individual taxpayers — that the Massachusetts legislature
and Department of Revenue should review and possibly
improve in 2015.
Now that their long winter1 has ended, many Massachusetts residents will begin their spring cleaning. Windows
latched tight since late November will be opened, and the
fresh air that follows will provide new energy to resume
long-neglected projects. What was accepted as commonplace during the stagnant winter months will now be subject
to closer inspection to identify what should be repaired,
discarded, or replaced.
The same should be true this spring for the Massachusetts
Department of Revenue and the Massachusetts legislature.
After the conclusion of tax season on April 15, the legislature
and the DOR should review tax laws and regulations to determine (1) whether each law or regulation is in proper working order, (2) what would be required to repair and perhaps
improve laws and regulations that are not working properly,
and (3) whether new laws and regulations are required. Massachusetts needs to clean house, especially regarding those tax
laws and regulations that diverge from their federal counterparts without principled explanations for doing so.
1
See, e.g., Alan Taylor, ‘‘What Record-Breaking Snow Really Looks
Like,’’ The Atlantic Photo, Feb. 17, 2015.
State Tax Notes, April 6, 2015
This article describes three problematic items the legislature and the DOR should review carefully in its statutory and
regulatory spring cleaning. The list is not intended to be
comprehensive or exclusive. However, the three items should
provide the legislature and the DOR with a productive starting point. The first two items (lien subordination and discharge of indebtedness regarding a sale of a principal residence) relate to unprincipled inconsistencies between
Massachusetts and federal income tax laws; the third problematic item, passive foreign investment company income,
regards an issue on which Massachusetts laws and regulations
are silent.
Problematic Item No. 1: Lien Subordination
The Massachusetts lien subordination regulation (830
CMR 62C.50.1(7)) is problematic because it does not allow
the DOR to subordinate its interest to the interest of a junior
creditor even if that subordination will facilitate collection of
the underlying tax liability. Subordination is typically defined as the process by which a priority creditor will subordinate its interest in the debtor’s property to allow the debtor
to obtain new financing from a new lender who requires a
superior position to make the loan. The Internal Revenue
Manual defines subordination as ‘‘the process of allowing a
junior creditor a position ahead of the Service lien regarding
any part of property subject to the Federal tax lien.’’2 Whereas
the Internal Revenue Code, on which the DOR lien subordination regulations are based, allows the IRS to subordinate
its interest if the amount of the subordinated interest is paid
to the IRS in full or if subordination will facilitate collection
of the tax liability, the DOR regulations state that lien subordination is only available when the DOR has been paid an
amount equal to the subordinated interest. Although payment of the subordinated interest to the DOR should be
required in a mortgage or refinance transaction, the DOR
should also be able to subordinate its interest without full
payment to facilitate collection of the tax liability.
The Massachusetts lien subordination regulation states:
In appropriate circumstances, the Commissioner may
certify that the tax lien as to some part of the property
2
IRM section 5.12.10.6(1): Subordination of Lien.
63
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SPECIAL REPORT
Special Report
The Massachusetts regulation is based on IRC section
6325(d), which states that the secretary ‘‘may issue a certificate of subordination of any lien imposed by this chapter
upon any part of the property subject to such lien if (1) there
is paid over to the Secretary an amount equal to the amount
of the lien or interest to which the certificate subordinates
the lien of the United States.’’ Similarly, section 6325 regulations state that a lien may be subordinated on the grounds
of full payment under section 6325(d)(1) ‘‘if a notice of
Federal tax lien is filed and a delinquent taxpayer secures a
mortgage loan . . . and pays over the proceeds of the loan to
the appropriate official after an application for a certificate
of subordination is approved.’’4
Under existing IRS regulations, however, full payment of
the proceeds of the loan is not required when the proceeds of
the loan are required to maximize the collection potential
from the taxpayer.5 IRC section 6325(d) contains two additional grounds for granting a certificate of subordination
that are not referenced in the Massachusetts regulation:
(2) the Secretary believes that the amount realizable by
the United States from the property to which the
certificate relates, or from any other property subject
to the lien, will ultimately be increased by reason of
the issuance of such certificate and that the ultimate
collection of the tax liability will be facilitated by such
subordination, or
(3) for any lien imposed by section 6324B [relating to
estate taxes], if the Secretary determines that the
United States will be adequately secured after such
subordination.
