Minnesota enacts income, pass-through, investment, and sales tax changes

UPDATE: On July 7, 2023, the Department issued a statement providing that the tax legislation included a drafting error inadvertently using 2019 standard deduction amounts for individual taxpayers for the 2024 tax year.  The Department "will pursue a correction to the tax bill in the 2024 legislative session. No taxpayers are impacted by this drafting error for the current 2023 tax year. If an update is made during the 2024 legislative session, no taxpayers would see an impact to their tax filing due to this drafting error."

In brief

H.F. 1938, enacted on May 24, makes several changes to the corporate income tax applicable starting with the 2023 tax year, including a reduction in the state’s DRD percentages, subjecting a taxpayer’s GILTI to tax, and decreasing from 80% to 70% the amount of taxable net income on which NOLs can be applied. 

The bill makes changes applicable starting with the 2023 tax year to the pass-through entity (PTE) tax that (1) allows LLCs taxed as S corporations to make the PTE election and (2) provides allocation guidance for resident and nonresident owners.

In addition, the bill creates a new net investment tax starting in 2024 on individuals, estates, and trusts equal to 1% of net investment income over $1 million.

The bill modifies individual itemized and standard deduction phaseouts. 

H.F. 2887, also enacted on May 24, imposes a retail delivery fee and a metro regional sales tax surcharge.

The takeaway: The Minnesota Democratic-controlled legislature and Governor’s office produced a session of legislation, much of which had been blocked by the prior Republican-controlled legislature. Earlier in the session, a mandatory worldwide filing regime for corporations was proposed; however, after a public reaction, this was dropped. Instead, the budget gap was filled, in part, by the corporate GILTI, dividend, and NOL changes noted above. The changes related to the PTE allow for more “qualifying entities” to participate in the election, as previously the election was not available for qualifying entities that had a partnership, limited liability company (other than a disregarded entity), or a corporation as a partner, member, or shareholder. Finally, Minnesota is the second state after Colorado to enact a retail delivery fee. 

[Minnesota H.F. 1938 (5/24/23)] 

[Minnesota H.F. 2887 (5/24/23)]  

Pass-through entity (PTE) tax  

Minnesota’s PTE tax allows an entity to pay an elective tax on behalf of its partners, members, or shareholders. The PTE tax election is available for an entity’s tax years beginning after December 31, 2020. 

Applicable for tax years beginning after December 31, 2022, H.F. 1938 makes several changes to the PTE tax, including that a “qualifying entity” includes a limited liability company (LLC) “taxed as a partnership or S corporation.” In addition, a qualifying entity is required to only have at least one “qualifying owner.” The definition of “qualifying owner” was expanded to include “a disregarded entity that has a qualifying owner as its single owner.” 

Observation: Prior to H.F. 1938, a qualifying entity included an LLC; however the law provided no further guidance in terms of the tax treatment type of the LLC. H.F. 1938 provides that a qualifying LLC taxed as a partnership or S corporation may make the PTE election. In addition, more entities may qualify to elect the PTE tax because of the expanded definition of “qualifying entity.” For example, a qualifying entity with a corporation or partnership as one of its owners may qualify if at least one other owner is a “qualifying owner.”   

Also applicable for tax years beginning after December 31, 2022, H.F. 1938 makes the following allocation distinctions between resident and nonresident owners: 

• The income of a resident owner of a qualified (1) partnership or (2) LLC taxed as a partnership is not subject to allocation outside Minnesota.
• The income of a resident owner of (1) an S corporation or (2) qualified subchapter S subsidiary is subject to allocation treatment.

Observation: Prior to H.F. 1938, a resident owner of a multistate PTE only received benefit of PTE taxation on its apportioned share of income. As many other state PTE taxes allow residents to have their entire share of partnership income taxed at the PTE, this law change should put Minnesotans on a more level playing field with residents of other states with PTE taxes. 

Individual income tax 

Individual itemized and standard deduction phaseouts modified  

Applicable for tax years beginning after December 31, 2022, H.F. 1938 modifies the itemized and standard deductions of a taxpayer with adjusted gross income over $220,650, to be reduced by the lesser of: (1) three percent of the excess of the taxpayer's adjusted gross income over $220,650 but not over $304,970; plus ten percent of the taxpayer's adjusted gross income over $304,970; or (2) 80% of the amount of the taxpayer's itemized deductions.

For a married individual filing a separate return, the reduction must be calculated using one-half of the adjusted gross income amounts specified.

For filers with AGI over $1 million, a taxpayer's itemized deductions are reduced by 80%.