Minnesota taxes GILTI and net investment income, increases sales tax

Minnesota taxes GILTI and net investment income, increases sales tax 
 

On May 24, 2023, Minnesota Governor Tim Walz signed an omnibus tax bill, H.F. 1938, containing several new and increased taxes on businesses and individuals.¹ As discussed below, H.F. 1938 makes numerous changes, including taxing global intangible low-taxed income (GILTI), reducing the dividend received deduction (DRD) and the net operating loss (NOL) deduction limitation, imposing a tax on net investment income, and amending the pass-through entity (PTE) tax regime. H.F. 1938 also provides tax breaks and rebates for seniors, renters, property owners, and those with dependents. On the same day, Governor Walz also signed the omnibus transportation bill, H.F. 2887, which enacts a retail delivery fee and increases motor vehicle sales tax, license tab fees, and the Minneapolis-St. Paul metro-wide sales tax.² Through all of the legislation enacted during the recent session, nearly $10 billion in taxes/fees will be increased over the next four years.
 

Income taxes

The Internal Revenue Code (IRC) conformity date is advanced from Dec. 15, 2022, to May 1, 2023.³ This is effective May 25, 2023, except the changes are effective retroactively at the same time the changes were effective for federal purposes. By advancing the conformity date, H.F. 1938 adopts the federal SECURE 2.0 Act of 2022 relating to retirement plans that was enacted on Dec. 29, 2022^.4
 

Corporate franchise tax

H.F. 1938 contains several important corporate franchise tax changes that are effective for taxable years beginning after Dec. 31, 2022. Taxpayers are required to include amounts under IRC Sec. 951A, GILTI, as dividend income.⁵ Prior to amendment, taxpayers subtracted GILTI when computing their Minnesota corporate franchise tax and added the amount of foreign-derived intangible income (FDII) deducted under IRC Sec. 250. The legislation repeals the GILTI subtraction but retains the addition for the IRC Sec. 250 deduction.⁶ Also, the DRD is reduced from 80% to 50% if the recipient corporation owns 20% or more of the stock.⁷ The DRD is reduced from 70% to 40% if the recipient corporation owns less than 20% of the stock.⁸ Because GILTI is included as dividend income, taxpayers may apply the DRD against GILTI. In addition, the corporate NOL deduction limitation is reduced from 80% to 70%.⁹ These limitations make the DRD and NOL deduction less favorable than the deductions provided by most states.

 

Pass-through entity tax

For taxable years beginning after Dec. 31, 2022, various amendments are made to the elective PTE tax. As amended, the PTE tax base includes all the distributive share income of resident PTE owners.¹⁰ The income of a resident qualifying owner of a qualifying entity that is a partnership or limited liability company (LLC) taxed as a partnership for federal income tax purposes is not subject to allocation outside Minnesota.¹¹ However, the income of a nonresident qualifying owner of a qualifying entity and the income of a resident qualifying owner of a qualifying entity that is an S corporation are allocated to Minnesota as provided for nonresident partners and shareholders.¹²
 

H.F. 1938 expands the list of qualifying entities to include those with pass-through and corporate owners provided at least one of the owners is a qualifying owner (an individual, estate, or trust, or a disregarded entity with a qualifying owner as its single owner).¹³ Publicly traded partnerships are excluded from the definition of qualifying entity.¹⁴ Also, the legislation requires the exclusion of any owner of a PTE that is not a qualifying owner from the election requirements and clarifies that the election must be made by the owners who collectively hold a majority of the total ownership interest of qualifying owners.¹⁵ The legislation removes the requirement that the election may only be made if a qualifying owner’s SALT deduction is limited federally, and sunsets the PTE tax when the federal SALT deduction cap expires.¹⁶ Qualifying owners may claim a credit against the PTE tax for PTE tax paid to another state.¹⁷
 

Individual income tax

H.F. 1938 also includes income tax provisions directed at individuals. For taxable years beginning in 2024 and thereafter, the legislation imposes a 1% tax on the net investment income of individuals, trusts and estates that exceeds $1 million.¹⁸ Net investment income includes the sum of gross income for interest, dividends, annuities, royalties, and rents not derived in the ordinary course of business.¹⁹

For taxable years beginning in 2023 and thereafter, the legislation limits the itemized and standard deductions taxpayers earning over $220,650 may take, with sharper phaseouts of the deductions at higher income levels.²⁰ For taxpayers with adjusted gross income (AGI) over $1 million, the deductions are reduced by 80%.²¹ In addition, a subtraction of 100% of social security benefits is allowed for married taxpayers with AGI of $100,000 or less and single taxpayers with AGI of $78,000 or less.²² The subtraction is phased out for taxpayers with income exceeding these thresholds.²³
 