In contrast to IRS regulations, Massachusetts regulations
only permit subordination when the amount of the subordinated interest is paid in full or when full payment is placed
in an escrow account. Although the DOR’s regulatory requirement for full payment of the liability makes sense in
the context of a mortgage or refinancing transaction for an
individual taxpayer, it does not make sense in a revolving
credit arrangement in which a lender extends financing to a
business taxpayer on the basis of new accounts receivable. If
the taxpayer is a business that relies on a revolving line of
credit as a source of working capital to keep the business
3
830 CMR 62C.50.1(7).
26 CFR section 401.6325-1(d)(1).
5
26 CFR section 401.6325-(1)(d)(2).
4
64
operating, requiring full payment of the subordinated lien
would jeopardize ongoing business operations as well as
further collections.
Massachusetts state courts do not appear to have addressed that issue directly,6 but the U.S. Tax Court in Alessio
Azzari Inc. v. Commissioner7 stated that a lender of a revolving line of credit does not stand in a priority position
regarding accounts receivable acquired more than 45 days
after the IRS filed its notice of federal tax lien, because the
lender’s interest in those receivables cannot be perfected
until the services giving rise to those receivables have been
rendered. Similarly, the accounts receivable in which the
creditor holds a security interest might have priority over the
DOR’s tax lien only to the extent that those accounts
receivable existed before the DOR’s lien filing. Thus, the
new accounts receivable generated after the DOR lien filing
date could be construed as new collateral for new financing,
in which case the DOR would have a priority position over
the revolving creditor.
The limited Massachusetts guidance regarding subordination of state tax liens focuses on mortgage or refinancing
transactions rather than revolving lines of credit. For example, in ‘‘Betterments and Liens: Assessment and Collection Issues,’’ the Massachusetts DOR, Division of Local
Services, presents a case study in which a valid lien was filed
against a homeowner who ‘‘wants to refinance his mortgage
and the potential lender has requested the town to subordinate its lien to the mortgage.’’8 Further, the DOR instructions titled ‘‘Request for Partial Release of Lien, Certificate
of Subordination’’ require a ‘‘Closing Attorney’s statement
listing the distribution of funds available from the sale of the
property or the refinance of the mortgage.’’9 There is no
discussion in the DOR guidance regarding the circumstances in which the DOR would be entitled to subordinate
its lien other than those circumstances in which the DOR is
paid in full the amount of the subordinated interest in a
mortgage or refinancing transaction.
Although Massachusetts reg. section 830 CMR
62C.50.1(7) does not mention facilitation of tax liability as
grounds for lien subordination, it does allow for a consideration of that factor in the context of a lien release: ‘‘The
Commissioner may issue a release of lien as to a part of the
property subject to a tax lien, provided that the Commissioner is satisfied that such partial release will facilitate the
collection of the outstanding tax liability.’’ A lien release is a
6
But see Tremont Tower Condo. LLC v. George B.H. Macomber Co.,
436 Mass. 677, 678 (2002) (lenders for a construction project in
downtown Boston refused to fund applications for loan advances until
the holder of a mechanic’s lien ‘‘executed a partial waiver and subordination of lien each month’’).
7
136 T.C. 9 (2011).
8
Massachusetts DOR, ‘‘Betterments and Liens: Assessment and
Collection Issues,’’ Workshop A, Case Study 9, at 12.
9
These instructions cannot be cited because they are taxpayerspecific and are unavailable in a generic format on the DOR website.
State Tax Notes, April 6, 2015
(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
subject to the tax lien is subordinate to a lien or
interest held by another party, if there is paid to the
Commissioner an amount equal to the amount of the
lien or interest to which the tax lien is made subordinate. If the certificate of subordination is to be issued
before such amount is paid over to the Commissioner,
a separate escrow account must be established in full
amount, to secure the tax lien.3
Special Report
The DOR’s administrative guidance supports the ‘‘administrative oversight’’ theory by offering conflicting interpretations of the requirements for lien subordination. DOR
Administrative Procedure 631 titled ‘‘The Collection Process’’ states that ‘‘a taxpayer may find that he or she can pay
a tax in full or in part only if the Department either partially
releases a lien or allows another lien holder to have priority
over DOR’s lien.’’10 Further, DOR instructions titled ‘‘Request for Partial Release of Lien, Certificate of Subordination’’ state that the ‘‘Commissioner may issue a release of a
lien as to a part of the property subject to a Tax Lien or a
Certificate of Subordination provided that the Commissioner is satisfied that the issuance of such document will
facilitate the collection of the outstanding tax liability.’’11
That suggests that high-level DOR officials, who have presumably reviewed and approved the instructions, do not
construe the grounds of ‘‘facilitating collection of the tax
liability’’ as unique and exclusive to partial releases.
