Massachusetts Court Ruling
Massachusetts Court Ruling on Capital Gains Could Result
in Significant Tax Refunds for Hedge Fund Investors
Joseph A. Pacello, CPA, JD, LLM
Courtesy the Hedge Fund Association
On April 6, 2004 the Massachusetts Supreme Judicial Court declared unconstitutional a state tax rate increase on long-term capital gains that became effective in May 2002. The court found that the mid-year rate change violated a clause in the state constitution that requires income from the same class of property to be taxed at the same rates in a given tax year.
Before the 2002 change, long-term capital gains were taxed at favorable rates based on six classes of holding periods. Assets held more than 6 years were not subject to tax; assets held more than 5 years were subject to a 1 % rate of tax, and so on. Assets held less than 1 year were subject to the Massachusetts ordinary income rate of 5.3%.
After the 2002 rate change, all long-term capital gains realized after May 1, 2002 were taxed at the 5.3% ordinary rate. According to the court, “only one tax rate may be applied to all long-term capital gains realized in calendar year 2002.” The court remanded the case, Peterson v. Commissioner of Revenue, to a lower court to decide the critical question of whether the 5.3% rate should be effective January 1, 2002 or January 1, 2003.
If the lower court decides the 5.3% tax rate is effective January 1, 2003, the beneficial rates that applied before May 1, 2002 would apply for all of 2002. In that case, investors who paid tax at the higher 5.3% rate on capital gains realized after May 1, 2002 could be entitled to significant refunds.
Investment partnerships may need to amend 2002 Massachusetts K-1s for investors that are Massachusetts residents in order for them to benefit.
Joseph A. Pacello, CPA, JD, LLM
Rothstein Kass
Entry Filed under: Legal & Regulatory Issues