Minnesota Pass-through Entity Tax Effective for Tax Years Beginning in 2021

By Riley Petersen, CPA

An optional Minnesota Pass-through Entity (PTE) Tax is effective for tax years beginning in 2021. Qualifying partnerships and S Corporations can elect to pay and deduct Minnesota income tax at the entity level on behalf of their qualifying owners. The PTE Tax was created in response to the Federal limitation of deductible state and local taxes. This new entity level tax could significantly reduce Federal tax liabilities for Minnesota business owners. Read on for additional details or consult an Abdo Advisor to determine if this election makes sense for you and your business.

Background

Pass-through entities, including partnerships and S Corporations, are exempt from income tax at the entity level. Instead, the business income is reported to owners annually via Schedule K-1. Owners report this business income on their individual income tax returns.

State and local taxes, including income, real estate, and personal property, are an itemized deduction on the individual level in the year paid. However, under current Federal tax law, this state and local tax (SALT) deduction is subject to a $10,000 annual limitation. In November 2020, the IRS announced optional PTE taxes will be considered a deducible expense at the entity level, thus avoiding the state and local tax limitations at the individual level.

Minnesota PTE Tax and Election:

• Election effective for tax years beginning in 2021, subject to certain conditions.
• The Minnesota PTE Tax is a federal tax deduction reducing the net taxable income of the business.
  • The deduction is not subject to the SALT deduction limitation.
• Qualifying entities include Partnerships, S Corporations, and LLCs taxed as a Partnership or S Corporation.
  • Entities do not qualify if they are single-member LLCS or owned by another PTE or Corporation.
• Qualifying owners include resident or non-resident individuals or estates.
  • A qualifying owner can also include a resident or non-resident trust that is a shareholder of a qualifying S Corporation.
• Annual optional election must be made by the due date of the return (including extensions) and is irrevocable for that tax year.
  • Election must be made by qualifying owners who collectively hold more than 50% ownership interest in the PTE. Election is then binding on all qualifying owners.
• PTE Tax is the sum each qualifying owners’ income sourced to Minnesota multiplied by the highest individual tax rate, which is currently 9.85%
• Quarterly estimated tax payments are generally required at the entity level.

Impact at the Individual Level:

• Qualifying owners may claim a refundable tax credit on their Minnesota individual income tax returns for their share of the PTE Tax liability.
• Non-Resident owners will not have an individual Minnesota filing requirement if their only Minnesota sourced income is from entities electing to pay the PTE Tax or filing and paying composite tax on the non-resident owner’s behalf.

Things to Consider:

• Electing entities are no longer required to withhold tax for non-resident partners or shareholders.
• Single Member LLCs and Sole Proprietorships could convert to a qualifying entity to qualify for the PTE Tax election.
• Estimated tax payments should be evaluated on both the business and individual level each year an entity elects the Minnesota PTE Tax.
  • The deductible state taxes paid will likely reduce the total Federal tax liability.
  • The PTE Tax will create or increase the Minnesota tax liability at the entity level.
  • The refundable Minnesota tax credit will likely reduce or eliminate the total Minnesota tax liability at the individual level.

Additional questions? Contact an Abdo advisor to determine if the PTE Tax election would be beneficial to you and your business. Your Abdo advisor can also update current year estimated tax payment calculations for the entity and/or ownership group.