Some Massachusetts corporations recently receiving large cash infusions from equity investors may be surprised to find the mere act of depositing the cash into their account can trigger thousands of dollars in excise taxes, whether or not they generate taxable income. “Massachusetts Security Corporations” can be used to solve this problem.
How can my company be taxed without income?
Massachusetts assesses an excise tax of .26% on corporations “net worth”. This excise tax is in addition to the Massachusetts corporate income tax (currently 8%). Corporations formed, and receiving investor funding prior to year-end, can trigger a significant excise tax liability prior to spending their first dollar.
Let’s look at an example:
ABC Corp. receives $10M of outside financing during their initial tax year. With that $10M they spend only $1M on tax deductible expenses, leaving $9M of cash and $9M in equity.
- Income tax – $1M loss X .08 = $0
- Excise taxes:
a) Property – $0 of property X .0026 = $0
b) Net worth – $9M of net worth X .0026 = $23,400
Total Tax Liability – $23,400
Surprised to find a company that incurs $1M in tax deductible losses is subject to a tax bill in excess of $23,000? You are not alone.
Are there any solutions to this problem?
Companies expecting large “net worth” excise taxes can consider transferring cash to a wholly owned “Massachusetts Security Corporation” (“MSC”) a tax vehicle that is not subject to the Massachusetts net worth tax. In our previous example, utilizing an MSC would have reduced ABC Corp’s tax liability from $23,400, to $456 (the minimum excise tax), resulting in almost $23,000 in tax savings!
I’m interested! How do I utilize a Massachusetts Security Corporation?
- Establish a Massachusetts Security Corporation, as defined under M.G.L. c. 63, § 38B, that is wholly owned by ABC Corp.
- Transfer cash, not required for immediate working capital, to the MA Security Corp. prior to year-end
- Invest the cash within the MA Security Corp. in low-risk investments that are within the parameters of M.G.L. c. 63 §, 38B(b ½) and 830 CMR 63.38B.1(4)(b)
- Periodically remit dividends to ABC Corp. to ensure future liquidity needs are met
Great! What’s the Catch?
Of course, tax planning is never simple and “one size does not fit all”. Additional requirements must be considered:
- To be classified as a MA Security Corporation, companies must submit an application to the Commissioner prior to the end of the year the classification is to be effective. Companies hoping to implement these opportunities for 2020 have a small window to apply before year-end.
- Massachusetts does not adopt the 100% “dividends received deductions”. As the wholly-owned security corp. remits dividends to ABC Corp (parent), they will only qualify for a 95% dividends received deduction. This may not be a concern if ABC Corp. does not have an expectation for profits in the near-term as the dividend income can be fully sheltered, only offsetting their NOL
- The revenue generated by the MA Security Corp. is subject to a maximum income tax rate of 1.32% and the minimum excise tax of $456 still applies, so there will still be some tax at the subsidiary level
- The MA Security Corp. needs to stay within defined parameters as to not jeopardize their classification, including but not limited to:
a) Ensure they are properly investing
b) Maintain separate books and records from their shareholder
c) Act independently and not be principally used as a bank account for the shareholder
- There will be professional fees to establish and maintain this structure. This should be weighed against the potential tax savings
Authors: Robert Traester, CPA, MST | firstname.lastname@example.org and Leonard M. Smith, CPA | email@example.com
Business Tax Services