Minnesota Business Tax Law

Guide to
Minnesota Law

Minnesota Business Tax Law

Business Tax Law

Business Tax Law

Businesses are responsible for paying a variety of local, state and federal taxes, depending in part on how the business is organized, the services the business provides, and the products it sells. In general, businesses are liable for federal and state income taxes, state sales tax, Social Security and Medicare tax (FICA), federal unemployment tax (FUTA), and state unemployment tax. Businesses involved in the sale of alcohol, tobacco, or fuel and those that generate hazardous waste are liable for additional taxes. Businesses that have employees are responsible for withholding taxes from the pay of employees. This chapter discusses some of these liabilities and responsibilities.

Taxes and the Form of Organization

Minnesota businesses are responsible for different types of taxes depending on the way they are organized. The three common forms of business organization -- sole proprietorships, partnerships, and corporations -- are discussed here. Limited liability companies that are recognized as partnerships in Minnesota are treated as partnerships for tax purposes. For more information on the forms of business organization, see the Small & Privately Held Business Law Chapter.

Sole Proprietorship

Under a sole proprietorship, the owner is the taxpayer. Thus, the individual tax rate applies, rather than the higher corporate rate. The owner reports income and expenses from the business on his or her individual federal income tax return, using federal Schedule C with Form 1040. Generally, a sole proprietor cannot claim personal insurance, such as health, dental, and life insurance, as a business expense. Most sole proprietors are liable for self-employment tax, discussed in this chapter in the Employment Taxes section, which is filed with federal Form SE. Usually, sole proprietors make estimated tax payments in quarterly installments during the year, using federal Form 1040-ES and Minnesota Form M-14. There is no special form for reporting sole proprietorship income to the state. Instead, copies of the federal forms and schedules are attached to Minnesota's individual return, Form M-1.

Partnership

A partnership itself does not pay taxes; each partner reports his or her income and deductions individually on federal Form 1040, Schedule E, and Minnesota Form M-1. Thus, the individual tax rate rather than the higher corporate rate applies. Generally, benefits such as health, dental, and life insurance are not deductible by individual partners. Partners are usually liable for self-employment tax, and they generally make quarterly estimated tax payments toward their year-end tax liability, using federal Form 1040-ES and Minnesota Form M-14. Even though it does not pay taxes directly, a partnership is required to file a federal "information return" (Form 1065) which reports partnership income and distributions to the partners. Other forms and schedules may be required. A partnership is also required to file an information return (Form M-3) with the Minnesota Department of Revenue (MDOR). Partnerships with combined Minnesota payroll, property, and sales of $500,000 or greater are subject to a graduated minimum fee to the state.

Corporation

A corporation is an association of shareholders created under law and regarded by the courts as an "artificial person" with its own legal identity. There are two kinds of corporations, C corporations and S corporations, and each is subject to different tax laws. At the federal level, a C corporation is taxed under the provisions of Subchapter C of the Internal Revenue Code, and it is subject to a tax rate that is higher than the individual rate. For 1993, the corporate tax rate ranged from 15 percent for corporations with incomes of $50,000 or less to 35 for those with incomes over $10 million. Corporations use federal Form 1120 or Form 1120-A to report income, deductions, and credits, and to compute tax. Other forms may also be required.

A C corporation's taxable income is determined prior to distribution of shareholder dividends. A shareholder reports dividend income from a C corporation on his or her individual Form 1040. Thus, profits that are distributed as dividends are taxed twice -- once on the C corporation's tax return and again on an individual shareholder's tax return. Shareholders are not able to use a corporation's losses for their individual tax purposes. However, dividends may be accumulated to certain limits by a corporation to postpone the double taxation. For state taxes, a C corporation uses Minnesota Form M-4 and is liable for a minimum fee based on property, payroll, and sales attributable to Minnesota.

For purposes of the state income tax, C corporations are permitted to deduct:

Contributions to the state or its political subdivisions for exclusively public purposes
Contributions to Minnesota charities
Contributions to a non-Minnesota charity, in proportion to the charity's activity in Minnesota, provided the charity conducts a large portion of its activities in Minnesota
Gifts to the federal government of Minnesota real property

Subchapter S of the Internal Revenue Code applies to an S corporation, which generally is not directly liable for federal income tax. Instead, each shareholder pays tax on his or her share of the S corporation's income and deductions by including it on federal Form 1040. However, an S corporation is required to file federal Form 1120-S with supporting schedules. Also, an S corporation files Minnesota Form M-3S-4, and it must pay a minimum fee to the state based on property, payroll, and a proportion of its sales attributable to Minnesota. Corporations that do business in Minnesota or own property in Minnesota may be subject to Minnesota taxes if they are determined to have a sufficient connection or nexus with the state. Some activities that justify imposition of Minnesota tax laws are:

Having a place of business in Minnesota
Having employees or independent contractors conducting business in Minnesota
Owning or leasing tangible personal property in Minnesota
Obtaining or regularly soliciting business from within Minnesota

A C corporation that expects to be liable for $500 or more in taxes must make estimated tax payments. Federal estimated tax payments are made quarterly to an authorized financial institution or Federal Reserve Bank, using Form 1120-W. Minnesota estimated tax payments are also due quarterly. They are made with Form M-18 to the MDOR. Penalties may be assessed for failure to pay estimated taxes promptly. S corporations are required to pay estimated tax on any income that is not passed to shareholders. For purposes of state income tax, a corporation may carry forward a net operating loss for 15 years, and may use the loss to offset future years' income. However, a net operating loss cannot be used to offset tax paid on personal income in previous years.

