Minnesota went two legislative sessions without updating its taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. conformity statute to reflect the changes made under the Tax Cuts and Jobs Act of 2017 (TCJA), so when a conformity bill passed during special session, the primary emotion was arguably one of relief that the job was done. There’s also a sense that it could have been worse—though the bill that passed certainly has its shortcomings and represents a net increase in business taxation.
Formerly one of a small (and shrinking) number of states using federal taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. as taxpayers’ income starting point, Minnesota shifts to federal adjusted gross income (AGI)Adjusted gross income (AGI) is a taxpayer’s total income minus certain “above-the-line” deductions. It is a broad measure that includes income from wages, salaries, interest, dividends, retirement income, Social Security benefits, capital gains, business, and other sources, and subtracts specific deductions. under H.F. 5, a change that enjoyed bipartisan support. Federal taxable income takes the federal standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. and (currently zeroed-out) personal exemption, as well as itemized deductionItemized deductions allow individuals to subtract designated expenses from their taxable income and can be claimed in lieu of the standard deduction. Itemized deductions include those for state and local taxes, charitable contributions, and mortgage interest. An estimated 13.7 percent of filers itemized in 2019, most being high-income taxpayers. s and the new pass-through income deduction into account; federal AGI is income before those adjustments are made.
In lieu of direct conformity to the now much-higher federal standard deduction and the temporary elimination of the personal exemption, Minnesota adopted its own standard deduction that matches the new federal amount ($12,200 for single filers and twice that for joint filers) and, while permitting the repeal of the personal exemption, substituted a new $4,250 per-dependent exemption. The loss of personal exemptions for filers and spouses is offset for most filers by the higher standard deduction, while the retention of exemptions for dependents confers a benefit compared to federal treatment. For the most part, Minnesota’s itemized deductions will track the limitations now imposed at the federal level. Like most states, Minnesota will not incorporate its own pass-through deduction.
The new plan also cuts the rate on the second income tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. from 7.05 to 6.8 percent, worth $360 million over the biennium, and expanded the working family tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. .
The following table show how this shift in deductions affects a family of four. Our filers may deduct more than they were before, since the increase in the standard deduction, combined with the retention of the personal exemption for dependents (but not filers and spouses), is more generous than the prior system.
Source: Tax Foundation calculations
Furthermore, the resulting taxable income is subject to a more attractive rate schedule under the new law, since taxable income between $38,771 and $154,020 for married filers, or $26,521 and $87,110 for single filers, will now be taxed at 6.8 rather than 7.05 percent. Taken together, these changes would represent a tax savings of about $250 for a family of four with a household income of $100,000 (prior to deductions), the bulk of which comes from the rate reduction.
Whereas on the individual side the conformity bill represents a next tax cut for most payers, taxes on businesses are going up—though not by nearly as much as once seemed possible. The most significant tax increases are the incorporation of the net interest limitation and the adoption of the new federal rules for net operating loss carryforwardA Net Operating Loss (NOL) Carryforward allows businesses suffering losses in one year to deduct them from future years’ profits. Businesses thus are taxed on average profitability, making the tax code more neutral. In the U.S., a net operating loss can be carried forward indefinitely but are limited to 80 percent of taxable income. s, which, in Minnesota, will not be balanced by other provisions of the federal tax law which reduced business tax burdens.
Under prior federal law, the deduction for interest expenses created a bias for debt over equity financing, a disparity that policymakers wanted to minimize. Reducing the scope of the interest deduction, however, increases the cost of investment, so at the federal level, lawmakers counterbalanced it with a provision for the full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. of machinery and equipment purchases in the first year. Minnesota, however, will only allow 20 percent rather than 100 percent expensing, in keeping with the state’s existing 80 percent addback formula for expensing under both Sections 168(k) and 179 of the Internal Revenue Code.
The good news for businesses is that, after significant debate, legislators and the governor reached an agreement not to expand the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. into international income by taxing Global Intangible Low-Taxed Income (GILTI)Global Intangible Low-Taxed Income (GILTI) is a special way to calculate a U.S. multinational company’s foreign earnings to ensure it pays a minimum level of tax. GILTI was adopted as part of the 2017 Tax Cuts and Jobs Act (TCJA) and can lead to high tax burdens on foreign profits, putting U.S. companies that operate abroad at a disadvantage. or repatriationTax repatriation is the process by which multinational companies bring overseas earnings back to the home country. Prior to the 2017 Tax Cuts and Jobs Act (TCJA), the U.S. tax code created major disincentives for U.S. companies to repatriate their earnings. Changes from the TCJA eliminate these disincentives. income, both of which were previously featured in House and governor’s office plans.
In fact, earlier legislation would have gone even further. Governor Tim Walz (D) sought to tax GILTI as what is known as Subpart F income, which would have made it eligible for the state’s 80 percent dividends received deduction. A House proposal would have instead required that when a foreign affiliate (a controlled foreign corporation, or CFC) generated GILTI for a U.S. shareholder company, that foreign company would be taxed as if it were a domestic corporation. Instead of having that income classified as foreign dividend income, it would be treated as just part of the larger corporate unitary group. This particularly aggressive approach, sometimes called “worldwide combined reporting,” would have raised an additional $384 million over the biennium.
Minnesota is a single sales factor state, meaning that corporate income is apportioned to the state for tax purposes in accordance with the percentage of a company’s sales in the state. A Minnesota-based company that has no in-state sales has no corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. liability; one with 10 percent of its sales in-state would have 10 percent of its net income subject to the state’s corporate income tax. This apportionmentApportionment is the determination of the percentage of a business’ profits subject to a given jurisdiction’s corporate income or other business taxes. U.S. states apportion business profits based on some combination of the percentage of company property, payroll, and sales located within their borders. formula keeps the state competitive for large multistate and multinational firms based in Minnesota despite the state’s unusually high 9.8 percent corporation franchise tax (the state’s term for its corporate income tax). Were the state to tax some share of firms’ international income at this rate, that could seriously undermine the state’s tax competitiveness.
Given concerns about the aggressive taxation of corporate income, the retreat from GILTI and repatriation taxation are positive developments for the state’s economic competitiveness, though conformity still represents a net business tax increase. With the enactment of H.F. 5 and the recent passage of a tax conformity bill in Arizona, only California still operates under a pre-TCJA version of the Internal Revenue Code for both individual and corporate income tax purposes.
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