Effective retroactively to taxable years beginning in 2021, H.F. 1938 provides a one-time refundable tax credit to individuals equal to $260 per person, plus spouse, and up to three dependents, so that the maximum credit available for a family of five or more is $1,300.²⁴ The credit is available for married joint filers with AGI not greater than $150,000 and for all other income tax filers with AGI not greater than $75,000 (per the 2021 tax returns).²⁵ In addition, the angel investment tax credit is extended for two years and now is available through the 2024 tax year.²⁶ The legislation also allocates $5 million for the angel investment tax credit for the 2023 and 2024 tax years.²⁷ Also, H.F. 1938 enacts and modifies several individual income tax credits, including the child tax credit,²⁸ working family credit,[29] dependent care credit,³⁰ and Minnesota education credit.³¹

 

Sales and use taxes

H.F. 1938 allows approximately 30 cities/counties to enact local option sales taxes for specific projects.³² The legislation also exempts sales and use tax on the purchase of qualifying construction materials for certain construction projects by specific cities and school districts.³³
 

In the omnibus transportation bill, H.F. 2887, the state enacts several important sales and use tax provisions. First, for sales and purchases made on or after July 1, 2023, the sales tax on motor vehicles is increased from 6.5% to 6.875% of the purchase price.³⁴ For sales and purchases made on or after Oct. 1, 2023, H.F. 2887 imposes a 0.75% regional transportation sales and use tax within the seven-county Minneapolis-St. Paul metro area to fund transportation projects.³⁵ For taxes payable for a registration period starting on or after Jan. 1, 2024, the registration fees for passenger automobiles are increased.³⁶ For taxes imposed on or after Jan. 1, 2024, H.F. 2887 also indexes the gas tax for inflation.³⁷ The current gas tax is 28.5 cents per gallon and estimates indicate the index could result in a 5-cent increase by fiscal year 2027.³⁸
 

Effective July 1, 2024, H.F. 2887 also enacts a 50-cent delivery fee on tangible personal property subject to tax and on clothing, which in many cases is not subject to tax, when delivered to a person in Minnesota as part of a retail sale exceeding $100.³⁹ Minnesota’s fee is imposed on the retailer but may be passed on to the consumer.⁴⁰ Some items such as food ingredients, prepared food, baby products, and medical supplies are exempt from the delivery fee.⁴¹ Small businesses earning less than $1 million in revenue in the previous calendar year are exempt from collecting the fee.⁴² Revenue from the fee will be used to repair roads.⁴³ This fee is similar to Colorado’s 27-cent (soon to be 28 cent) retail delivery fee.⁴⁴

 

Commentary

H.F. 1938 and H.F. 2887 are key legislative bills that make up both the largest tax decrease and largest tax increase in Minnesota history. But they also are important for what they do not contain. For example, there are no provisions allowing for a subtraction of FDII under IRC Sec. 250. Also, the proposal to turn Minnesota into the only jurisdiction in the world to require corporate worldwide combined reporting was dropped from the bill by the conference committee. This surprising proposal generated national attention from media and taxpayers’ groups. Other proposals to increase the highest marginal individual income tax rate and to modify or eliminate the sales tax exemption on hardware and software purchased for use in a qualified data center did not pass.
 

Due to the rush to adjourn the legislative session by the constitutional deadline and the lack of hearings on the GILTI, NOL, and DRD provisions, several questions still remain. Minnesota will tax GILTI for tax years beginning on or after Jan. 1, 2023, without any inclusion of foreign sales in the sales factor denominator.⁴⁵ Query whether businesses may decide to file suit contesting the prima facie constitutionality of the law taxing foreign income without any sales factor relief.
 

The reduction of the limitation of the corporate NOL deduction from 80% to 70% is effective for tax years beginning Jan. 1, 2023, per bill language. However, the fiscal spreadsheet noting the revenue impact indicates it is effective for tax years Jan. 1, 2024, and beyond. There has been some discussion among legislators, staff, and lobbyists that this was a drafting error and the intention was for the provision to become effective Jan. 1, 2024, per the fiscal analysis. It remains to be seen if Governor Walz will call a special legislative session to correct this oversight or if the tax committee chairs might send a letter of intent to the Minnesota Department of Revenue representing that the NOL provision’s effective date was drafted in error and that the legislature intends to correct it the next time it is in session.
 

The retail delivery fee will need to be accounted for by retail businesses in the sales tax software and invoicing software they use. While the sale of clothing is exempt from sales tax, it will be subject to the delivery fee. An out-of-state clothing retailer may technically have nexus with Minnesota but not be registered or file a sales tax return, since clothing is exempt from sales tax. However, under the new retail delivery fee, an out-of-state clothing retailer may now need to register, file a return, and remit the 50-cent delivery fee for every transaction over $100 delivered to a Minnesota address.
 

