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Effective for tax years beginning on or after January 1, 2022, Massachusetts conforms to Federal QSBS regulations, and therefore capital gains realized after Jan 1, 2022 may be eligible for up to the 100% QSBS exclusion at the state level. Prior to 2022, MA allowed the section 1202 tax exclusion on capital gains from the sale of QSBS with modifications, which generally cap the exclusion at 50% at the state level.
Federal QSBS Exclusions and State Tax Implications
Allowing capital gains tax exclusions for Qualified Small Business Stocks (QSBS) encourages investment in US small business. QSBS laws help provide capital for these businesses while offering a savvy tax strategy for investors who want to minimize capital gains taxes.
Investors who hold qualified small business stock for at least 5 years can exclude up to $10,000,000 or more of their recognized capital gains from their taxable income if certain criteria are met.
Learn more about the criteria for Qualified Small Business Stock.
Each state has its own treatment of QSBS gains at the state income tax level. There are three ways in which states typically address the exclusion.
- Some states fully conform to the Federal QSBS guidelines, and therefore allow a full exemption if the stock meets the Section 1202 QSBS criteria. States conform to the federal tax code on either a static or rolling basis. “Static” conformity means the state starts conforming to the Internal Revenue Code as of a specific date. “Rolling” conformity means that the state adopts IRC changes as they occur. Alternatively, certain states do not have state income taxes and therefore there is no QSBS implication at the state level.
- Some states partially conform to the Federal QSBS guidelines, whereby the capital gains from QSBS are exempt if additional criteria beyond the Federal guidelines are met, such as only allowing exemptions if the QSBS gains were from a company doing business in that state.
- Lastly, certain states do not allow any capital gains exclusions for QSBS.
Find out how QSBS is recognized by each state here.
Massachusetts QSBS Exemptions
Effective for tax years beginning on or after January 1, 2022, Massachusetts conforms to Federal QSBS regulations, and therefore capital gains realized after Jan 1, 2022 may be eligible for up to the 100% QSBS exclusion at the state level. Refer to further details at mass.gov.
Prior to January 1, 2022, Massachusetts allowed the Section 1202 tax exclusion on capital gains from the sale of QSBS with modifications to the Federal rules, whereby:
“Gains derived from the sale of certain “qualified small business stock” (“QSBS”) are eligible for a 50% income exclusion because of Massachusetts’ conformity with section 1202 of the Internal Revenue Code (the “Code”) as in effect in 2005.” (See https://www.mass.gov/doc/1042-and-1501-favorable-tax-treatment-of-qualified-small-business-stock-qsbs-gain/download) Because the 100% Federal QSBS exclusion did not become part of the code until 2010, Massachusetts law locks in the 50% original QSBS exclusion level.
Additionally, the state provided a reduced tax rate for the 50% of such QSBS gains that are included in income if further requirements are met, whereby the capital gains will be taxed at a rate of 3% instead of the state’s capital gains tax of 5.2%. See Mass. Gen. LawsAnn. ch. 62, § 4(c) and this Mass.gov information on how the state handles QSBS for additional guidance.
Massachusetts Capital Gains Tax Rates
The state of Massachusetts has a 5% tax rate for both income and most long-term capital gains. The following types of capital gains are taxed at a 12% rate:
- Short-term capital gains
- Long-term capital gains on collectible and pre-1996 installment sales
- Gains on the sale of property when used in a trade or business for one year or less
In comparison, federal capital gains tax rates have 3 brackets for single taxpayers which are:
- 0% for $0 to $39,375
- 15% for $39,376 to $434,550
- 20% for $434,551 or more
Entrepreneurship in Massachusetts
Ideagist has a vast, comprehensive list of startup incubators and accelerators in the state of Massachusetts.
According to the University of Massachusetts, “Massachusetts is a hotbed of entrepreneurial activity, from high-growth tech and life sciences to small businesses and student-run enterprises.” Through the student entrepreneurship program, the university encourages students to pursue their passions and fosters a culture of entrepreneurship.
Among other industries, the following industries in particular thrive in the state:
- Marine Trade
- Information Technology
- Higher Education
Massachusetts Opportunity Zones
Massachusetts is home to approximately 138 Opportunity Zones.
Opportunity Zones (OZ) were created to help economically distressed areas by giving investors preferential tax treatment with new investments in these “specified” areas. Similar to QSBS, if the investment meets eligibility criteria and is held for at least 5 years, the investor can defer or be exempted from capital gains taxes (i.e. if held for at least 5 years, the taxpayer can exclude 10% of the gain and the percentage increases (or “steps up”) to 15% after 7 years).
Opportunity Zone investments can be in the stock of an OZ Qualified Business, an OZ partnership interest or an OZ business property.
To be a Qualified Opportunity Zone Business, the business must meet requirements such as at least 50% of the business’s total gross income being derived from within the Opportunity Zone. To learn more about Opportunity Zone qualifications, please refer to the Opportunity Zones and QSBS article.
Under the Tax Cuts and Jobs Act of 2017, 26 USC 1400Z-2, Massachusetts made Opportunity Zones, is also home to the associated tax relief incentives that accompany these zones which are effective for tax years beginning on or after December 31, 2017. Refer to this mapfor the Opportunity Zones in the state and here for all Opportunity Zones in the United States.
Some Examples of Opportunity Zone Funds in Massachusetts include:
- Community Outcome Fund (Commercial, Infrastructure, Mixed-Use, Residential)
- Ozone Capital Worcester Apartment Complex QOZ Fund (Multi-Family Housing)
- P&R Opportunity Zone Fund 1, LP (Healthcare, Office, Storage)
See more at the Opportunity Zone Database.
If you are curious about your QSBS situation, we would suggest starting at our home page to learn about your potential QSBS Exemption or try our QSBS Calculator
Learn more about QSBS and the State of Massachusetts below with this QSBS News article.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.