The Minnesota Legislature passed a sweeping tax bill on March 21, 2014, and Governor Dayton signed it into law that same evening. The tax law significantly affects taxpayers and their estates by repealing the Minnesota gift tax and amending the estate tax.
Minnesota Gift Tax
Among the most significant elements of the tax law is the retroactive repeal of the Minnesota gift tax after it had been in force for less than a year. Because the Minnesota gift tax is repealed retroactively, individuals will not be required to file 2013 Minnesota gift tax returns. Federal gift tax return filing obligations remain unchanged for those who made taxable gifts in 2013.
Minnesota Estate Tax
Another substantial change introduced by the tax law is the phased in doubling of the Minnesota estate tax exemption amount from $1 million to $2 million. Under the new law, the exemption amount is $1.2 million in 2014, and it will increase by $200,000 each year until it reaches $2 million in 2018.
The Minnesota estate tax rates are also slightly revised under the tax law. While the top marginal estate tax rate remains 16 percent, the tax law eliminates the "rate bubble" that was a relic of old federal law and imposed a 41 percent tax on approximately the first $100,000 of an estate in excess of the exemption amount. The Minnesota estate tax rates and exemptions will be phased in as follows:
Click here to view table.
Although the Minnesota gift tax is retroactively repealed, the new law will include in a decedent's Minnesota taxable estate any gifts in excess of the annual exclusion amount (currently $14,000 per donee) that the decedent made within three years of his or her death. Unlike the law enacted in 2013, it does not appear that the three-year look back is limited to gifts made after June 30, 2013, under the 2014 law. It is not clear whether this was intentional or an inadvertent change resulting from the repeal of the gift tax. We hope and expect that further guidance (perhaps in the Omnibus Tax Law currently working its way through the legislature) will be provided to clarify this issue.
The tax law also allows for a new Minnesota qualified terminable interest property (QTIP) election for certain trusts. Federal tax law permits the estate's executor to make a QTIP election over certain trusts established for the surviving spouse and therefore qualify the trust for the estate tax marital deduction. Previously, Minnesota would respect such an election only if it was made on the federal estate tax return. Under the new tax law, an executor may make a Minnesota QTIP election and thereby qualify certain trusts for the marital deduction only for Minnesota estate tax purposes. The Minnesota QTIP election will be of particular interest for individuals who want to use their entire federal estate tax exemption upon the first death without triggering Minnesota estate tax.
Finally, in 2013, the Minnesota estate tax law was amended so that it applied to nonresident decedents who owned interests in pass-through entities to the extent that those pass-through entities held real or personal property located in Minnesota at the time of the decedent's death. Pass-through entities are defined to include S corporations, partnerships and other entities taxed as partnerships (including LLCs), single member LLCs, and trusts that are includable in the decedent's taxable estate. The new tax law modifies current law to specifically exclude publicly traded entities from the definition of pass-through entities.
Related Tax Developments
The changes described above should be considered in the context of other recent tax developments, including:
- Congress established a federal estate and gift tax exclusion of $5 million and a generation-skipping transfer tax exemption of $5 million, each of which is adjusted for the cost of living ($5.34 million for 2014).
- Congress established a flat rate of 40 percent for the gift, estate and generation-skipping transfer tax.
- Congress introduced the concept of estate and gift tax exclusion portability, which allows the surviving spouse to use the unused exclusion of the first spouse to die.
- Congress imposed a 3.8 percent Medicare tax on certain unearned investment income.
- Capital gains tax rates will generally be imposed at a rate of 20 percent (and are now subject to the 3.8 percent Medicare tax).
- Minnesota increased its top marginal income tax rate to 9.85 percent.
Importantly, under both Minnesota and federal law, any asset owned by a decedent at the time of his or her death will continue to receive a stepped up basis equal to the fair market value of the asset on the date of the decedent's death.