Unfortunately, the 2023 Minnesota legislature failed to address much-needed changes to the definition of a Minnesota resident trust under Minn. Stat. Sec. 290.01, subd. 7b that came to light in the Minnesota Supreme Court’s 2018 decision in Fielding v. Commissioner.⁴⁶ In this case, the court held that one of the definitions of a resident trust was unconstitutional, stating that neither past Minnesota residency of the grantor nor current Minnesota residency of a trust beneficiary establishes “the necessary minimum connection to justify taxing the Trusts’ income.”⁴⁷ This marks the fifth legislative session since the Fielding decision where the Minnesota legislature did not address this issue, adding unnecessary uncertainty for those looking to create a trust with some connection to the state.

 

1 Ch. 64 (H.F. 1938), Laws 2023.

2 Ch. 68 (H.F. 2887). Laws 2023.

3 Minn. Stat. §§ 289A.02, subd. 7; 290.01, subd. 19(f), subd. 31; 290A.03, subd. 15; 291.005, subd. 1(3).

4 This was enacted as part of the Consolidated Appropriations Act, 2023, Div. T. Pub. L. No. 117-328.

5 Minn. Stat. § 290.21, subd. 10.

6 Minn. Stat. § 290.0131, subd. 18; H.F. 1938, Art. 1, § 53, repealing Minn. Stat. § 290.0134, subd. 17.

7 Minn. Stat. § 290.21, subd. 4(a). Note that the remaining 50% of dividends may be deducted if: (i) the dividends received are the stock in an affiliated company transferred in an overall plan of reorganization and the dividend is eliminated in consolidation; (ii) the dividends are received from a corporation which is subject to tax as an investment company and which is a member of an affiliated group of corporations and the dividend is eliminated in consolidation or is deducted under IRC Sec. 243(b) (qualifying dividends); or (iii) the dividends are received from a property and casualty insurer which is a member of an affiliated group and the dividend is eliminated in consolidation or is deducted under IRC Sec. 243(b).

8 Minn. Stat. § 290.21, subd. 4(b).

9 Minn. Stat. § 290.095, subd. 2(c).

10 Minn. Stat. § 290.01, subd. 19(h), (i).

11 Minn. Stat. § 289A.08, subd. 7a(a)(1).

12 Id.

13 Minn. Stat. § 289A.08, subd. 7a(a)(2), (3).

14 Minn. Stat. § 289A.08, subd. 7a(a)(2).

15 Minn. Stat. § 289A.08, subd. 7a(b).

16 Minn. Stat. § 289A.08, subd. 7a(b), (l).

17 Minn. Stat. § 290.06, subd. 23a.

18 Minn. Stat. § 290.033.

19 Minn. Stat. § 290.033(a). This statute generally adopts the definition of “net investment income” provided by IRC § 1411(c).

20 Minn. Stat. §§ 290.0122, subd. 2; 290.0123, subd. 5.

21 Id.

22 Minn. Stat. § 290.0132, subd. 26.

23 Id.

24 H.F. 1938, Art. 1, § 49.

25 Id.

26 Minn. Stat. § 116J.8737, subd. 12; H.F. 1938, Art. 1, § 51, reviving and reenacting expired provisions in Minn. Stat. §§ 116J.8737; 290.0692.

27 Minn. Stat. § 116J.8737, subd. 5(i)(2).

28 Minn. Stat. § 290.0661.

29 Minn. Stat. § 290.0671.

30 Minn. Stat. § 290.067.

31 Minn. Stat. § 290.0674.

32 H.F. 1938, Art. 10, §§ 10–50.

33 H.F. 1938, Art. 5, §§ 12–32.

34 Minn. Stat. § 297B.02, subd. 1.

35 Minn. Stat. §§ 297A.9915; 473.4465.

36 Minn. Stat. § 168.013.

37 Minn. Stat. §§ 296A.07, subd. 3(b); 296A.08, subd. 2(b).

38 Briana Bierschbach, Jessie Van Berkel and Janet Moore, Minnesota DFL legislators agree to index gas to inflation, Star Tribune, May 20, 2023.

39 Minn. Stat. §§ 168E.01–168E.09.

40 Minn. Stat. § 168E.03.

41 Minn. Stat. § 168E.05, subd. 1.

42 Minn. Stat. § 168E.05, subd. 2.

43 Minn. Stat. § 168E.09,

44 Colo. Rev. Stat. § 43-4-218. For further discussion of the Colorado retail delivery fee, see GT SALT Alert: “Colorado’s retail delivery fee effective July 1.”

45 Note that Minnesota excludes dividends from the sales factor. Minn. Stat. § 290.191, subd. 5(a)(2).

46 916 N.W.2d 323 (Minn. 2018).

47 Id. at 331.

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