The IRM instructs its employees to exercise discretion
when determining whether to subordinate a federal tax lien:
The Service must exercise good judgment in weighing
the risks and deciding whether to subordinate the
federal tax lien. The Service’s judgment is similar to
the decision that an ordinarily prudent business person would make in deciding whether to subordinate
his/her rights in a debtor’s property in order to secure
additional long run benefits.12
Just as the IRS is expected to exercise the judgment of an
‘‘ordinarily prudent business person . . . in deciding
whether to subordinate his/her rights in the debtor’s property in order to secure additional long run benefits,’’ so
should the DOR. For a revolving line of credit or any other
type of financing arrangement, the DOR should be entitled
to subordinate its interest if the long-run benefits of the lien
subordination — which may keep the business alive,
thereby generating the capital required to pay the underlying liability in full over the next several years — justify the
subordination as a prudent business decision.
On the basis of the unprincipled inconsistencies between
federal law and DOR regulations discussed above, the DOR
should consider supplementing the existing lien subordination regulation with additional provisions that would allow
for subordination to assist collection of the tax liability. This
is not a situation in which the entire regulation would need
to be discarded and replaced in order to restore it to proper
working order. The DOR simply needs to add new language
to the existing regulation to clarify that the same standards
that apply to lien releases (payment in full or facilitating
collection of the tax liability) also apply to lien subordinations.
Problematic Item No. 2: Cancellation of Debt Income
Regarding the Sale of a Principal Residence
As the lien subordination issue discussed in the first part
illustrates, the DOR’s interpretation of Massachusetts tax
laws can lead to unfairness and uncertainty when the DOR
departs from federal guidance on the same tax issue without
a principled reason for doing so. The same is true for discharge of indebtedness, or cancellation of debt income
(CODI), incurred in connection with a principal residence.
While the IRS allows taxpayers to exclude CODI from gross
income, the DOR refuses to extend relief to those same taxpayers on the basis that the federal mortgage debt relief forgiveness provisions were enacted after January 1, 2005.
The abuses and excesses of the subprime mortgage market
in the late 2000s led to a sharp drop in home prices that left
many homeowners under water (that is, the amount of the
mortgage exceeded the fair market value of the property).13
When homeowners (or banks through foreclosures and short
sales) sold those underwater properties, the former homeowners were left in an impossible tax and financial situation:
Those individuals had not only lost their homes without
adequate funds to pay the outstanding mortgage in full, but
they were also responsible for reporting and paying income
tax on CODI incurred in connection with the bank’s writeoff of the outstanding mortgage balance after the property
was sold (usually in a foreclosure or short sale). In most cases,
the foreclosed or short-sold taxpayers did not have the resources to pay the income tax liability incurred in connection
with CODI. In response to this situation and the associated
income tax consequences for foreclosed and short-sold taxpayers, Congress enacted the Mortgage Forgiveness Debt
Relief Act (MFDRA) in December 2007.14
Specifically, the MFDRA allows taxpayers to exclude
CODI from gross income when CODI is incurred in connection with the taxpayer’s principal residence.15 The
13
10
AP 631.1.2: Partial Release of Lien and Subordination of Lien.
Supra note 9.
12
IRM section 5.17.2.8.6(4) (Dec. 14, 2007).
11
State Tax Notes, April 6, 2015
See John V. Duca, ‘‘Subprime Mortgage Crisis,’’ federalreserve
history.org, Nov. 2013 (‘‘Prices fell so much that it became hard for
troubled borrowers to sell their homes to fully pay off their mortgages
— even if they had provided a sizable down payment’’).
14
See Bloomberg BNA Tax Practice Series para. 1040.04.F.1.
15
Id.
65
(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
full waiver of the DOR’s interest in the underlying property,
whereas a lien subordination is a retention of the DOR’s
interest in the property as a lower-priority creditor; it therefore seems illogical and inconsistent for the DOR to make it
easier for a taxpayer to achieve a more complete, taxpayerfavorable remedy (release), but to make it more difficult for
a taxpayer to achieve a less complete, DOR-favorable remedy (subordination). That unprincipled inconsistency between lien releases and subordinations suggests that the
difference between federal and Massachusetts law is nothing
more than an administrative oversight.
