House to take up tax compromise

About 80,000 of the 120,000 investors who owe Massachusetts capital gains taxes from 2002 after a recent Supreme Judicial Court ruling would be spared under a proposal making its way through the Legislature.

The proposal, part of a broader tax measure the Joint Committee on Revenue approved yesterday, exempts anyone whose state capital gains tax bill for the first four months of 2002 would be $100 or less.

Under the proposal, about 40,000 other taxpayers who owe more than $100 for those four months in 2002 would still have to pay. The average tax bill for those larger investors is $3,725. The proposal would waive penalties and interest for all investors large and small.

The House is expected to take up the proposal today.

The effort is the latest attempt to minimize the fallout from the Legislature's 2002 decision to raise capital gains taxes as of May 1, 2002. Last year, the SJC found the tax increase unconstitutional, because tax rates must remain constant through a calendar year. Two months ago, the high court gave the Legislature a choice: Either designate January 2002 as the effective date for the increase and collect about $150 million in unpaid taxes or move the date back to January 2003 and refund as much as $275 million that has already been paid.

Last week, Governor Mitt Romney urged the Legislature to support a refund, but Democratic leaders on Beacon Hill argue that the state's budget is too tight to give back the $275 million. They have decided to make the tax hike effective January 2002, but to shield small investors.

''I agree this is not easy, but who's going to pay for the $275 million you'd give back?" said Senator Cynthia S. Creem, the Newton Democrat who cochairs the Revenue Committee. ''You're going to cut services. Somebody is going to have to pay for it, one way or another."

Creem said that people who paid $100 or less in capital gains taxes after the effective date of the tax hike also would be eligible for a refund. That provision, designed to make sure taxpayers are treated equally no matter when in 2002 they sold their assets, would cost the state about $1 million.

Romney said yesterday he supports sparing smaller investors and waiving interest and penalties for everyone, but he insisted that no taxpayer should owe money on a transaction completed three years ago.

''We as a government made a mistake," Romney said. ''By virtue of our mistake, we are now in a setting where certain people may have to go back and retroactively be expected to pay taxes at a rate that did not exist at the time they carried out a transaction. That's just not fair."

Romney would not say whether he would veto the bill, since it does provide some relief to taxpayers and is part of a package that would close $85 million in corporate tax loopholes.

Some critics say Romney, who is weighing a run for president, is supporting the refund to score points with conservatives beyond the state's borders. In recent months, he has drawn fire from some prominent antitax groups for moving aggressively to close what he describes as corporate tax loopholes, and backing the refund may help him shore up his antitax credentials.

But Romney spokesman Eric Fehrnstrom said that Romney initially backed a revenue-neutral solution to the capital gains controversy that would not have cost taxpayers or the state, before finally concluding that the court ruling precluded that option.

''It's too convenient to dismiss the governor's concerns by accusing him of playing politics," Fehrnstrom said. ''It's too facile. The fact is, you can't really talk about this case without talking about the court ruling and the unfairness of retroactive taxation."

The 2002 tax increase on capital gains was adopted during the state's fiscal crisis, when Beacon Hill was desperate to raise more revenue. Lawmakers raised the tax rate on long-term capital gains to 5.3 percent, replacing six lower rates. Under the old system, the rates ranged from zero to 5 percent, based on how long the investor had held on to the asset. The state levied no tax on assets held longer than six years.

But in March 2003, about 100 investors filed a lawsuit challenging the constitutionality of the midyear tax increase.

Revenue Commissioner Alan LeBovidge says his agency anticipated the high court's ruling and has already begun the process of reviewing 2002 returns to determine who owes more and how much. LeBovidge said he is confident his agency can track down the taxpayers, even those who have left the state.

Scott Greenberger can be reached at greenberger@globe.com.