July 20, 2021
Minnesota enacts elective pass-through entity tax and IRC conformity provisions
Minnesota Governor Tim Walz signed House File 9 (HF 9), an omnibus tax bill that: (1) conforms certain provisions of state income tax law to the Internal Revenue Code (IRC); (2) establishes a new elective pass-through entity tax (SALT deduction limitation "workaround"); (3) requires reporting federal partnership audit adjustments to Minnesota tax authorities; and (4) modifies certain Minnesota tax credit and incentive programs.
In January 2021, Governor Walz proposed significantly increasing Minnesota's individual income and capital gains taxes on high-income individuals, increasing the state's corporate income tax rate, and subjecting previously-taxed foreign income to Minnesota corporate income tax. The Governor modified these proposals in March 2021, dropping the proposals increasing the corporate income tax rate and focusing instead on the individual tax rate increases on high-income individuals. None of the Governor's proposals, however, were ultimately included in HF 9, which he signed on July 1, 2021.
Minnesota conformity to the IRC
Minnesota is a fixed date conformity state and HF 9 retains its general conformity to the IRC as of December 31, 2018. HF 9 also conforms Minnesota's income tax law to select provisions of the IRC that have been enacted since that date, including those that:
In addition, HF 9 conforms state law to the most current IRC provisions on:
These IRC conformity provisions have various effective and applicability dates.
HF 9 also clarifies that no state addition is required for the IRC Section 179 expense deduction claimed for tax year 2020 and thereafter.
SALT deduction limitation "workaround"
HF 9 establishes an electable Minnesota pass-through entity tax (PTE tax) effective for tax years beginning after December 31, 2020. The new Minnesota PTE tax is designed to apply where the state and local tax deductions of a qualifying owner for federal income tax purposes are otherwise limited by IRC Section 164 (i.e., the federal SALT deduction limitation). In such a case, under the new law qualifying entities (i.e., partnerships, S corporations and limited liability companies) may elect to file a return at the entity level and pay the PTE tax.
The election, once made, is irrevocable for the tax year, and: (1) must be made on or before the due date (or extended due date) of the qualifying entity's PTE tax return; (2) may only be made by qualifying owners who collectively hold more than a 50% ownership interest in the qualifying entity; and (3) is binding on all qualifying owners who have an ownership interest in the qualifying entity. The PTE tax imposed on a qualifying entity equals the sum of the tax liability of each qualifying owner. For both resident and nonresident individuals the income liability is the amount of the owner's income allocated and assigned to Minnesota as provided for nonresident partners and shareholders under Minnesota Statutes 290.17, 290.191, and 290.20 and then multiplied by the highest Minnesota income tax rate for individuals. In determining a qualifying owner's tax liability, nonbusiness deductions, standard deductions and personal exemptions are not included. Further, a credit or deduction is allowed only to the extent allowed to a qualifying owner in determining the owner's PTE tax. The credit or deduction amount used to determine the owner's PTE tax liability also must be used to calculate the owner's income tax liability.
A qualifying owner of a PTE electing to pay the PTE tax may claim the amount of its Minnesota income tax liability as a credit. If the credit exceeds the owner's Minnesota tax liability, the excess will be refunded to the owner. Qualifying owners are required to make estimated payments of PTE tax in the same manner as Minnesota composite return filers.
HF 9 also treats the PTE tax return as a composite return and the qualifying entity filing a PTE tax return as a partnership filing a composite return. For purposes of penalties, paying the PTE tax and filing a PTE tax return are considered the payment and filing of a corporate tax. Under HF 9, the Minnesota withholding rules do not apply to nonresident partners in a partnership and nonresident shareholders of an S corporation that elect to file and pay the PTE tax.
Conformity to federal partnership audit rules
HF 9 adopts requirements for reporting federal partnership audit adjustments to the Minnesota Department of Revenue (Department) and allows tax assessments to be paid at the entity level. Under the new rules, generally, within 90 days after the final determination date of a final federal adjustment, an audited partnership must file a federal adjustment report with the Department and notify each of its direct partners of their distributive share of the final federal adjustment. Direct partners will have 180 days to file a federal adjustments report on their distributive share of reported adjustments and pay the additional Minnesota tax, penalty and interest due.
An audited partnership that originally reported or paid Minnesota income tax on behalf of some or all of its partners through a composite return or a withholding report must file an amended composite return/withholding report and pay the additional tax, penalty and interest due. This must be done no later than 90 days after the final determination date. Alternatively, an audited partnership can make an irrevocable election to pay the assessed tax, penalty and interest due at the entity level. If the election is made, the partnership will have 180 days after the final determination date to pay the additional Minnesota tax owed. These reporting and payment provisions, including the payment election, apply to direct and indirect partners of an audited partnership that are tiered partners and all of the partners of such tiered partners that are subject to Minnesota income tax.
These provisions are retroactively effective for tax years beginning after December 31, 2017, except for partnerships making an election under Treas. Reg. Section 301.9100-22T (i.e., those that made an early election into the federal partnership audit regime). For those making that election, the provisions are retroactively effective and apply to the same tax periods to which the election relates.
Tax credits and incentives
HF 9 modifies various Minnesota tax credits and incentives provisions. It extends by one year through 2022 the sunset date of the state's small business investment tax credit (the angel credit) and allocates $5 million to the credit for tax years beginning in 2022 (reduced from the $10 million allocated to the credit pre-2022). It also extends by one year through 2022, the sunset date of the Minnesota historic structure credit.
HF 9 establishes a Minnesota film production tax credit of 25% of eligible production costs paid during the tax year. Taxpayers may claim the credit against Minnesota income, franchise and premium tax; the amount claimed is limited to the tax liability. They may carry forward any unused credit for up to five years. To claim this credit, a taxpayer must be issued a credit certificate from the Minnesota Department of Employment and Economic Development. The taxpayer can assign the credit certificate to another taxpayer but the assignment is not valid unless the assignee notifies the Minnesota revenue commissioner within 30 days of the date of assignment. The total amount of credit available in a year is $4.95 million; credits will be allocated on a first-come, first-served basis. The film production tax credit is available for 2021 through 2024.
HF 9 also establishes the Minnesota housing tax credit, which can be claimed against Minnesota income, franchise and premium tax. The credit is 85% of a contribution to the housing tax credit contribution account. Contributions can range from $1,000 up to $2 million. The credit is nonrefundable but taxpayers can carry forward any unused credit for up to 10 years. The credit is available for tax years 2023 through 2028.
Lastly, the new law establishes the Minnesota Tax Expenditure Review Commission, which is required to review the state's tax expenditures and evaluate their effectiveness and fiscal impact.
The changes to Minnesota income tax law enacted by HF 9 were more modest than those originally proposed by Governor Walz. Taxpayers will need to consider the application of the selective IRC conformity updates for federal provisions enacted after December 31, 2018. Taxpayers operating through PTEs may want to consider the application of the elective PTE tax to mitigate the effects of the federal SALT deduction limitations on individual investors as well as Minnesota's conformity to the federal partnership audit rules.