Recent Minnesota Tax Law Changes

Reprinted with permission from Cory Wessman, attorney and shareholder of Erickson & Wessman, P.A.
On May 23, 2013, Minnesota Governor Mark Dayton signed an Omnibus Tax Bill into law. Little has been written about the impact on high wage earners as well as for those Minnesotans who intend to make large lifetime gifts and for those Minnesota nonresidents who own significant property in Minnesota. However, the changes are potentially significant. The key points are as follows:

  • Income Tax. Minnesota income tax rates increase retroactively to January 1, 2013 for the state’s highest income earners. For Minnesotans with taxable income over $250,000 (or $150,000 for singles) the top income tax rate is now 9.85%, increased from 7.85%. The Minnesota alternative minimum tax rate also increases from 6.4% to 6.75%.
  • New Gift Tax. Minnesota now has a gift tax. Starting July 1, 2013, a Minnesota resident or a nonresident owning property located in Minnesota may make total lifetime “taxable gifts” of up to $1.0 million, during lifetime, free of any Minnesota gift taxes. Any total lifetime “taxable gifts” in excess of this $1.0 million exemption amount are subject to a 10% rate. The following types of gifts are not considered “taxable gifts” for Minnesota gift tax purposes: (1) gifts to spouses and charities; (2) certain transfers made on behalf of family members for medical or educational expenses; and (3) so-called “annual exclusion gifts” (total gifts made to a beneficiary in a particular calendar year not exceeding $14,000 in value).
  • Three-Year “Look Back” Rule For Lifetime Gifts. The law includes a three year “look-back” rule as it relates to any “taxable gifts” made within three years of death.[1] If an individual makes a “taxable gift” within three years of his or her death, the gift will be considered part of the “taxable estate” for determining the Minnesota estate tax liability. However, if an individual makes a gift at least 3 years before his or her death, the value of this gift will not reduce such individual’s Minnesota estate tax exemption. In such an event, the individual would hold the right to make total lifetime gifts of $1.0 million free of Minnesota gift taxes as well as distributions of up to $1.0 million free of Minnesota estate taxes following death.[2] The new law does not change the estate tax exemption amount ($1.0 million per person) or the estate tax rates (average rate of about 10%, with the highest marginal rate being 16%).
  • Expanded Reach of Estate Tax to Nonresidents. The law expands the reach of the Minnesota estate tax so that the tax will apply to all nonresidents of Minnesota who die with real estate or tangible property of at least $1.0 million physically located in Minnesota. Previous to this legislation, nonresidents who owned real estate, inventory or equipment located in Minnesota through a “pass-through entity,” such as a Subchapter S Corporation, partnership, LLC or trust, were not subject to the Minnesota estate tax. Now, under the new law, such “pass through entities” are disregarded, and the nonresident owner of a pass-through entity that owns such real estate, inventory or equipment will be deemed to own such assets in proportion to their ownership interest in the “disregarded entity.”

Basic Case Study

To illustrate the impact of these new rules, consider the following basic case study.[3] Mr. Taxpayer is a Minnesota resident and owns the following assets:

$ 500,000 Traditional IRA
$ 1,000,000 Taxable Investment Account
$ 500,000 Home
$2,000,000 Total

Scenario 1:
Mr. Taxpayer gifts his entire taxable investment account (valued at $1.0 million) to his children on September 1, 2013. He dies on September 1, 2018. Following his death, Mr. Taxpayer’s family would pay no gift or estate taxes. This is because the value of the 2013 gift does not exceed the $1.0 million state gift tax exemption amount, and the family would also be able to make full use of Mr. Taxpayer’s remaining $1.0 million Minnesota estate tax exemption.

Scenario 2:
Mr. Taxpayer gifts his entire taxable investment account (valued at $1.0 million) to his children on September 1, 2013. He dies on September 1, 2014. In this case, the $1.0 million gift made in 2013 would be considered part of the “taxable estate” for Minnesota estate tax purposes because the gift he made was within three years of his death. The approximate estate tax liability would therefore be approximately $100,000.

There are several technical issues related to this law that have not been summarized in this brief overview. Also, the Minnesota Revenue Department has yet to provide additional guidance on some of these technical issues, which may impact a recommendation for a particular individual’s situation. However, since the new law becomes effective on July 1, 2013, individuals who are in a position to do so may consider making substantial gifts before July 1. If you have questions or concerns about how the new tax law might impact you, please do not hesitate to contact us with specific questions or concerns.

FOOTNOTES:

[1] This three year “look back” rule is retroactive to January 1, 2013.
2 If the individual’s estate is subject to Minnesota estate taxes following death, then the value of the gifts made during lifetime will impact the total estate tax liability.
3 For this basic illustration, we will assume no change in asset value during the time periods reference and that current state and federal estate and gift tax laws remain intact.