Investment Management
FEBRUARY 2003
Massachusetts Tax Law Changes on
Treatment of Capital Gains and Reporting Losses
On January 1, 2003, the Department of Revenue
of the Commonwealth of Massachusetts issued
Technical Information Release 02-21, which
alerted taxpayers to changes in the tax treatment
of capital gains and losses under chapter 62 of the
Massachusetts General Laws. In the endeavor to
raise revenue for the Commonwealth of
Massachusetts, the state legislature eliminated its
reduced tax rate structure for the treatment of
capital gains, which based its multiple-class tax
rate structure (ranging from 5% to 0%) on the
holding period of the capital asset sold. Under the
prior law, capital gains distributions were included
in Part C income, which included all Part C capital
gains. Part C capital gains were defined as longterm gains from the sale or exchange of capital
assets (except collectibles) which were divided
into six classes carrying six different tax rates
depending on the holding period of the capital
asset. For tax years beginning on or after January
1, 2002, the legislature has replaced the multiple
tax rates for Part C income with a single rate
(5.3% for 2002) for transactions completed on or
after May 1, 2002. Part C gross income is now
defined as any gains from the sale or exchange of
capital assets (except collectibles) that are held for
more than one year before disposition.
MULTIPLE RATE STRUCTURE
UNDER PRIOR LAW
Class
Holding Period (in years)
Class Tax Rate
B
More than one,
not more than two
5%
C
More than two,
not more than three
4%
D
More than three,
not more than four
3%
E
More than four,
not more than five
2%
F
More than five,
not more than six
1%
G
More than six
0%
Under the prior law, capital gain distributions to
mutual fund shareholders were included in Part C
income. Mutual funds could allocate the capital
gain dividends attributable to each class and report
this allocation to the taxpayer and the
Commissioner on or before March 1 of the year
following the year of distribution. If the mutual
fund made this election, shareholders could report
their distributions on their personal income tax
returns in the same manner as the mutual fund. If
the mutual fund did not elect to report the
allocation to the shareholders, the entire capital
gain distribution would be included in Part C,
Class B gross income, carrying the highest tax rate
(5% under prior law) for capital gains.
Shareholders could not offset their Part C gross
income with net capital losses incurred by their
mutual funds.
Kirkpatrick & Lockhart LLP
PRIOR LAW EXAMPLE.
The ABC Growth Fund (ABC) pays a $100
capital gain dividend to Shareholder X. ABC
has a Class B (5%) net gain of $400,000 and a
Class D (3%) net gain of $100,000 after offset
by capital losses in all classes. ABC has total
Part C capital gains of $500,000 ($400,000 +
$100,000). Eighty percent of that amount
($400,000/$500,000) is designated as Class B
capital gains (5%) while twenty percent of that
amount ($100,000/$500,000) is designated as
Class D capital gains (3%). ABC can report to
Shareholder X that 80% (i.e., $80) of his
capital gain dividend is included in Part C,
Class B gross income and that 20% (i.e., $20)
of his capital gain dividend is included in Part
C, Class D gross income.
For taxable year 2002, transactions that are
completed on or after May 1, 2002 will not benefit
from the multiple rate structure and resultant
capital gains will be taxed at the rate of 5.3%.
Transactions completed prior to that date will be
treated under the old tax regime, so that fund
shareholders will still be able to benefit from the
multiple rate structures if their mutual fund elects
to report their allocation to the Commissioner and
to the shareholders. If the mutual fund fails to
make that election, a shareholder’s entire capital
gain distribution will be included in Part C gross
income and taxed at the flat rate of 5.3%. Gain
categories are determined not by the date of
distribution to shareholders but rather by the date
of realization by the fund.
netted against long-term losses within each class
(e.g., 4% long-term gains against 4% long-term
losses), and then all net long-term gains were
netted against all net long-term losses, irrespective
of their holding periods. The netting started with
the highest rate capital gain, and flowed down to
the lowest rate capital losses. Under the new
provisions dealing with capital losses, gains and
losses from transactions completed before May 1,
2002 are offset in accordance with the ordering
rules under prior law. However, if the fund has, as
of April 30, 2002, an aggregate net capital loss,
the net loss will be considered a loss from the sale
or exchange of a capital asset held for more than
one year and will offset capital gains realized
during the last eight months of 2002. For tax year
2002, long-term capital gains resulting from
transactions completed in the first four months of
2002 will be offset by any net long-term capital
losses recognized on or after May 1, 2002, even if
the long-term capital gain in the first four months
falls within the 0% tax class. Carrying forward a
net long-term capital loss in the last eight months
to subsequent years is not an alternative to first
offsetting gains (of any class) in the first four
months. Any unused net capital loss for the entire
year, however, will carry over for an indefinite
number of years at the fund level.
