he Massachusetts Department of Revenue has continued its an enormous commitment to information technology and this shows in the 1997 Massachusetts income tax form and instruction booklet.
This year's focus is on Telefile, a system that allows you to file using a touch-tone phone, and there is a full page of instructions on how to use it. The actual tax forms have a handy tool that tells you if you are eligible to use Telefile: If you must complete a line that has a pictured telephone with a line through it, Telefile will not apply to you.
The Revenue Department also offers PC-based methods for filing, which are described in the booklet. The department's Web site (www.state.ma.us/dor) describes these methods and contains other useful information such as errors that may pop up in the forms or instructions.
Not all taxpayers can use these technology alternatives; you should study them to see if you can take advantage of these quick methods of filing. If not, use the forms that are specially prepared to be scanned with imaging equipment to speed processing.
A number of changes effective in 1997 will affect your total Massachusetts tax bill. These are detailed in the instruction booklet. The most complex change arises from phasing in legislation passed in 1994 that has lowered capital gains taxes. Capital assets (excluding collectibles) that have been held for more than one year but not more than two years are taxed at 5 percent.
Those capital assets that have been held for more than two years are taxed at 4 percent. For this purpose, no asset will be treated as purchased prior to Jan. 1, 1995. Worth noting is that in each succeeding tax year, there will be a new category with a lower tax bracket.
So for tax year 1998, there will be a 5 percent, 4 percent, and 3 percent bracket, until in the year 2001 those capital assets that have been held for more than six years will not be subject to tax.
An interesting quirk that remains unchanged for 1997 is that Massachusetts continues to follow the federal tax law that was in effect on Jan. 1, 1988. Thus, there are several situations in which you will have to adjust your Massachusetts income to reflect this difference. The example will point out some important situations.
Because there are a number of federal changes taking effect in 1998, you should monitor this situation. For example, the Revenue Department just announced it will not follow the federal rules on the new Roth IRAs and these accounts will be subject to current tax.
If you need assistance with completing Form 1, the inside back cover of the booklet describes where you can get forms, publications, and assistance. Revenue Department publishes ''A Guide to Filing 1997 Massachusetts Income Taxes,'' which covers complex provisions. You can also call for help or visit a Revenue Department office. The booklet lists the offices and telephone numbers.
To prepare the sample Massachusetts return, we call on Philip and Grace Sandblom, who have just completed their Form 1040. Complete your federal return before starting Massachusetts Form 1 since it refers to your federal return.
Since some of the lines the Sandbloms must complete have the telephone picture indicating they cannot file electronically, they must use Form 1. If you must file a paper form, Form 1 is the only alternative.
Since the paper forms are designed to be scanned, there are special rules to follow in completing them. You cannot file photocopies, only originals. The forms must be completed in black ink. Negative numbers or losses are not reported with minus signs or parentheses; mark the box with an ''X'' next to the number to show it is negative.
Obviously, you must use special care to follow these rules. It makes sense to photocopy the forms, complete them in pencil until you are satisfied, and then fill them out in ink. If you use a software program to do your return, be certain that the Department of Revenue has approved the forms prepared by the program.
Because the preprinted information on their Form 1 is incorrect, and they do not use it. Instead, the Sandbloms complete the name, address, and Social Security information in black ink. Of course, wait until you have finished your draft return before filling out the preprinted form. Make sure the order of your names corresponds with the order of your Social Security numbers.
Next, the Sandbloms fill in the blocks indicating that they each opt to contribute $1 to the Mass. Election Campaign Fund. Don't make an ''X'': Fill in the ovals fully here and throughout the return. They indicate that they will use the whole-dollar method of filing and they complete the oval indicating their address has changed.
Filing Status
The Sandbloms check the box at Line 1 for filing a joint return. This is almost always the best choice for married couples since joint filers are allowed to claim certain exemptions (these are listed in the instructions) that are not available to those filing separately.
Even if you have used married filing separately for your federal return, you may still file jointly for Massachusetts purposes. You may want to compute your tax on a joint vs. separate basis if you are not sure which is best for you.
Exemptions
At Line 2, they complete the amount of exemptions. Exemptions differ from federal rules. The Sandbloms are entitled to a $5,260 personal exemption on Line 2a since they file jointly; this amount has changed from 1996.
They are also entitled to an exemption of $1,000 for each child they claimed as a dependent on their federal return; these are claimed on Line 2b. The form asks for Social Security numbers. Unlike the federal rules, they are not allowed a further exemption for themselves. Their total exemptions of $7,260 are totaled on Line 2f.
