On May 24, 2023, Minnesota Governor Tim Walz signed the omnibus tax bill, House File 1938 (HF 1938), which imposes new taxes on multinational corporations, as well as individuals with net investment income over $1 million. The more significant income tax changes included in HF 1938 are discussed below.

IRC conformity

HF 1938 updates Minnesota's IRC conformity date to May 1, 2023 (from December 15, 2022). This IRC conformity change is effective the day after the final enactment of HF 1938, except Minnesota tax law changes that incorporate federal changes are effective retroactively to the date the changes were effective for federal purposes.

Dividends received deduction (DRD)

For tax years beginning on or before December 31, 2022, Minnesota allows a deduction from taxable net income (i.e., income after allocation and apportionment) for dividends received from domestic and foreign corporations. Corporations that are at least 20% owned by the recipient of the dividend may claim an 80% DRD. Those owning less than 20% may claim a 70% DRD.

The legislature considered aligning the ownership thresholds with those in the Tax Cuts and Jobs Act (TCJA), which provides for a 65% and 50% DRD for dividends from at least 20%-owned and less-than-20%-owned corporations, respectively. Instead, HF 1938 reduces the deduction percentages even further to 50% and 40%, respectively. This change is effective for tax years beginning after December 31, 2022.

Global intangible low-taxed income (GILTI)

Minnesota previously decoupled from the federal treatment of GILTI. Effective for tax years beginning after December 31, 2022, HF 1938 conforms to the federal treatment of GILTI, except Minnesota does not allow an IRC Section 250 deduction. GILTI is classified as dividend income for Minnesota purposes and, thus, is subject to the revised Minnesota DRD provisions discussed previously (i.e., a Minnesota DRD will apply to the extent of the relevant ownership thresholds).

Corporate net operating losses (NOLs)

Effective for tax years beginning after December 31, 2022, HF 1938 decouples from the federal 80% limitation on corporate NOLs, which was enacted under the TCJA, by limiting the NOL deduction for Minnesota purposes to 70% of taxable income in a given year (with unused amounts still being carried forward).

PTET

Starting in 2021, Minnesota adopted an elective PTET intended to comply with the requirements of IRS Notice 2020-75 (see Tax Alert 2021-1393). The PTET applies as if the electing pass-through entity were a C corporation (i.e., tax is imposed at the entity level on the owners' distributive share of income apportioned to Minnesota). Effective for tax years beginning after December 31, 2022, HF 1938 modifies the PTET base to include a resident owner's unapportioned distributive share of income.

HF 1938 also makes the following changes to the PTET:

• Modifies the definition of a "qualifying entity" to (1) clarify a qualifying limited liability company is one taxed as either a partnership or an S corporation, and (2) replace the entities that are not a "qualified entity" (i.e., partnership, LLC or corporation that has a partnership, LLC other than a disregarded entity, or corporation as a partner, member or shareholder) with a publicly traded partnership
• Expands the definition of "qualified owner" to include a disregarded entity that has a qualifying owner as its single owner
• Ends the PTET when the federal limitation on the state and local tax deduction under IRC Section 164(b)(6)(B) expires (currently set to expire after 2025)
• Requires taxpayers, for purposes of credits and deductions, to compute their federal adjusted gross income (AGI) without any deduction for specified income tax payments as defined in Notice 2020-75 and substantiate that computation
• Allows a qualifying owner to claim a credit against the PTET imposed on a qualifying entity for a PTET paid to another state, until IRC Section 164(b)(6)(B) expires

There had been an effort to make these changes retroactive, but those provisions were removed from the final version of the legislation.

Individual income taxes — standard and itemized deductions

Effective for tax year 2023, HF 1938 modifies the existing phaseout of standard and itemized deductions for high-income earners by adding two new thresholds. The standard and itemized deductions for individual taxpayers with AGI over $220,650 will decrease by the lesser of 3% percent of the excess of the taxpayer's AGI over $220,650 (but not over $304,970), plus 10% over $304,970, or 80% of the standard or itemized deduction. The deduction will decrease by 80% for those with AGI over $1 million.

Net investment income tax

Effective for tax year 2024, HF 1938 imposes a new 1% tax on net investment income over $1 million for individuals, estates and trusts. "Net investment income" includes interest, dividends, annuities, royalties and other gains not derived from a trade or business but excludes gains from agricultural land sales. A nonresident's tax liability is based on a ratio of net investment income from Minnesota sources over total net investment income.

Implications

HF 1938 classification of GILTI as a dividend creates parity in the treatment of the two income sources and aligns Minnesota with GILTI policy in most states. The changes to the DRD thresholds and NOL rules will also impact corporations by potentially increasing Minnesota cash tax liabilities starting in 2023 and 2024, respectively. Resident owners of pass-through entities will want to consider the changes made to the elective PTET.

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Published by NTD’s Tax Technical Knowledge Services group; Jennifer A Brittenham, legal editor