TAX UPDATE: MN Pass-Through Entity Tax
Overview
On July 1st, 2021, MN passed a new, elective, pass-through entity (PTE) tax effective for tax years beginning after December 31, 2020. This law allows certain qualifying pass-through entities the ability to pay state income taxes at the entity level on behalf of their owners. The owners are then allowed to take a credit on their MN returns for their respective share of the MN tax paid by the PTE.
With the passing of the Tax Cuts and Jobs Act in 2017, the state and local tax (SALT) itemized deduction was limited to $10,000. This led taxpayers who live in states with higher taxes, like Minnesota, to have a higher federal tax burden and in some cases switch to the standard deduction. The purpose of this new elective tax is a workaround for the $10,000 limitation.
Eligibility
Partnerships and S corporations (including LLCs taxed as either) that do not have a partnership, LLC, or corporation as an owner, are eligible. This means the ownership of the passthrough must be entirely made up of individuals, estates, trusts, and disregarded entities (such as single member LLCs or revocable trusts). Estates, trusts, single member LLCs taxed on Schedule C, and C Corporations are not eligible for PTE tax.
Pass-through Entity Tax Election
This election reduces the Federal income of Minnesota taxpayers by shifting the deduction for Minnesota taxes paid from the personal return (which is limited to $10k on Form 1040) to the passthrough entity return (which has no limit on Form 1065 or 1120s). The tax is calculated at the maximum Minnesota tax rate of 9.85% of taxable income and reduces the Federal income on the passthrough return and the associated K1’s.
In addition to being deductible on the federal passthrough return, all shareholders get a proportional refundable credit for their share of the PTE tax paid to be claimed on their MN return. If the credit results in an overpayment of MN taxes, the overpayment could be refunded or applied to future years.
Minnesota Nonresident Information
Nonresidents with passthrough income from Minnesota are eligible for the credit as well. Nonresident individual or estate partners/shareholders who have the PTE tax fulfill their income tax filing requirement are not required to separately file in MN. Trusts that are shareholders of qualifying S-corps who have the PTE tax fulfill their income tax filing requirement are not required to separately file in MN. A nonresident taxpayer with additional income sources from Minnesota may still be required to file a Minnesota tax return. MN PTE tax is also usable as a credit for tax paid to other states on your resident return.
Payment of PTE Tax
PTE tax is paid along with your MN minimum fee with your quarterly estimated payments. For calendar year taxpayers these are due April 15th, June 15th, September 15th, and January 15th of the following year. MN extension payments can be used to pay the tax as well. Any amount remaining will be paid with the return and can be subject to late and underpayment penalty. Passthroughs electing to pay PTE tax are no longer required to withhold tax for non-resident partners or shareholders.
PTE Taxable Income Calculation
In the computation of the PTE tax, many of the Minnesota additions and subtractions to income that are currently on the Minnesota personal return are shifted to the passthrough return. The most prevalent Minnesota addition and subtraction to income is MN bonus depreciation, also known as accelerated depreciation. In the calculation of taxable income, 80% of bonus depreciation is added back in the current year and then subtracted equally over the next five years.
This bonus addback and subtraction to income was previously calculated on the MN personal return, and for those not electing to pay PTE tax it will continue to do so. Those electing for the PTE tax will have this calculation on their passthrough return. All subtractions from prior year bonus depreciation will still be recorded on the personal return. The PTE taxable income calculation also includes other niche addbacks and subtractions for foreign activity and all other federal changes not recognized by MN.
SDK Can Help
With all the updates and changes you may have questions. SDK is here to help and provide answers and expert advice. Please contact your tax advisor with questions regarding your specific situation. If you do not currently have a tax advisor, please contact us by clicking the button below and we can connect you with an expert who can help.