JOEL D. ALMQUIST
617.261.3104
jalmquist@kl.com
WAL
TER G. VAN DORN
WALTER
617.951.9102
wvandorn@kl.com
Although capital losses incurred by funds still do
not flow through to their shareholders, mutual
funds that are subject to taxation in Massachusetts
will be affected by recent tax law changes at the
fund level. Prior to the changes, capital losses,
like long-term capital gains, were allocated into
six classes based on the holding period of the
underlying capital asset. Long-term gains were
CHRISTINA H. LIM
617.261.3243
clim@kl.com
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Kirkpatrick & Lockhart LLP
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BOSTON
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DALLAS
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HARRISBURG
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LOS ANGELES
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MIAMI
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NEWARK
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NEW YORK
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PITTSBURGH
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SAN FRANCISCO
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WASHINGTON
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This bulletin is for informational purposes and does not contain or convey legal advice. The information herein
should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.
KIRKPATRICK
& LOCKHART
LLP INVESTMENT MANAGEMENT ALERT
2003 KIRKPATRICK & LOCKHART
LLP. ALL
RIGHTS RESERVED.
©
Kirkpatrick & Lockhart LLP maintains one of the leading investment management practices in the United
States, with over 60 lawyers devoting all or a substantial portion of their practice to this area. According to
the April 2002 American Lawyer, K&L is a mutual funds “powerhouse” that represents more of the largest 25
investment company complexes and their affiliates than any other law firm.
We represent mutual funds, insurance companies, broker-dealers, investment advisers, retirement plans,
banks and trust companies, private funds, offshore funds and other financial institutions. We also regularly
represent mutual fund distributors, independent directors of investment companies, retirement plans and
service providers to the investment management industry. In addition, we frequently serve as outside counsel
to industry associations on a variety of projects, including legislative and policy matters.
We work with clients in connection with the full range of investment company industry products and
activities, including all types of open-end and closed-end investment companies, funds of hedge funds,
variable insurance products, private and offshore investment funds and unit investment trusts. Our practice
involves all aspects of the investment company business: from organizing and registering open-end and
closed-end funds, both as series and individual portfolios, to providing ongoing advice and representation to
the funds and their advisers, directors and distributors.
We invite you to contact one of the members of our investment management practice, listed below, for
additional assistance. You may also visit our website at www.kl.com for more information, or send general
inquiries via email to investmentmanagement@kl.com.
BOSTON
Michael S. Caccese
Philip J. Fina
Mark P. Goshko
Thomas Hickey III
Nicholas Hodge
617.261.3133
617.261.3156
617.261.3163
617.261.3208
617.261.3210
mcaccese@kl.com
pfina@kl.com
mgoshko@kl.com
thickey@kl.com
nhodge@kl.com
LOS ANGELES
William P. Wade
310.552.5071
wwade@kl.com
NEW YORK
Beth R. Kramer
Richard D. Marshall
Robert M. McLaughlin
Loren Schechter
212.536.4024
212.536.3941
212.536.3924
212.536.4008
bkramer@kl.com
rmarshall@kl.com
rmclaughlin@kl.com
lschechter@kl.com
SAN FRANCISCO
Eilleen M. Clavere
David Mishel
Mark D. Perlow
Richard M. Phillips
415.249.1047
415.249.1015
415.249.1070
415.249.1010
eclavere@kl.com
dmishel@kl.com
mperlow@kl.com
rphillips@kl.com
FEBRUARY 2003
WASHINGTON
Clifford J. Alexander 202.778.9068
Diane E. Ambler
202.778.9886
Catherine S. Bardsley 202.778.9289
Arthur J. Brown
202.778.9046
Arthur C. Delibert
202.778.9042
Robert C. Hacker
202.778.9016
Benjamin J. Haskin
202.778.9369
Kathy Kresch Ingber 202.778.9015
Rebecca H. Laird
202.778.9038
Thomas M. Leahey
202.778.9082
Cary J. Meer
202.778.9107
R. Charles Miller
202.778.9372
Dean E. Miller
202.778.9371
R. Darrell Mounts
202.778.9298
C. Dirk Peterson
202.778.9324
Alan C. Porter
202.778.9186
Theodore L. Press
202.778.9025
Robert H. Rosenblum 202.778.9464
William A. Schmidt
202.778.9373
william.schmidt@kl.com
Lynn A. Schweinfurth 202.778.9876
Donald W. Smith
202.778.9079
Robert A. Wittie
202.778.9066
Robert J. Zutz
202.778.9059
calexander@kl.com
dambler@kl.com
cbardsley@kl.com
abrown@kl.com
adelibert@kl.com
rhacker@kl.com
bhaskin@kl.com
kingber@kl.com
rlaird@kl.com
tleahey@kl.com
cmeer@kl.com
cmiller@kl.com
dmiller@kl.com
dmounts@kl.com
dpeterson@kl.com
aporter@kl.com
tpress@kl.com
rrosenblum@kl.com
lschweinfurth@kl.com
dsmith@kl.com
rwittie@kl.com
rzutz@kl.com
Kirkpatrick & Lockhart LLP
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Boston, Massachusetts 02109
TEL 617.261.3100
FAX 617.261.3175
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FAX 310.552.5001
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TEL 412.355.6500
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TEL 415.249.1000
FAX 415.249.1001
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TEL 202.778.9000
FAX 202.778.9100
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Kirkpatrick & Lockhart LLP
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KIRKPATRICK & LOCKHART LLP INVESTMENT MANAGEMENT ALERT