Although Massachusetts generally does not allow federal itemized deductions, if you claimed a medical expense deduction on Schedule A of your federal return you may claim the same amount on your Massachusetts return.
Since this deduction is only permitted if medical expenses exceed 7.5 percent of federal adjusted gross income, the Sandbloms are not permitted to claim this deduction.
5.95% Income
The Sandbloms are now ready to complete the first income category, 5.95 percent income. They complete Line 3, Wages, salaries, and tips, by referring to Philip's salary of $65,000. In most cases, the amount of wages and salaries for Massachusetts purposes will be the same as the federal amount.
Occasionally they are different; your Form W-2 will separately state the Massachusetts wages.
The amount received from Philip's IRA plan is not taxable for Massachusetts purposes since Philip made a rollover contribution. If you received a taxable pension or IRA distribution, read the instructions carefully, because these rules are complex. Line 4 is blank.
Although interest and dividends generally are taxed at a rate of 12 percent, interest from Massachusetts banks is taxed in the 5.95 percent category.
The Sandbloms refer to Schedule B of their federal return to determine the amount of interest from Massachusetts banks. This interest receives special treatment because it is taxed at the lower rate and up to $200 is exempt from tax.
On federal Schedule B, the Sandbloms reported $400 from a savings account with Massachusetts Bank. They report the total on Form 1, Line 5, subtract the $200 exemption for married filing jointly, and enter $200 on Line 5.
Since Grace has consulting income, she must complete Form 1, Line 6, Business/professional income by referring to Form 1040, Line 12. She must complete and attach Massachusetts Schedule C and include a copy of US Schedule C. Check the instructions for Massachusetts Schedule C to determine exactly how to prepare both forms and reconcile any differences.
In this case, she incurred $300 of business meals meeting with clients and prospects. For federal purposes, only 50 percent of this amount may be deducted. As of Jan. 1, 1988, the federal rules allowed 80 percent of business meals to be deducted. Thus, there is a difference in Schedule C income for Massachusetts ($26,870) and federal income on Schedule C ($26,960).
If you filled out Federal Form C-EZ, note that it requires no detail of your expenses, while the Massachusetts form does. The Sandbloms insert $26,870 on Line 6.
To report Grace's $1,000 of lottery winnings, the Sandbloms must complete Schedule X, Other Income. For federal purposes, she deducted gambling losses of $650 as an itemized deduction.
For Massachusetts purposes, gambling losses are not deductible. You may only reduce your winnings by the cost of the winning ticket. She bought the ticket for $1 and reduces the amount on Schedule X by $1. The total, $999, from Schedule X goes on Line 9 of Form 1.
To determine their total 5.95 percent income of $93,069, the Sandbloms add Lines 3 through 9 and enter the total on Line 10. This total excludes the total exemptions that are picked up later.
Deductions
Deductions from 5.95 percent income are next. The biggest difference between Massachusetts taxable income and federal taxable income is the treatment of deductions.
Massachusetts does not allow most of the itemized deductions that the IRS allows you to claim on US Schedule A. Thus, mortgage interest, state income and real estate taxes, and charitable contributions do not reduce your Massachusetts taxes.
There are a limited number of deductions as well as the exemptions that are allowed on Form 1; these typically reduce 5.95 percent income.
First, amounts paid for Social Security, Medicare, and Self-Employment taxes are deductible up to a limit of $2,000 for each person; the Sandbloms each claim this amount on Lines 11a and 11b; they enter $4,000 on Line 11.
Massachusetts takes a different approach toward the child-care deduction. To complete Line 12 for the child-care deduction, the Sandbloms refer to Form 2441, which was filed with their US Form 1040. Federal law allows a credit for these expenses while Massachusetts allows a deduction.
The Sandbloms enter the total amount of eligible child-care expenses paid - $3,000 - and not the credit claimed on Line 12. The form asks for the name and Social Security number of the care provider.
Massachusetts also allows this deduction for children ages 13 and 14; federal limits qualifying children to those under 13. For this reason, computing this Massachusetts deduction can be complex. If you are claiming this deduction, you should complete the worksheet included in the instruction booklet.
Massachusetts also allows a $1,200 deduction (it was $600 last year) for one child under age 12 as of Dec. 31, 1997 on Line 13. This deduction is not permitted if you claim the child-care deduction on Line 12. Since they are allowed the higher of the two deductions, the Sandbloms leave Line 13 blank.
