Minnesota – Budget Bill Includes Numerous Tax Changes
First-time home buyer account, 529 provisions, tax credits among the highlights
After a year-long debate over the state budget, including the passing and subsequent veto of different budgets, the Minnesota legislature and Governor agreed on a final bill late in the 2017 legislative session. This budget bill included a variety of tax changes affecting college saving, new home purchases and the state estate tax, as well as a variety of new tax credits and deductions. Most of the changes are retroactive to the beginning of 2017, although some go back to 2016 or are delayed to future years.
Below is a summary of many of the key provisions affecting Minnesota taxpayers.
529 Savings Account Incentives
This bill created two separate incentives for using Section 529 Plans to save for college expenses. The first is a tax credit that can offset a Minnesota tax liability. The credit is equal to 50% of the amount contributed to the plan, with a maximum credit of $500. If money is both contributed to and withdrawn from the plan in the same year, only the net contribution amount is eligible for the credit. This maximum credit is available to both singles and married couples with federal AGI up to $75,000. Once AGI exceeds that level, the credit is phased out as follows:
• For singles, the credit amount is reduced by 2% of AGI over $75,000. Once AGI reaches $100,000, the credit is fully phased out.
• For couples, the maximum credit amount is calculated as follows: o Couples with AGI below $75,000 receive the full credit of $500.
o For those with AGI between $75,000 and $100,000, the maximum credit is reduced by 1% of AGI over $75,000.
o Those with AGI between $100,000 and $135,000 receive a maximum credit of $250.
o For those with AGI over $135,000, the maximum credit is reduced by 1% of AGI over $135,000.
o Once AGI reaches $160,000, the credit is fully phased out.
These income thresholds are subject to annual inflation adjustments.
The second new incentive is a new deduction for contributions to 529 plans. The deduction is limited to $3,000 for couples ($1,500 for single taxpayers) and is only available to those taxpayers who did not claim the tax credit for 529 plan contributions. Using the top Minnesota tax rate of 9.85%, this deduction provides a net tax benefit of up to $295 for couples ($148 for singles). This deduction is available to taxpayers at any income level.
Both provisions are effective for tax year 2017, and both apply to contributions to the plan administered by any state, not just Minnesota.
Student Loan Tax Benefits
This bill also created a new tax credit for those making payments on student loans. The maximum credit is equal to the least of the following items:
• Loan payments made during the year less 10% of federal AGI over $10,000
• Earned income of the loan holder
• The sum of (1) total interest paid during the year plus (2) 10% of the original loan amount.
To summarize, the maximum credit is $500, but can be reduced by other factors. If the borrower has no earned income, they are not eligible for a credit.
In addition to this new tax credit, Minnesota borrowers using an income-driven repayment plan are allowed to exclude from Minnesota tax the amount of the student loan that is eventually discharged.
Both of these provisions are effective for tax year 2017.
First Time Home Buyer Accounts
Minnesota has created a new form of savings account that allows “first-time home buyers” to save for the purchase of a home without any Minnesota income tax assessed on the earnings, effective immediately. Any interest or dividends earned in the account are still subject to federal income tax, but those amounts are subtracted from income when computing the amount subject to Minnesota tax. The law contains no reference to capital gains realized in the account, however, so presumably those are still taxable to the resident. A first-time home buyer is defined as someone who has not owned a principle residence in the three years prior to the earlier of (1) the end of the first tax year they exempt earnings from the account from Minnesota tax or (2) the date they purchase a home with the funds in this account.
Any individual can open an account, but they must name a beneficiary on the account who meets the definition of first-time home buyer. Annual contributions to the account are limited to $14,000, and no more than $50,000 can be contributed for the life of the account ($28,000 and $100,000 for married couples filing jointly). Contributions are allowed from anyone, but must be made in cash only. Account balances are not allowed to exceed $150,000.
Withdrawals from the account can be used to fund “eligible costs” associated with acquiring a home. This includes the down payment and any closing costs for the purchase of the home, and any cost of construction (or financing the construction) of the home. Only expenses related to single-family homes are eligible.
Withdrawals in excess of the contribution that aren’t used for eligible costs must be added back to Minnesota income in the year of withdrawal. Any balance in the account after 10 years that exceeds the contributions must also be added to income at that time. Both of these amounts are also subject to a 10% penalty. In other words, contributions to these accounts should be made with the express intent to purchase a home in the next 10 years, not as a way to create a long-term tax-deferred savings vehicle. This 10% tax is waived if withdrawals are due to the death, disability or bankruptcy of the account owner.
