The new Minnesota income tax law strengthens conformity with federal tax reform, and that could mean individuals and businesses will have to revisit tax returns that have already been filed.
Minnesota Governor Tim Walz has signed a 2019 omnibus tax bill that brings more of the state’s income tax provisions into conformity with federal law. Many individual and business taxpayers may have to amend their 2018 Minnesota returns (or adjust if not already filed under extension) to account for this retroactive alignment with federal law.
2019 First Special Session H.F. 5 (H.F. 5) focuses primarily on which provisions of the Tax Cuts and Jobs Act of 2017 (TCJA) that Minnesota conforms to. It is unusually complex, caused by the state’s previously near-total nonconformity with the TCJA and the failure to pass tax legislation in 2018. Inaction last year produced a burdensome process for preparing 2018 Minnesota individual and business tax returns that were either filed or extended in spring 2019.
The new tax law is designed to produce “net zero” spending, meaning that all revenues that it raises are offset by either tax relief or higher spending on tax aids and credits. However, it achieves this result largely by raising taxes on businesses and lowering taxes on individuals, and it does so by conforming primarily to TCJA provisions that increase the tax base for businesses while lowering it for individuals. As a result, H.F. 5 does not appear to reflect a single, unifying approach of generally either conforming or not conforming to the provisions of the TCJA.
Impact on individual taxpayers
In general, H.F. 5 should decrease the Minnesota individual income tax liability of most taxpayers, and is projected to reduce individual income tax revenues by more than $530 million during fiscal year 2020-21. It accomplishes this primarily through its conformity to the increased standard deduction used by the TCJA, and through the following, all first effective for the 2019 tax year:
Download additional highlights of H.F. 5’s conformity to federal tax reform provisions affecting individuals.
- An increase in the Social Security subtraction from $4,700 to $5,150 for married taxpayers filing jointly
- An expansion of the working family tax credit
- A reduction in the second-tier tax rate from 7.05 percent to 6.8 percent
Perhaps the most significant adjustment for individuals was to change the starting point for computing state taxable income from federal taxable income (FTI) to federal adjusted gross income (AGI), bringing Minnesota in line with most other states.
Even though this eliminated the need for Minnesota law to automatically follow federal changes to the standard and itemized deductions, H.F. 5 enacted a Minnesota-specific standard deduction that matches the amounts used under the TCJA. Under prior Minnesota law, the standard deduction for a married couple filing joint (MFJ) was $13,000; H.F. 5 raises it to $24,400. There is also a Minnesota-specific itemized deduction, with provisions generally matching those under the TCJA.
H.F. 5 makes the $4,250 per-dependent exemption permanent and eliminates all personal exemptions. These changes, along with the change from FTI to AGI and the enactment of Minnesota-specific standard and itemized deductions, are also first effective for the 2019 tax year.
Impact on pass-through businesses and their owners
Because Minnesota changed the starting point for calculating individual income taxes from FTI to AGI, H.F. 5 continues Minnesota’s nonconformity to the qualified business income (QBI) deduction under IRC Section 199A. H.F. 5 also conforms to the TCJA’s limitation on the use of active losses from one business to reduce other income (e.g., wages, investment income, or income from another business) to $500,000 for married taxpayers filing jointly and $250,000 for others.
Impact on most businesses
In fiscal year 2020-21, H.F. 5 is expected to raise revenue of up to $730 million from Minnesota businesses, primarily through its conformity with provisions of the federal tax law that increase the income tax base of business entities. Perhaps the most significant of these provisions is the cap on the net interest expense deduction under IRC Section 163(j), and the limitation on the deductibility of net operating loss (NOL) carryforwards to 80 percent of taxable income in the carryforward year.
However, the new law also conforms to several components of the TCJA that reduce taxable income, such as its expansion of the types of property that qualify for bonus depreciation and Sec. 179 expensing, and its expansion of taxpayers’ eligibility to use the cash method of accounting. On the other hand, the new law also retains Minnesota’s historical approach of adding back 80 percent of the bonus depreciation and Sec. 179 deductions and amortizing that add-back over the following five tax years.
H.F. 5 does not bring conformity to any of the TCJA’s provisions governing companies with international operations, such as foreign-derived intangible income (FDII), global intangible low-taxed income (GILTI), or the so-called repatriation toll charge under IRC Section 965.
Federal conformity may mean amending 2018 returns
H.F. 5’s TCJA conformity provisions are effective retroactively to the date that those provisions became effective at the federal level. Because most of these federal provisions first became effective for tax years beginning on or after January 1, 2018, Minnesota’s conformity to the TCJA is generally also effective for the 2018 tax year.
Even though this conformity to the TJCA provides much-needed administrative simplicity, its retroactivity to 2018 is complicated by the fact that many individual and business taxpayers have already filed their 2018 Minnesota returns and others have extended them.
Except for a limited safe harbor called the “special limited adjustment to tax,” which only protects certain individuals and partnerships that filed on a composite basis and only for a limited number of TCJA provisions, this retroactive conformity will require many taxpayers to amend their 2018 Minnesota returns. It will also require taxpayers who have extended their 2018 Minnesota returns to incorporate these new conformity items into the returns that are ultimately filed.
H.F. 5 does not provide any guidance regarding when affected taxpayers who have already filed their 2018 returns must amend them to reflect the retroactive federal conformity, or whether they must wait for a revised version of the 2018 amended return form.
The law also does not offer any guidance on when the Minnesota Department of Revenue (MDR) will provide revised versions of the 2018 returns, or whether those revisions will be available in time for affected taxpayers to file them by the extended due dates.
Because the MDR typically requires up to nine months after a legislative change to issue the related final forms, it seems unlikely that revised 2018 forms will be available by the extended due date.
What H.F. 5 does offer is limited penalty relief relating to underpayment of estimated taxes stemming from federal conformity, though it seems unlikely to benefit taxpayers who owe significantly more tax. For taxpayers who attest in writing that an underpayment of estimated taxes under than $1,000 was caused by uncertainties in tax planning resulting from the enactment of federal tax reform, Minnesota will waive individual and business income tax penalties for tax years 2017 and 2018.
However, for individuals and businesses who see an increase in Minnesota liability exceeding $1,000 as a result of Minnesota’s retroactive conformity, the penalty relief does not seem to apply.
As of June 2, 2019, the MDR website explained that taxpayers “do not need to take any action at this time and should not file any amended returns relating to retroactive provisions in this year’s law changes,” adding that further guidance regarding will be forthcoming.
Impact of unrelated business income tax (UBIT) on nonprofits
Under federal tax reform, nonprofits were required to pay UBIT on the value of certain employee fringe benefits, such as employee parking and transit passes.
They were also prohibited from using net operating losses (NOLs) from one unrelated business against the profit of another. Minnesota did not conform to either one of these federal changes for 2018 prior to the enactment of H.F. 5, and H.F. 5 makes this nonconformity permanent.
How we can help
Even though H.F. 5 provides much-needed closure relating to how Minnesota will respond to the 2017 federal tax law, it raises large questions about how and when Minnesota taxpayers must retroactively conform for the 2018 tax year. CLA state and local tax professionals are monitoring MDR guidance on these and related issues stemming from H.F. 5 and will communicate updates as they are available.