Massachusetts’ “Stinger” Tax, Explained
There are various classes of business entities, and how each enterprise chooses to be recognized influences its tax treatment. One major difference between being classified as an S Corporation rather than a C Corporation is that the business in question would no longer be subject to double taxation, in which the owners of the entity are required to pay both an income tax on its earnings and another on the dividends they receive from the corporation.
Rather, S Corporations are known as flow-through entities, as business income and deductions flow directly through to its shareholders, who are then required to report the income on their individual tax returns. An enterprise must file with the IRS to be recognized as an S Corporation, using Form 2553. Entities must be domestic, have no more than 100 eligible shareholders, have only one class of stock, and must not be an ineligible type of business (such as certain financial institutions) to qualify for S Corporation status.
Once recognized federally, the entity’s tax treatment within its state depends on that state. According to Tom Corrie and Christian Burgos of Marcum LLP, there are generally four approaches when it comes to S Corporation tax treatment: unconditional recognition with no entity-level tax, conditional recognition on certain shareholder elections, no recognition resulting in the entity taxed as a C Corporation, or a limited or modified basis recognition.
Massachusetts recognizes S Corporations, and allows for their flow-through taxation. However, it also has a distinct “stinger tax” on owners of S Corporations. All individuals in the state are subjected to a 5 percent flat rate personal income tax. For S Corporation shareholders, there is an additional tax on their reported income depending on the entity’s revenue and industry.
Businesses that are not financial institutions and report less than $6 million in revenue have no additional tax, while those reporting between $6 million and $9 million must pay another 2 percent on those earnings and those who report more than $9 million must pay an additional 3 percent.
Businesses that are financial institutions and report less than $6 million in revenue are also not subject to the stinger tax. However, those meeting the other revenue thresholds must pay higher rates. Financial businesses with revenue between $6 million and $9 million must pay 2.67 percent on their earnings, while those grossing over $9 million owe 4 percent. For all types of institutions, the minimum tax payment is $456.
Michael Lucci of the Tax Foundation is critical of the Massachusetts system and calls for it to be reformed, stating that “[t]his rate structure is nonneutral between industries, uncompetitive with other states, and based on business revenue triggers with little economic justification. Furthermore, it creates tax cliffs at $6 million and $9 million of business revenue. Once companies hit those revenue thresholds, they have a new tax that kicks in and is imposed on all previous income.”
This system is profitable for the state, though. The Massachusetts Taxpayers Foundation recently stated in their release, “Tax Policy Next Steps in 2023,” that while, “… the Department of Revenue does not separate out [stinger tax revenues] in public revenue reports…[they] recommend that policymakers set a target to reduce annual stinger tax costs by $125 million annually.”
Based upon this statement, and the fact that Massachusetts had $25.3 billion in revenue attributable to the income tax category (including income taxes paid by those who are not S Corporation shareholders) according to MassOpenBooks, it becomes evident that the state is profiting well from S Corporation taxes. As the Massachusetts Taxpayers Foundation noted, the combination of the new surtax on income over $1 million and the stinger tax is likely to put the effective tax rate for S Corporations in excess of that of C Corporations, providing a significant incentive for S Corporations to relocate. To avoid losing surtax and other revenue, the state should consider taking up reforms.
About the Author: Sarah Delano is a Roger Perry Government Transparency Intern at the Pioneer Institute for the summer of 2023. She is a senior studying Political Science at the University of Massachusetts-Amherst.