Account owners are required to notify the state that the account qualifies as a first-time home buyer account, and identify the beneficiary and any transfers to the account. Owners are also responsible for informing the state of any withdrawals from the account, how the funds were used and the remaining balance in the account. Although the process for all of this this has yet to be developed, it’s expected to be part of the owner’s Minnesota tax return for the year. The institution holding the account is not responsible for ensuring compliance with these rules, tracking activity or any other reporting or special designations other than what they would already be required to do for any other account.
Increased Estate Tax Exemption
The individual exemption from the Minnesota estate tax has been retroactively increased for deaths occurring after 2016 as detailed in the following table:
Year of Death Exemption Amount Old Law New Law
2017 $1,800,000 $2,100,000
2018 $2,000,000 $2,400,000
2019 $2,000,000 $2,700,000
2020 $2,000,000 $3,000,000
The additional exemption for small businesses and farms and the tax rate itself remain unchanged.
Exclusion of Social Security Benefits
A new Minnesota subtraction modification for Social Security benefits has been created, effective for 2017. Minnesota residents are allowed to subtract a limited amount of their benefits based on their filing status, although the subtraction is reduced by 20% of their “provisional income” over a threshold. Provisional income is defined as:
• Adjusted Gross Income as calculated for federal tax purposes
• Less any Social Security income included in AGI
• Plus any tax-exempt interest income received during the year
• Plus 50% of the Social Security benefits received during the year
The subtraction and threshold amounts are subject to inflation adjustments, with the 2017 amounts shown below:
Provisional Income Level:
Filing Status Maximum Subtraction When Subtraction Begins Phasing Out When Subtraction is Fully Phased Out
Married Filing Joint, Surviving Spouse $4,500 $77,000 $99,500
Single, Head of Household $3,500 $60,200 $77,700
Married Filing Separate $2,250 $38,500 $49,750
Nonresidents who sell their S Corporation or Partnership, or individuals who terminated their Minnesota residency in the year of the sale, are now required to report the entire Minnesota portion of the gain as income in the year of the sale. This includes any gain that is deferred for federal purposes under the installment sale provisions. An individual who becomes a nonresident in any year after entering an installment sale agreement must recognize the full remaining gain on their final Minnesota tax return. Nonresidents can avoid this accelerated gain recognition by irrevocably agreeing to file a Minnesota tax return in all subsequent years as necessary to report the gain.
The state also clarified their rules for determining if an individual is a resident of Minnesota for tax purposes. The state will no longer consider the location of their attorney, CPA, financial advisor or any institution where an individual applies for credit.
Farming-Related Tax Credits
Two new tax credits are established beginning after 2017 to promote farming in Minnesota.
• The first is the Beginning Famer Management tax credit. This a credit offered to new farmers who attend a financial management program approved by the state. The credit is equal to 100% of the cost of the program, up to $1,500, and can be claimed for up to three tax years.
• The second credit is available to owners of agricultural assets who sell or rent the equipment to a beginning farmer. The credit varies based on whether the equipment is sold or rented, and is only claimed after approval and certification by the state.
For both of these credits, a beginning farmer is someone is new to farming in the last 10 years, is not purchasing the assets from a family member, and meets standards regarding their personal net worth and the level of labor and management they provide for the farm, among other requirements.
Other Tax Credit Changes
• A new tax credit provides incentive for teachers to earn their master’s degree in one of the following areas of study: reading, English or language arts, mathematics, science, foreign languages, civics and government, economics, arts, history, or geography. This is a one-time credit equal to the amount paid for tuition and other expenses, reduced by the amount paid by an employer or through scholarships, with a maximum credit of $2,500. The credit only applies to master’s programs begun after June 30, 2017, and is available upon completion of the program.
• The Minnesota working family credit will be available to families without children beginning at age 21, rather than age 25 as under the federal earned income credit, beginning in 2019. Income earned by enrolled tribal members living and working on a reservation will be eligible for the credit in 2017.
• The dependent care credit is increased to equal the federal credit for those families with AGI of up to $50,000.
Robert W. Baird & Co. does not provide tax advice. Please consult with your tax advisor. ©2017 Robert W. Baird & Co. Incorporated. Member NYSE & SIPC. Robert W. Baird & Co. 777 East Wisconsin Avenue, Milwaukee, Wisconsin 53202. 1-800-RW-BAIRD. www.rwbaird.com First Use: 6/2017