Special Report
Massachusetts does not recognize the principal residence
debt forgiveness provisions of the MFDRA because the
MFDRA was enacted after January 1, 2005. DOR Technical Information Release (TIR) 13-2 states that ‘‘in general,
the Massachusetts personal income tax follows the provisions of the Internal Revenue Code . . . as amended on
January 1, 2005 and in effect for the taxable year, in determining Massachusetts gross income.’’19 That statement derives from the definitions of the terms ‘‘code’’ and ‘‘federal
gross income’’ set forth in Massachusetts General Laws,
Chapter 62, section 1:
When used in this chapter the following words or
terms shall, unless the context indicates otherwise,
have the following meanings:
(c) ‘‘Code,’’ the Internal Revenue Code of the United
States, as amended on January 1, 2005, and in effect
for the taxable year; but Code shall mean the Code as
amended and in effect for the taxable year for sections
62(a)(1), 72, 105, 106, 139C, 223, 274(m), 274(n),
401 through 420, inclusive, 457, 529, 530, 3401 and
3405 but excluding sections 402A and 408(q).
(d) ‘‘Federal gross income,’’ gross income as defined
under the Code.20
Because there appears to be no principled reason for
Massachusetts to tax CODI that the federal government
excludes, the legislature should add section 108 to the list of
sections for which the term ‘‘code’’ means ‘‘the Code as
amended and in effect for the taxable year.’’21 By adding
code section 108 to the list of sections in Mass. Gen. Laws
Chapter 62, section 1(c), the legislature will extend a significant income tax benefit to its constituents who may otherwise be forced to recognize CODI on the sale or foreclosure
of their underwater principal residences. That minor statutory addition will help restore the fairness and functionality
of Massachusetts laws regarding mortgage-related CODI
forgiveness.
Problematic Item No. 3: Guidance on PFIC Income
PFIC income is an exceedingly complicated concept at
the federal level, and is even more confusing at the state level.
Generally speaking, PFIC income is income derived from an
investment in a foreign corporation if (1) 75 percent or more
of that corporation’s income is passive income or (2) the
average percentage of assets held by the corporation during
the tax year which produce passive income or which are held
for the production of passive income is at least 50 percent.22
The classic example of PFIC income is interest, dividends,
and capital gains generated from a foreign mutual fund. It is
the IRS’s position that each foreign mutual fund is to be
treated as a separate PFIC for federal income tax purposes.23
For purposes of this article, we will focus on three different
reporting regimes for PFIC income: the default rules under
IRC section 1291, the qualified electing fund (QEF) election
under IRC section 1295, and the mark-to-market election
under IRC section 1296.
IRC section 1291 establishes the default rules for taxation of PFIC income.24 The basic default rules, which do
not require an affirmative election, comprise three distinct
requirements:
• Excess distributions will be allocated ratably to each
day in the taxpayer’s holding period for the stock.25
Excess distributions are defined as the amount of the
distributions received during the tax year over 125
percent of the average amount received in respect of
20
Mass. Gen. Laws c. 62, section 1 (emphasis supplied).
Id.
22
IRC section 1297(a).
23
See IRS LTR 200752029 (‘‘an unincorporated, open-ended, limited purpose trust’’ established under the laws of a non-U.S. jurisdiction, which was created for investment purposes and qualified as a
mutual fund trust under the laws of the jurisdiction in which it was
organized would be regarded as a foreign corporation for U.S. income
tax purposes).
24
See generally IRC section 1291.
25
IRC section 1291(a)(1)(A).
21
16
IRC section 108(a)(1)(e). H.R. 5771, which extended the CODI
relief provisions of the MFDRA to tax year 2014, was signed into law
by President Obama on December 19, 2014.
17
IRC section 163(h)(3)(B).
18
See IRS, ‘‘The Mortgage Forgiveness Debt Relief Act and Debt
Cancellation’’ (last updated Jan. 2015).
19
Massachusetts DOR, TIR 13-2: Massachusetts Tax Year 2013
Exclusion Amounts for Employer-Provided Parking, Transit Pass and
Commuter Highway Vehicle Benefits (Jan. 31, 2013).
