Report: State could lose out on ‘Millionaires Tax’ benefits if high-earning couples file separately

On New Year’s Day, the so-called “millionaires tax” went into effect in Massachusetts. In November, residents voted to amend the state constitution in order to to levy an extra 4% surtax on income over $1 million. 

The additional dollars from this surtax will go towards education and transportation infrastructure. Research last year from Tufts University’s Center for State Policy Analysis estimated that the tax would raise about $1.3 billion in 2023 “in a highly progressive way likely to advance racial and economic equity.”

But, Tufts researchers cautioned, the new law could lead to “widespread” tax avoidance that would seriously cut into the amount of revenue raised by the state. 

A new study released Monday explored one way that high-income filers could exploit the system to their benefit. This strategy, according to the study, would center around couples who earned more than $1 million combined filing their taxes jointly with the federal government and separately with the state government. 

The study, from the Massachusetts Budget and Policy Center, found that Massachusetts could lose between $200 million and $600 million in potential tax revenue. 

MassBudget called on lawmakers to pass legislation that would require taxpayers to file their state income taxes with the same status they use on their federal taxes.

The authors of MassBudget’s study said that such tax avoidance would impair the state’s ability to make new investments right when the state budget could be negatively impacted by less federal aid. 

A recession would exacerbate these challenges, they wrote. 

“If the economy dips into recession, public revenues will face further challenges. Massachusetts residents who are counting on funds from the millionaire tax to help repair bridges and schools, support public transportation, or launch new programs for subsidized early education or community college, for instance, may find themselves disappointed,” MassBudget said in its report

MassBudget warned that high-income couples that file their state taxes as “married filing separately” would have added incentive to break the law by misreporting how their income is divided when one person earns more than $1 million and the other earns less than $1 million. 

“By mischaracterizing a portion of the higher-income filer’s income as earned by the lower-income filer, they would exploit their separate $1 million exemptions,” MassBudget said in its report. 

To combat this behavior, the state could be forced to increase “scrutiny and controls” of how taxpayers attribute their income, according to MassBudget. 

The state’s Department of Revenue relies on the federal government to conduct audits and prevent illegal tax evasion. But federal audits do not usually help determine whether income has been properly attributed between joint federal filers if they file their state tax returns separately, according to MassBudget. If state law required people to file their state and federal taxes the same way, Massachusetts officials would face less of a burden to conduct their own audits to figure out if there are illegal discrepancies. 

Most married couples would elect to file their taxes jointly if Massachusetts taxpayers had to use a consistent status in their federal and state taxes, MassBudget said. This is because the federal tax advantages of filing jointly for couples earning more than $1 million usually “far exceed” the potential advantages of filing singly with the state. 

“This would reduce the opportunity for the highest-income 1 percent of tax filers to avoid the new surtax,” MassBudget said in its report. “To prevent the loss of $200 – 600 million of revenue the Commonwealth need only require that people file their state income taxes with the same status they use on their federal taxes.”