Minnesota Governor’s Proposal Hits Real Estate Sector With Sales Tax Hike

Minnesota Governor’s Proposal Hits Real Estate Sector With Sales Tax Hike

Governor Mark Dayton recently issued his proposed budget priorities, which includes increasing individual income taxes, expanding sales taxes, and lowering real estate and corporate income taxes. These tax changes may significantly affect construction contractors, design and engineering professionals, landlords, and tenants.

“While this is just the legislative session’s first argument in a long tax policy debate, it signals key fiscal objectives that include substantial tax payment and compliance burdens for real property related businesses,” says Perry McGowan, a tax director with CliftonLarsonAllen’s construction and real estate group.

Sales and use taxes

The proposed reforms include a general sales tax rate decrease from 6.875 percent to 5.5 percent. However, the sales tax would be applied to a much broader range of transactions that are routine to real estate businesses, hitting all segments of real estate industries with dramatic consequences.

The governor’s proposed expansion of the sales tax base would target purchases after January 1, 2014, including:

• Engineering and architecture
• Design services, including interior, exterior, landscape, industrial, and graphic
• Consulting, such as marketing, environmental, scientific, technical, research, and administrative. This includes services applicable to real estate development and redevelopment, but excludes services by a licensed real estate broker, closing agent, or appraiser
• Real estate development services, including cleaning, safety, and security, but excluding some environmental, sanitation, and remediation
• Construction services, excluding qualified labor for improvement of real property, whether it is site preparation, new construction, additions, alterations, repairs, or demolition. Only defined construction labor is excluded, so construction companies should expect other labor and other services to be taxable (construction materials remain taxable)
• Market research, polling, photographic work, advertising materials, publication, and translation services, including work for real estate promotion, leasing, and brokerage
• Temporary help, placement, executive search, and professional employer organization services
• Business services, such as legal, accounting, computer, management consulting, business support, and other personal services purchased by a business (not yet specifically described)

Effect on real property industries

“It appears the architect and engineering sectors, which are just getting back on their feet after a long and brutal recession, are in the crosshairs on this proposal and most of their services will become taxable,” says McGowan. “Construction contractors doing design-build work may also be swept up in the net, even if construction labor continues to be excluded. The extent of the exemption for construction labor is unknown. Certain management consulting will become taxable, and this might include construction management services. In addition, some ‘business support services’ that a building owner charges a tenant may become taxable revenue if they are invoiced separately from the rent,” he adds.

All businesses will have budgeting concerns because their sales tax obligations on many business services they buy (e.g., legal, accounting, and design fees) will become taxable. Equipment repair labor also appears slated for taxation.

“The issue of sales tax compounding when a business owner uses subcontractors has not been addressed. It is possible that in some cases, clients may want to contract for selected services before the legislation passes,” says McGowan.

As an example, an architecture business with $20 million of annual revenue may need to charge over $1 million in additional sales tax in 2014. As high as that seems, the number could be higher if subcontracting is involved (a routine practice in real estate project work).

“The large additional tax burdens may leave some projects on the drawing board,” notes McGowan.

While the tax is substantial, the complexity of compliance should also not be overlooked. An introduction to South Dakota, a neighboring state with existing service taxation, illustrates the challenges of compliance. It may be helpful to review their guide for sales tax on architect, engineer, and surveyor services.

Other budgetary tax proposals

True to his campaign pledges, the governor has included a tax rate increase on high-income individuals. Similar to recent federal reforms, the top 2 percent of state income earners would see an increased tax, while individuals at lesser income levels would have no change. The rate changes include:

• Top individual rate increase from 7.85 percent to 9.85 percent in 2014, but only for those earning more than $250,000 of taxable income for joint filers ($150,000 for single filers)
• Top corporate rate decrease from 9.8 percent to 8.4 percent
• Doubling of the tobacco taxes

The individual tax rate increase is in line with the governor’s campaign pledge. Expectations for the DFL-controlled legislature suggest the rate increase will be at least partially implemented. There is also a proposal to treat snowbirds as part-year residents if they spend 61 to 182 days in the state and maintain an abode here for at least six months.

The proposal includes good news for homeowners, who would have their real estate taxes reduced and receive a $500 annual credit.

How we can help

All of these budget proposals will likely result in a vigorous debate in the coming months. The best ways to have your concerns addressed are to participate in trade associations and contact your elected representatives. Contact your tax professional for updates and guidance on how to address these changes for your business.

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Perry McGowan, Tax Director, Construction and Real Estate Group
perry.mcgowan@cliftonlarsonallen.com or 612-376-4632