The Sandbloms then determine their total deductions, $7,000, on Line 16, and then add up their 5.95 percent income after deductions on Line 17. This total is $86,069. They are now ready to apply the exemptions to further reduce 5.95 percent income. To do so, they turn to Page 2 of Form 1 and begin by putting the amount in Line 17 on the top of the page.
They then copy their total exemptions of $7,260 from Line 2f to Line 18 and determine their 5.95 percent income after exemptions, $78,809, on Line 19.
Computing 5.95% Tax
Based upon the amount on Line 19, the Sandbloms must use the tax tables in the instruction booklet to determine their 5.95 percent tax; this amount, $4,690, goes on Line 20. You must use the tables unless your 5.95 percent income is more than $80,000.
12% Income and Tax
The next set of computations, which are on Page 2 of Form 1 and accompanying schedules, is the determination of 12 percent income and tax.
To prepare this section, you must turn to Massachusetts Schedule B and federal Schedules B and D. Because of the change in Massachusetts capital gains rates, the form and the computations have changed.
Although we have not displayed Schedule B, we will explain how the schedules are completed; you may wish to use a Schedule B to follow along.
To compute interest and dividend income subject to 12 percent tax, you must complete Schedule B. The basic format of Schedule B is to start with all interest and dividend income from the federal returns and then subtract those items that get special treatment. The result is interest and dividend income subject to the 12 percent rate.
Total interest income on federal Schedule B was $900, which is reflected on Line 8a of Form 1040. In addition there was $175 of tax-exempt income from a mutual fund reflected on Line 8b of Form 1040. This total, $1,075, goes on Line 1 of Schedule B.
Dividend income from Line 6, Schedule B of Form 1040, $850, goes on Line 2 of Massachusetts Schedule B. Thus, the sum of all dividend and interest income is $1,925. This amount will not agree with the front of Form 1040 since it includes the $600 capital gains dividend.
Line 5 through 8 of Massachusetts Schedule B are the adjustments from this total. On Line 5, the capital gains dividend of $600 is reflected. On Line 6, the Sandbloms reflect interest from Massachusetts banks, $400, which comes from Line 5 on Form 1.
On Line 7, input the total of all income that is excluded from Massachusetts tax. In this case, income from US Savings Bonds of $400 is reflected; a schedule supporting this number must be attached. Interest on debt obligations of the US government such as Savings Bonds is exempt from Massachusetts tax.
Note that the rules for which government and agency income are exempt from Massachusetts tax are complex; TIR 89-8, available from the Revenue Department, details which issues qualify for exemption.
The tax-exempt money market fund dividend from Line 8b of the federal return is included in Line 1 above. For Massachusetts purposes, interest income from out-of-state municipal obligations is taxed as 12 percent income even though this income is exempt for IRS purposes; income from Massachusetts municipals is exempt from state tax. Since this was not Massachusetts income earned by the mutual fund, all of this interest remains in 12 percent income.
The total adjustments from 12 percent income, the sum of Lines 5 through 7, or $1,400, must be subtracted from Line 4, resulting in net 12 percent interest and dividend income of $525 on Line 8.
To test your amount, this $525 consists of $250 of dividends from corporations and money market funds, $100 of interest from Outofstate Bank, and $175 of municipal income.
To finalize the 12 percent income schedule, the Sandbloms must refer to federal Schedule D, which shows a short-term capital loss of $200 and a long-term capital gain of $3,100. The long-term amount already includes the capital gains distribution that was subtracted in Line 5 above. The short-term loss (or gain) is 12 percent income and must be included on Massachusetts Schedule B.
Therefore, the $200 loss goes on Line 15 with the box to the left filled with an ''X'' to indicate that it is a loss. None of the other line items on Schedule B apply to the Sandbloms. They total Schedule B income, $325, and place this total on lines 18 and 21; the last line is 12 percent income that is carried to line 21 of Form 1. They then compute the tax using the 12 percent tax rate; $39 goes on Line 21.
The final basket of income is for long-term capital gains and requires both Massachusetts and US Schedule D. Again, you should follow along. The tax rate for long-term gains in 1997 is either 5 percent or 4 percent. Schedule D has been largely revised this year: It now has two columns into which you must assign gain as either coming from assets held for more than one year but less than two (Column A, 5 percent gain) or assets held for longer than two years (Column B, 4 percent gain).
