The information below is from our friends at Copeland Buhl.
This past summer, Minnesota enacted a new passthrough entity (PTE) tax for years beginning after December 31, 2020. This entity-level tax is considered a workaround for the federal $10,000 state and local tax deduction limitation (SALT limitation) imposed on individuals who itemize deductions on their personal income tax returns. Many owners of passthrough entities already maximize the $10,000 SALT limit with state income taxes on other income and/or their personal real estate taxes. Thus, the SALT limitation prevents owners from a receiving federal tax benefit for the payment of state income taxes on their business income.
Upon election by 50% or more (by ownership percentage) of the owners of a passthrough entity, this new legislation allows entities to elect taxation at the entity level at a rate of 9.85% of net income sourced to Minnesota. This election is made on an annual basis with the entity’s Minnesota income tax return.
Advantages of the PTE election:
- Federal tax savings from the entity’s deduction for payment of tax that may have been nondeductible if paid and deducted by the owner.
- Eliminates the need for Minnesota nonresident withholding and composite payments.
- Owners do not need to make estimated state tax payments for the Minnesota income covered by the PTE tax.
Potential disadvantages of the PTE election:
- The PTE election only covers Minnesota-source income. Owners will still need to personally pay tax on non-Minnesota income, which limits the benefit of the PTE regime.
- Potential cash flow issues may arise. The entity must pay 9.85% tax on the Minnesota-source income. If the individual owners are in a lower tax bracket, they will receive a refund on their personal returns, but that could be months after the business paid the tax. While the PTE election does not change the overall tax paid to Minnesota (it merely changes who pays it), the cash flow is not the same as if the owner simply paid it directly.
- Some owners may disqualify the entity from making the election. Your Copeland Buhl representative can determine whether or not your business is eligible to make the election.
- Nonresidents need to consider their resident state’s rules to confirm the election does not result in double paying the tax between Minnesota and their resident state.
Copeland Buhl anticipates that most owners will find this tax law change beneficial and make the election.
Sanford, Pierson, Thone & Strean recommends that you speak with an attorney if you have questions regarding the structure of your business.