Executive summary: Minnesota seeks new revenue in 2023 tax bill
On May 24, 2023, Minnesota Gov. Tim Walz signed House File 1938, making sweeping changes to Minnesota’s tax code affecting both businesses and individuals. In addition to including the taxation of global intangible low-taxed income (GILTI) and broadening the applicability of the pass-through entity election, the state will impose its own net investment income tax on millionaires. A summary of the more salient provisions follows below.
Minnesota seeks new revenue with comprehensive tax bill
House File 1938 updates Minnesota conformity to the Internal Revenue Code through May 1, 2023. Previously, Minnesota had conformed to the federal law as of Dec. 15, 2022.
The legislation enacts numerous changes impacting individuals with higher income. First, there is the creation of a new net investment income tax of 1% on individual, trust and estate income in excess of $1,000,000. The tax is imposed on “net investment income” as defined in federal section 1411(c) which is the federal net investment income tax provision. However, the Minnesota definition excludes the net gain on agricultural homestead property (“class 2a property” under Minnesota section 273.13, subdivision 23.) The net investment income tax applies to residents, and nonresidents will be required to pro-rate the tax to Minnesota based on Minnesota-sourced net investment income to total net investment income. The net investment income tax will be imposed for tax years beginning after Dec. 31, 2023.
In addition, certain taxpayers with adjusted gross income (AGI) over $1,000,000 must reduce their otherwise allowable itemized or standard deduction by 80%. The phase-out of itemized deductions are revised as follows: itemized deductions of a taxpayer with AGI over $220,650 are reduced by the lesser of 3% of the excess of the taxpayer’s AGI over $220,650, but not over $304,970, plus 10% of the taxpayers adjusted gross income over $304,970; or 80% of the amount of the taxpayer’s itemized deductions. These provisions are effective for tax years beginning after Dec. 31, 2022. The listed threshold amounts are adjusted for inflation beginning in 2024.
Finally, residents that are the sole member of a disregarded limited liability company are considered to have paid the net income tax imposed by other states on the disregarded entity.
Pass-through entity provisions
The legislation allows more pass-through entities to elect the PTET. Originally, the state did not allow multi-tier partnership structures to make the election. Under the new law, a partnership may be eligible for the election if it is not a publicly-traded partnership. To be eligible, the partnership must have at least one “qualifying owner” to make the pass-through entity election (generally an individual). However, the election still can only be made by qualifying owners who collectively hold more than 50% of the ownership interests. The expansion of electing entities is effective for taxable years beginning after Dec. 31, 2022.
The bill also changes how partnerships electing the PTET determine income for the tax. Previously, residents were only taxed on their Minnesota-apportioned share of income for PTET. Under the new law, resident owners of an electing pass-through entity that is taxed as a partnership are included in the PTET calculation at 100% of their share of income, without regard to apportionment. Prior law taxed residents on their Minnesota apportioned share of income for PTET purposes. Note that this does not change the resident owner’s ultimate treatment on a Minnesota individual return and appears to only apply to partners in a partnership, not to S corporation shareholders. The PTET will also include qualifying owner’s net investment income tax.
For purposes of a composite filing, a partner’s tax liability includes the computation of net investment income tax liability under the new provisions. The change is effective with the imposition of the new tax.
The legislation also addresses federal audits, requiring partnerships that have been subject to a federal audit and that have made a pass-through entity election to file an amended pass-through entity return reporting the federal changes. The provision is retroactive to taxable years beginning after Dec. 31, 2020.
Finally, the bill creates a new credit against the tax imposed on a qualifying entity for PTET paid to another state. The credit may only be claimed by a qualifying owner in generally the same manner as Minnesota’s existing credit for taxes paid to other states. This provision expires when the $10,000 SALT cap expires.
Corporate and other provisions
Originally, the legislature was contemplating making Minnesota the first mandatory world-wide reporting state. Those provisions did not make it into the final version of the bill. Instead, the legislature decided to treat GILTI under section 951A as dividend income subject to the state’s dividend received deduction. However, the dividend received deduction has been reduced from 80% to 50% for a recipient who owns 20% or more of the stock. A 40% deduction will be allowed where the recipient owns less than 20% of the stock. This provision is effective for tax years beginning after Dec. 31, 2022.
The bill also limits the new operating loss deduction that may be utilized to 70% of taxable net income, effective beginning after Dec. 31, 2022. Under prior law, taxpayers could utilize 80%.
Even with the Democrats flipping the state senate in the 2022 election, and creating a trifecta in the process, the tax bill passed along a narrow margin of 34-33 in the senate and 69-63 in the house. Major revenue raisers in the bill include the changes to the multinational corporation provisions, the deduction changes for high-income taxpayers and the new net investment tax. However, most individual taxpayers will benefit from the legislation with favorable expansion to the social security subtraction, a permanent adoption of student loan discharge subtraction, certain other retirement benefit changes, and a number of credits including a child tax credit and a revised working family credit, among others.
Multinational businesses and high-earners will need to review the tax bill carefully. Taxpayers with questions about the changes are encouraged to speak with their Minnesota state and local tax professionals.