66
State Tax Notes, April 6, 2015
(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
MFDRA’s new exclusion from the discharge of indebtedness
rules, IRC section 108(a)(1)(E), states that gross income does
not include any amount that would otherwise be includable
in gross income as discharge of indebtedness income if ‘‘the
indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2015.’’16
Qualified principal residence indebtedness is defined as ‘‘acquisition indebtedness’’ incurred in connection with the
principal residence of the taxpayer in an amount not to exceed $2 million. Acquisition indebtedness is defined in IRC
section 163(h)(3)(B) as ‘‘debt incurred in acquiring, constructing, or substantially improving the home and is secured
by the home.’’17 Thus, the proceeds of a first mortgage that
enable the homeowner to purchase or build the home and the
proceeds of a second mortgage that enable the homeowner to
substantially improve the home both fall under the definition of acquisition indebtedness. However, the proceeds of a
first or second mortgage used for any purpose other than
‘‘acquiring, constructing, or substantially improving’’ the
taxpayer’s principal residence will not qualify for the exclusion. The CODI relief provisions of the MFDRA (as extended by later federal legislation) apply to discharges after
January 1, 2007, and before January 1, 2015.18
Special Report
26
IRC section 1291(b)(2)(A).
IRC section 1291(a)(2).
28
IRC section 1291(a)(1)(B).
29
IRC section 1291(a)(1)(C).
30
IRC section 1291(c)(1).
31
IRC section 1291(c)(2).
32
See generally IRC sections 1293 and 1295.
33
All PFIC income, including PFIC income taxed under the section 1291 default rules, must be separately reported on Form 8621,
‘‘Information Return by a Shareholder of a Passive Foreign Investment
Company or Qualified Electing Fund.’’
34
See IRC section 1293(a)(1).
35
See CFR section 1.1295-1(g)(1) (‘‘For each year of the PFIC
ending in a taxable year of a shareholder to which the shareholder’s
section 1295 election applies, the PFIC must provide the shareholder
with a PFIC Annual Information Statement’’).
36
See generally IRC section 1294; CFR section 1.1294-1T.
27
State Tax Notes, April 6, 2015
marketable stock.37 The mark-to-market provisions of section 1296 require an affirmative election on Form 8621.38
Generally speaking, the mark-to-market rules enable PFIC
shareholders to include in gross income the difference between the FMV and the adjusted basis in the PFIC at the
end of the tax year. If the FMV of the PFIC at the end of the
year is greater than the adjusted basis, the taxpayer will
include the difference in gross income; if the FMV of the
PFIC at the end of the year is lower than the adjusted basis,
the taxpayer will be entitled to claim that amount as a loss to
the extent of mark-to-market gains reported in prior tax
years (referred to as unreversed inclusions).39
Chapter 62, section 2 of the Massachusetts General Laws
states that ‘‘Massachusetts gross income shall mean the
federal gross income, modified as required by section six F
[relating to the computation of Massachusetts capital gains],
with the following further modifications.’’ None of those
modifications, or any other section of the Massachusetts
General Laws, requires PFIC income to be added to or
subtracted from federal gross income for Massachusetts
income tax purposes. Although by law Massachusetts gross
income is based on federal gross income, PFIC income
presents two distinct problems for Massachusetts income
tax purposes: (1) PFIC income is not one of the specified
categories of income identified on the Massachusetts Form
1 and (2) PFIC income generated under the QEF and
mark-to-market elections might be subject to Massachusetts
income tax, whereas deferred PFIC gains under the default
section 1291 rules might not.
Unlike income tax forms for other jurisdictions,40 Massachusetts Form 1 does not use federal adjusted gross income as a starting point to which various state-specific
additions and subtractions are made. Instead, Form 1 requires taxpayers to report some types of income (for example, wages, taxable pensions and annuities, business/
profession, or farm income/loss) and uses a catchall
provision for other income in Schedule X. The Form 1
instructions state that Massachusetts gross income includes
‘‘any other income not specifically exempt,’’ and the Schedule X instructions state that ‘‘other Massachusetts 5.2 percent income reported on U.S. Form 1040, line 21 and not
reported elsewhere in Form 1’’ should be reported on line
37
See generally IRC section 1296. Generally speaking, marketable
stock is stock that is regularly traded on a national securities exchange
registered with the SEC or any exchange or other market for which the
IRS determines has adequate rules. See IRC section 1296(e)(1)(A).
