Massachusetts does allow the section 1202 100% tax exclusion on capital gains from the sale of QSBS with modifications. The state follows the same qualified small business guidelines, but the business must be incorporated on or after January 1, 2011 and stock must be acquired within five years of the businesses incorporation. Also the state follows the same investor guidelines and guidelines for after the stock is acquired, except the holding period for Massachusetts is three years not five. If the guidelines are followed the capital gains will be taxed at a rate of 3% instead of the states capital gains tax of 5.2%. Therefore, capital gains on the sale of QSBS will not only be excluded from federal income taxes, but also taxed at a lower rate for state income taxes if all of the guidelines are followed.
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.
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.
Massachusetts QSBS Exemptions
Massachusetts does allow the Section 1202 100% tax exclusion on capital gains from the sale of QSBS with modifications. The state follows the same qualified small business guidelines, but the business must be incorporated on or after January 1, 2011 and stock must be acquired within five years of the businesses incorporation.
Also, the state follows the same guidelines for investors and for after the stock is acquired, except the holding period for Massachusetts is three years rather than the five years required by Section 1202. If the guidelines are followed the capital gains will be taxed at a rate of 3% instead of the state’s capital gains tax of 5.2%. Therefore, capital gains on the sale of QSBS will not only be excluded from federal income taxes, but also taxed at a lower rate for state income taxes if all of the guidelines are followed. See Mass. Gen. LawsAnn. ch. 62, § 4(c).
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.
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.