In part one of this post, I covered three planning strategies to help reduce or defer income in light of the new “millionaire” tax in Massachusetts. These included leveraging an installment sale, filing taxes as married filing separately, and utilizing a like-kind exchange. In this Part 2, I offer up four more ideas to help in different scenarios.
4. Invest in a qualified opportunity zone (QOZ)
A QOZ is a low-income community with a poverty rate of at least 20%. All 50 States and the District of Columbia have designated more than 8,700 QOZs. Congress authorized the creation of Qualified Opportunity Funds (QOF) through the Tax Cuts and Jobs Act (TCJA) of 2017 to encourage investment in QOZs by providing substantial tax breaks to investors, including allowing them to defer, reduce, and even eliminate various capital gains.
Investors can defer the gain attributable to any property (real estate, stocks, mutual funds or ETFs, etc.) by re-investing the gain portion of the sale into a QOF while retaining the basis tax-free. The longer you hold the QOF, the greater the benefits towards reducing the original capital gain.
5. Change state of residence
Everyone has a different tolerance for taxation. Some people believe that because of this new tax high-income earners will gravitate to low tax states…but changing your state of residence may not be as easy as you think. If you retain a home or continue to spend more than half your time in Massachusetts, the state may continue to levy income taxes as a resident or non-resident. Massachusetts is known for conducting residency audits, and the onus is on the taxpayer to prove they have truly moved out of state.
6. Shift your income to another year
This applies primarily to people who have stock options, restricted stock, or access to non-qualified deferred compensation plans (sometimes called SERPs). With stock options, you get to choose when to exercise the option to purchase company stock. For non-qualified stock options (NSOs), income tax is recognized upon exercise, so it is important to carefully plan when you exercise (and sell). With restricted stock, you might consider an 83(b) election on a portion of stock to break up the tax liability into multiple years. Finally, if you have access to a non-qualified deferred compensation plan, you might use it to spread income over many years (usually up to 10) during retirement.
7. Rent out your house or take a reverse mortgage
This planning strategy is ideal for elderly residents who need access to their home equity but have a multi-million-dollar unrealized capital gain embedded in their primary residence. Although primary homes qualify for a $250K or $500K capital gains exemption, if you have owned in Boston or Cambridge for several decades, you may very well still have millions worth of capital gains. Rather than selling to unlock your home equity, you could rent out your house and downsize nearby to avoid a sale. You can also take out a reverse mortgage if you meet the age and equity requirements. If you can hang on to your home until death, it should qualify for a step-up in basis, which would eliminate the capital gain and associated tax.
If you make more than $1M every year and live in Massachusetts, chances are you are going to end up paying 9% to the state for your income above $1M. But if you make far less and just happen to have a one-time income event that drives you above the $1M threshold in a single year, there are plenty of options to reduce or eliminate the extra taxes. Just remember, planning is something you do in advance, not spur of moment!