The Sandbloms' total federal long-term capital gains from stock sales are $2,500. Of this amount, $1,500 is from assets held for more than one year but less than two, which goes in Column A, and the remainder of $1,000 from Microhard Corp., which was held for longer than two years, goes in Column B. Next, the Sandbloms allocate their $600 in capital gains distributions, which is found on US Schedule D, line 13, column f.
The Sandbloms learn from D&I Mutual fund that of this $600 distribution, $200 is 5 percent gain (held between one to two years) and $400 is 4 percent gain (held for more than two years). This information should be included with your mutual fund tax information.
Then they must account for the gain realized on the sale of their house on Line 6. Remember, Massachusetts only follows the tax law that was in effect in 1988. The new federal exclusion does not apply and they did not reinvest the entire proceeds from the sale; taxpayers over 55 should be eligible for the old $125,000 exclusion.
Using Part III of US Schedule 2119 as a worksheet (which you should attach to your return), they enter taxable gain of $25,000 in column B on line 6.
They total their long-term gains in columns A and B, which are $1,700 and $26,400 respectively, and enter these amount in lines 8, 10, 12, and 14. They then apply the applicable tax rate at line 15, which produces a tax of $85 for column A and $1,056 for column B. The sum of these two amounts, $1,141, is entered at Lines 16 and 18 and is carried to Line 22 on Form 1.
Many parts of Massachusetts Schedules B and D are difficult. If you have a long-term capital loss, you may have to complete Schedule B-1.
Total tax is simple: The Sandbloms simply add Line 20 (5.95 percent tax), Line 21 (12 percent tax), and Line 22 (5 percent and 4 percent) for a total tax of $5,870, which is entered on Line 24. The total tax is carried to Line 28, because none of the credits apply.
The Massachusetts form permits you to make voluntary contributions to four funds. The voluntary contributions are added to your tax and will increase the amount you owe or decrease your refund.
Contributions to the funds qualify as charitable contributions, but the deduction may only be claimed on the next year's federal return. The Sandbloms elect to contribute $5 to each of these funds which increases their liability to $5,890 on Line 30.
To determine payments, the Sandbloms refer to Philip's Form W-2 for his Massachusetts income tax withholding of $3,600 and enter this amount on Line 31. On line 32, they enter last year's overpayment applied of $300. In addition, Grace made estimated tax payments of $1,300; this amount goes on Line 33. Total payments, $5,200, go on Line 35. Their total tax is $5,870, which means they owe $690 (reflected on Line 40).
To avoid a penalty for failure to pay sufficient taxes during the year, the sum of withholdings and estimated tax payments must exceed 80 percent of your tax liability for the year; note that this threshold is more lenient than the 90 percent level required for federal purposes. The Sandbloms met this requirement. If they had failed to meet this threshold, they would have been subject to penalty for underpayment of estimated tax unless their payments exceeded their 1996 tax.
If you want to be certain to avoid penalties for the underpayment of tax, be certain that your withholding plus timely estimated payments at least equal your prior year's tax. This rule is comparable to the federal rule for 1998.
The instructions for assembling your return are relatively simple. With one staple, attach to your return Forms W-2, W-2G, and any Forms 1099 that include any Massachusetts withholding. If you must make a payment, The Revenue Department has provided a Form PV-Income Tax Payment Voucher; staple your check to Form PV but do not attach it to your return. The actual return and schedules should not be stapled together.
Prior to filing, the Sandbloms check their math, verify that correct Social Security numbers appear on each schedule, make a copy for their files, sign and date the return on Page 2, and send it to the Massachusetts Department of Revenue, P.O. Box 7003, Boston, MA 02204-7003.
Note that if you are owed a refund, you must use a different address. The instruction booklet has envelopes with both addresses. Many tax advisers suggest using certified mail.
The return is due on Wednesday, April 15. Massachusetts permits extensions to file but its procedures differ from the federal rules. First, the extension period is automatically six months: An extended return is due Oct. 15, 1998, which an automatic federal extension expires Aug. 17, 1998. Second, if you owe tax with your extension, use Form M-4868 to obtain this extension; there is no extension of time for the payment of tax due.
However, if you owe no tax, simply send Massachusetts a copy of your federal extension, US Form 4868 (indicate that it is for Massachusetts purposes), by April 15 to secure the six-month extension, or file for extension by that date using your touch-tone phone.
Michael Carona is a tax partner with Coopers & Lybrand LLP in Boston.
Find extensive information on filing your 1997 taxes at Boston.com's Your Taxes, sponsored by Ernst & Young.