Marketable stock is also ‘‘stock in any foreign corporation which is
comparable to a U.S. regulated investment company and which offers
for sale or has outstanding any stock of which it is the issuer and which
is redeemable at its net asset value’’ and any option on stock described
in (A) or (B) above. IRC section 1296(e)(1)(B) and (C).
38
Supra note 33.
39
IRC section 1296(a)(2)(B).
40
See, e.g., Missouri 2014 Form MO-1040.
67
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such stock during the three preceding tax years.26
When a PFIC is sold or otherwise disposed under the
default rules, any gain recognized on the disposition
will be treated as an excess distribution.27
• The taxpayer’s gross income for the year shall include
only the amount of the excess distributions allocable to
the current tax year and for pre-PFIC years.28 For most
taxpayers, this simply means that the taxpayer’s gross
income for the current tax year only includes the portion of the excess distribution attributable to that tax
year.
• The tax for the current tax year shall be increased by the
deferred tax amount,29 which includes a deferred interest charge.30 The deferred tax amount is computed
on the basis of the highest marginal rates applicable to
the prior years in the taxpayer’s holding period.31
IRC sections 1293 and 1295 set forth the requirements
for the QEF election.32 The QEF provisions of section 1293
require an affirmative election under section 1295, which
must be reported on Form 8621.33 The QEF election enables a PFIC shareholder to report his ratable share of the
PFIC’s ordinary income and net capital gains.34 The QEF
election is generally the most tax-favorable PFIC tax option
because it entitles shareholders to more favorable capital
gains rates on their ratable share of the PFIC’s net capital
gains. The shareholder’s ability to make a QEF election is
limited by the PFIC’s underlying transparency — in order
to make a QEF election, the PFIC must provide the shareholder with a PFIC annual information statement that
contains enough information for the shareholder to determine her pro rata share of the PFIC’s ordinary income and
net capital gains.35 Under IRC section 1294, PFIC shareholders who make a QEF election can also elect to defer
payment of income tax on the shareholder’s pro rata share of
the undistributed earnings of the PFIC until those earnings
are actually distributed to the shareholder or on the occurrence of other specified events.36
IRC section 1296 sets forth the requirements for the
mark-to-market election for PFIC income generated by
Special Report
The DOR and Massachusetts courts have been silent
regarding the taxation of PFIC income.44 The lack of guidance regarding the taxation of PFIC income in Massachusetts has resulted in too much uncertainty for taxpayers.
Without specific direction from the DOR, practitioners
have started to reach their own conclusions regarding state
taxability of PFIC income. Some taxpayers and practitioners might conclude that PFIC income (including PFIC
income from QEF and mark-to-market elections) is not
subject to Massachusetts income tax based on the fact that
PFIC income does not fall within one of the specified
categories of Massachusetts gross income.45 Other practitioners might report PFIC income as other income on Massa-
41
See 2014 Massachusetts Form 1: Resident Income Tax Return;
2014 Schedule X: Other Income; 2014 Form 1 Instructions at 17.
42
If a QEF election is made, the shareholder’s pro rata share of
ordinary income will likely be reported as other income on Form 1040,
line 21 (Schedule X, line 3 for Massachusetts income tax purposes), but
her pro rata share of net capital gains will be reported separately on
Schedule D of the Form 1040 (as well as Schedule D of the Massachusetts Form 1).
43
The same is true for taxpayers who have elected to use the
alternative mark-to-market resolution under the IRS offshore voluntary disclosure program. Because the alternative mark-to-market resolution (authorized by the Offshore Voluntary Disclosure Program
Frequently Asked Questions A10) computes PFIC gains (and losses)
under a flat 20 percent tax rate, the PFIC gains are not in federal gross
income, even though the tax and deferred interest on those gains is
added to the total tax for the year (‘‘Regular and Alternative Minimum
Tax are both to be computed without the PFIC dispositions or MTM
gains and losses’’). Therefore, OVDP participants may be able to avoid
Massachusetts income tax on PFIC income on their federal change
amended state returns by electing the alternative mark-to-market
resolution.
44
Searches for ‘‘passive foreign investment company’’ or ‘‘PFIC,’’
both on the DOR website and on LexisNexis for Massachusetts state
cases, produce zero results.
45
See, e.g., Philip S. Gross, ‘‘Tax Planning for Offshore Hedge
Funds — The Potential Benefits of Investing in a PFIC,’’ 21 J. Tax’n of
Inv. 2, Feb. 2004 (‘‘Many states base their taxable income on federal
taxable income and the PFIC income allocated to prior years would
not be includible in the federal taxable income base and hence may not
be includible in state taxable income. Also, some states may tax only
some types of income including dividend income but would not tax
other types of income such as PFIC income which would generally
flow through on the other income line, Line 21 of Form 1040’’).
