"Higher net worth individuals … will want to consider a final round of gifts during June of 2013, ahead of the new Minnesota gift tax." — Sue Clark, Private Client Tax Partner
|Update 3/21/14: The Minnesota Legislature repealed the state’s gift tax retroactively. No transfers made January 1, 2014 through March 21, 2104, will be taxable. Also, the bill raised the exemption amount from one million to two million. More
Minnesota Estate and Gift Tax Changes
The Minnesota omnibus tax bill passed by the legislature on May 20, 2013, includes significant changes to the Minnesota estate and gift tax law. Most notably, Minnesota now becomes just the second state with its own gift tax.
“Minnesota residents facing exposure to our state estate tax will want to consider taking advantage of gifts to family members before the July 1, 2013, effective date of the new gift tax,” says Sue Clark, an estate and gift tax partner with CliftonLarsonAllen. “Non-residents of Minnesota who own significant Minnesota real estate or business interests will also need to review how this legislation impacts them.”
The current Minnesota estate tax system
Prior to this legislation, Minnesota only had an estate tax. The exemption from that estate tax is $1 million per person at death. The net worth of a decedent that exceeds the $1 million exemption is subject to a complex rate system, but generally will average about 10 percent for most estates.
The Minnesota $1 million estate exemption is significantly lower than the current federal estate tax exemption of $5.25 million. A Minnesota couple can effectively shield $10.5 million from the federal estate tax, but only $2 million from the Minnesota estate tax. The federal exemption inflation indexes annually, while the Minnesota exemption does not.
Minnesota does not currently have a state-level gift tax; Connecticut is the only state that does. For federal purposes, however, gifts in excess of the annual $14,000 exclusion count against the $5.25 million estate exemption.
The new Minnesota gift tax
The new Minnesota gift tax applies at a flat rate of 10 percent. The definition of a taxable gift for Minnesota purposes is closely linked to the federal gift tax definition. Therefore:
- The gift tax annual exclusion, currently $14,000, applies.
- The exclusion for medical expenses and educational expenses if paid directly to the medical organization and education organization, applies.
- The unlimited marital deduction, and the unlimited charitable deduction, for gift tax purposes is available.
Gift splitting between spouses will also be applicable to Minnesota.
An individual is allowed a lifetime credit of $100,000 against this gift tax, so that the credit will effectively shelter $1 million of lifetime gifts. The gift tax applies to Minnesota residents, and also to gifts of Minnesota real estate and Minnesota tangible personal property owned by non-residents. A Minnesota resident’s transfer of real property and tangible personal property located outside of the state of Minnesota is not subject to the gift tax.
The new gift tax is effective for transfers made on and after July 1, 2013.
“Higher net worth individuals that already face a significant Minnesota estate tax will want to consider a final round of gifts during June of 2013, ahead of the new Minnesota gift tax,” says Clark. “But act quickly; tax advisors and attorneys will have a hectic month with clients looking to get ahead of this new tax.”
Last-minute gifts before death will be included. The Minnesota estate tax will now be computed by including any gifts made within three years of death. This provision is retroactive to persons dying after December 31, 2012.
The $4 million extra small business and farm exemption
For the past several years, the Minnesota estate tax has allowed an extra $4 million exemption for estates that include a small business or farm. Family members must continue ownership, and in some cases active operation of the business or farm after the original owner’s death. Eligibility rules in the original legislation were murky, but the new bill clarifies and generally liberalizes access to this extra exemption. For example, the legislation extends the privilege to estate property held in a trust for family members, and does so retroactively to deaths after June 30, 2011.
“Families that incurred Minnesota estate tax in the last two years where there was ownership of a small business or farm will want to review whether this legislation could allow an amended return to obtain a refund,” says Nick Houle, a private client tax partner with CliftonLarsonAllen.
Non-residents of Minnesota
The present Minnesota estate tax affects non-residents if they own Minnesota real estate and tangible personal property, such as assets in a proprietorship. However, that tax has not reached ownership of an entity, such as a partnership or S corporation, even though some or all of its assets may be located within Minnesota.
The new legislation changes this exception, taxing a non-resident’s estate for Minnesota property held in pass-through entities such as S corporations, an entity taxed as a partnership, a single-member LLC or similar entity, or a trust.
The Minnesota gift tax will also reach transfers of Minnesota property by non-residents.
How we can help
“Those who face the Minnesota estate tax will certainly need to consider gift strategies as a result of this legislation,” says Clark. “In addition to the window of opportunity in June of 2013, the legislation effectively gives a taxpayer $2 million of exempt transfers: $1 million of lifetime gifts and another $1 million exemption at death. But the lifetime transfer needs to be at least three years prior to death to avoid pullback into the estate.” Those with Minnesota assets in excess of the exemptions should revisit their estate planning.
Lifetime gifts involve more than just a decision about the timing of when heirs receive the assets. Those assets transferred by gift maintain their historical tax cost, so there can be higher capital gains taxes later. But assets passing through an estate receive a new tax cost equal to the market value at the date of death; this effectively eliminates any capital gains recognition by heirs on appreciation occurring before death.
This new gift tax system, along with the higher Minnesota individual income tax rates, may cause some higher net worth taxpayers to reconsider their Minnesota residency. Contact your tax advisor for help in assessing the potential cost of these tax increases, and a discussion of strategies you may wish to consider.
Sue Clark, Private Client Tax Partner
email@example.com or 612-376-4725
Nick Houle, Private Client Tax Partner
firstname.lastname@example.org or 612-376-4760