A tax battle is brewing at the state Capitol
ST. PAUL — When the Minnesota Legislature returns from spring break, political mud season will begin with lawmakers having just six weeks to find agreement on how to rewrite the state's tax code.
That would be tricky anytime, but it's even more complex this year with the entire state House of Representatives up for election and a wide field of candidates seeking to replace Gov. Mark Dayton, who is not running again.
And failure isn't really an option. The federal Tax Cuts and Jobs Act approved by Congress in December made once-in-a-generation changes to the tax code that could lead to thousands of Minnesotans paying more in state taxes if lawmakers don't act.
What did the federal tax bill do?
Essentially, the federal legislation lowered tax rates across the board, and to cover some of the cost of those cuts, it reduced or eliminated many popular credits and deductions.
It also repealed personal and dependent exemptions. Those are offset for many taxpayers by an increase of the standard deduction and an expanded credit for children 16 and younger.
Business taxes also were dramatically reduced and corporations have new tax credits and deductions to shrink their tax liability. Businesses holding profits overseas can pay a lower rate if they bring that money back to the U.S.
What is tax conformity?
Minnesota uses parts of federal tax law to design the state's tax code. Now that the federal law has changed, Minnesota lawmakers must decide which of those changes to incorporate into the state's tax structure.
If state lawmakers do nothing, thousands of taxpayers would pay more in state taxes. If they decide to conform to all the federal changes, other residents would see a hike.
That means the Republican-led House and Senate and the Democratic governor need to agree on a mix of changes. Everyone says they want to do that in a way that results in the fewest tax increases.
But somebody is probably going to pay more, and who the bill falls to often depends on the political persuasion of who is making the proposal.
Why might I have to pay more?
There are several reasons state taxes may go up for individuals and families. A big one is due to the way Minnesota defines taxable income.
Minnesota is one of a few states that defines income for state tax purposes as wages and other earnings after standard and itemized deductions and exemptions. Since those write-offs were modified in the federal tax bill, many Minnesotans might have a higher taxable income for state purposes and pay more tax.
Filers with dependents could also see an increase if the larger standard deduction and the expanded child tax credit don't offset the loss of dependent and personal exemptions.
Taxpayers who itemize, or list their deductions rather than just taking one big deduction, could also see changes. As would those who pay more than the new cap of $10,000 in property or state taxes that can be written off.
Finally, taxpayers will be unable to take advantage of certain other deductions under the new federal law, such as moving expenses and interest from home-equity loans.
Don't forget, all of these changes expire at the end of 2025 unless Congress extends them.
What does it mean for business owners?
The federal tax bill cut rates for businesses from 35 percent to 21 percent for profits — that's a 40 percent reduction.
Besides reduced rates, businesses owners also have new or expanded options for reducing their tax liability.
A new provision allows certain business owners to deduct 20 percent of their income, but that is subject to a number of complicated limitations. This could affect Minnesota if it doesn't change the way taxable income is defined.
Businesses are now allowed to deduct the total amount of certain capital expenses in one year rather than stretching those deductions over time. Not conforming to this change could make filing state taxes much more complex for certain businesses.
Corporations with foreign earnings held overseas have a chance to "repatriate," or bring that money home, at a one-time federal tax rate of 15.5 percent. This could mean new revenue for Minnesota even without conformity.
Remember, unlike the temporary changes for individuals and families, the corporate tax overhaul is permanent.
What comes next?
State lawmakers and their advisers have spent much of the time since the federal bill was approved studying its effects to determine the best way for Minnesota to line up its code with the changes.
Dayton released his proposal for tax conformity along with his supplemental budget in March. The governor wants to focus much of the benefits of conformity on working families, and his proposals include new revenue from reinstating other recent tax cuts and other sources.
Republicans are expected to detail their plans soon. Proposals from the House and Senate could be very different, but party leaders have been clear that they want to minimize any tax increases and avoid raising new revenue.
That means Republicans and Democrats have some stark differences to reconcile before the legislative session concludes in May.