68
chusetts Schedule X or on other sections of the Form 1.
Because the catchall provision of Schedule X captures all
income not specifically exempted, taxpayers and practitioners cannot be faulted for taking a cautious approach.
Further, those taxpayers who have made a QEF election
under section 1294 and an election to defer payment of tax
on the undistributed pro rata share of the PFIC’s earnings
under section 1293 might still be responsible for paying
current-year Massachusetts income tax on those earnings
because no deferral election is available at the state level.
By allowing practitioners to reach their own conclusions
regarding PFIC income, the DOR is indirectly supporting a
system by which Massachusetts tax laws are applied differently to different taxpayers. The tax result in each case may
depend on the strength of the practitioner’s advocacy rather
than on economic reality. That potential for disparate interpretations and applications of Massachusetts tax laws regarding PFIC income requires guidance detailing exactly how (or
whether) PFIC income should be reported for Massachusetts
income tax purposes. Regarding income generated from
QEF and mark-to-market elections, the DOR should follow
the lead of other states46 by issuing administrative guidance
clarifying that those categories of PFIC income should be
reported as other income on Schedule X, line 3. Regarding
income generated under the section 1291 default rules, the
legislature has a decision to make: either pass a law specifically subjecting deferred gains from prior tax years to Massachusetts income tax, or do nothing and allow that category
of income to escape Massachusetts income tax altogether.
That is a situation in which the legislature and the DOR do
not currently have the appropriate tools to address the needs
of Massachusetts taxpayers, and therefore need to promulgate a new statute, regulation, administrative procedure, or
technical information release that will clarify the taxation of
PFIC income in Massachusetts.
Conclusion
The legislature, the DOR, and Massachusetts taxpayers
would all benefit from a statutory and regulatory spring
cleaning. The legislature and the DOR should consider three
major problem areas, all of which arise from an actual (subordinations and mortgage debt relief ) or perceived (PFIC
income) inconsistency between federal and Massachusetts
income tax laws. For lien subordinations and mortgagerelated CODI relief, the inconsistencies between federal and
Massachusetts law appear unintentional: In neither case does
there appear to be a specific statutory or regulatory purpose
for treating those categories of taxpayers differently for Massachusetts tax purposes than for federal tax purposes.
46
See, e.g., New York State Department of Taxation and Finance,
‘‘Passive Foreign Investment Companies (PFIC) Tax Liability’’ (Feb. 7,
2011) (‘‘Report any PFIC income gain or loss for the tax year as ‘Other
Income’ on the appropriate income tax return’’).
State Tax Notes, April 6, 2015
(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
3.41 The problem is that income generated by two of the
three main PFIC categories — the QEF election and the
mark-to-market election — is required to be reported for
Massachusetts tax purposes,42 but income generated under
the default (section 1291) rules is not. That is because the
default rules under section 1291 only require taxpayers to
report their ratable share of gain for the current tax year in
current-year gross income; tax on the deferred gains from
prior tax years is computed separately from the tax on
current-year taxable income. This means that the deferred
gain for prior tax years under section 1291 might escape
Massachusetts income tax altogether.43
Special Report
(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
For the taxation of PFIC income, it is possible that the
DOR’s silence on that issue speaks volumes. The DOR may
share the perspective of many Massachusetts taxpayers and
practitioners (1) that PFIC income generated under QEF or
mark-to-market elections is required to be reported for Massachusetts purposes because those items of income are in
federal AGI but (2) that deferred PFIC income generated
under the section 1291 default rules is not required to be
reported for Massachusetts purposes because it is not in
current-year AGI for federal income tax purposes. If that is
the DOR’s position on PFIC income, it should promulgate
a regulation or issue administrative guidance to clarify the
issue and promote consistency of tax treatment among similarly situated taxpayers who own foreign mutual funds or
other PFIC investments. If the DOR determines that deferred PFIC gains generated under the section 1291 default
rules should also be subject to Massachusetts income tax, the
legislature should pass a new law that specifically includes
that category of income in the scope of the definition of
Massachusetts gross income set forth in Chapter 62, section
2(a).
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State Tax Notes, April 6, 2015
69