Businesses that Operate Inside and Outside of Minnesota

Firms that do business both inside and outside of Minnesota are assessed state income tax based on a weighted formula that takes into account the percentage of property, payroll, and total sales that is attributable to the business' Minnesota operations. A sale is considered subject to Minnesota taxes if its destination was Minnesota. Minnesota does not follow a "throwback rule," which means that sales made to states that do not assess tax are not subject to Minnesota taxes.

Tax Credits

Various federal tax credits are available to certain businesses. Some examples that were effective for 1995 include:

Businesses that had 30 or fewer full-time employees or $1 million or less in gross receipts were eligible for credit for expenses related to complying with the Americans with Disabilities Act.
Employers of persons from targeted groups with particularly high unemployment rates or special employment needs were eligible for credits for wages paid to members of the targeted groups.
Some businesses that increased their research activities over a base amount were eligible for a credit of about 20 percent of the amount of increase.

The state of Minnesota also provides a number of tax credits to businesses to encourage them to engage in socially beneficial endeavors. An enterprise zone credit is available to partnerships and corporations, and this credit may be passed through to partners and S corporation shareholders. Enterprise zones are areas that have been designated for encouragement of business growth. Enterprise zone businesses may qualify for certain sales tax exemptions, as well as income and property tax credits. Other credits currently available are alternative minimum tax carryover credit, alternative minimum credit for individuals, and research and experimental expenditures credit. The MDOR is the contact office for more information on these credits.

Taxpayer Identification Numbers

There are three types of taxpayer identification numbers that apply to Minnesota businesses: the Federal Employer Identification Number (EIN), the Minnesota Taxpayer Identification Number (TIN), and the Unemployment Compensation Employer Identification Number. An EIN is required for all businesses. A sole proprietor generally uses his or her personal Social Security number as the EIN. However, certain sole proprietors, and all partnerships and corporations must apply for an EIN from the Internal Revenue Service (IRS) using Form SS-4. Sole proprietors must apply if they have employees or have a retirement plan, or if they are liable for federal excise taxes, such as for alcohol, tobacco, or firearms. A TIN is required for all Minnesota businesses. Sole proprietors who do not have employees, who are not required to file information returns, and who do not make retail sales that are subject to Minnesota sales and use tax generally may use their Social Security number. Other businesses must submit an Application for Business Registration (Form ABR) to the MDOR. There is a $100 penalty for failure to obtain the number. Businesses with employees are required to get an Unemployment Compensation Employer Identification Number by registering with the Minnesota Department of Jobs and Training.

Selecting the Tax Year

A tax return is based on an accounting period called a tax year. A tax year may be either a calendar year or a fiscal year. A calendar year is 12 consecutive months from January 1st through December 31st. A fiscal year is generally composed of any other 12 consecutive months. Once a tax year is established, a business needs IRS approval to change it. Businesses use the same tax year for federal and state tax returns. Sole proprietorships usually use a calendar tax year. A partnership generally must use the same tax year as the partners who own a majority interest. If the majority partners' years differ, the business must use the same tax year as the principal partners -- those with a 5 percent or greater interest in partnership profits or capital. If the principal partners' years conflict, a partnership generally uses a calendar tax year. A fiscal tax year can be used if either of the following is true:

The IRS agrees that there is a business purpose for using a fiscal year.
The partnership files IRS Form 8716, Election to Have a Tax Year Other than a Required Tax Year, also known as a "Section 444 election." In this case, a business may have to pay a fee that represents the amount of tax deferral benefit that results from using a fiscal, rather than calendar, year.

A C corporation's first income tax return establishes its tax year. The first tax year must not be greater than 12 months from the date of incorporation. A C corporation that provides personal services must use a calendar tax year unless it has IRS approval to use a fiscal year or it makes a Section-444 election. An S corporation must use a calendar tax year unless it gets IRS approval. In some cases, S corporations may make a Section-444 election.

Employment Taxes

A number of taxes are of interest to businesses with employees.

Payroll Taxes

The taxes discussed here are often called payroll taxes because employers are responsible for deducting an employee's share from his or her earnings before the employee is paid.

FICA Taxes

Taxes under the Federal Insurance Contributions Act (FICA) help pay for Social Security and Medicare benefits. Businesses without employees do not pay FICA tax. Instead, most sole proprietors and partners in partnerships without employees pay a self-employment tax, which is discussed later in this chapter. Businesses that have employees contribute half of the total FICA tax, and are responsible for collecting the other half from employees through payroll deductions. For 1995, the tax rate for the Social Security portion of FICA tax was 6.2 percent each for employers and employees (a total of 12.4 percent). The maximum wage subject to the tax changes annually. The 1995 tax rate for the Medicare portion of FICA tax was 1.45 percent each for employers and employees (2.9 percent total). Special rules apply to employees who receive tips, to persons who receive both wages and self-employment income, and to non-wage payments to employees for items such as meals, lodging, clothing, and some services. The employer's share of FICA taxes is deductible as a business expense.

Income Tax Withholding

Along with the employee's share of FICA tax, employers must withhold federal and state income tax from the employee's pay. The amount to withhold is determined by the employee's pay and by the number of withholding allowances that the employee claims on federal Form W-4, Withholding Allowance Certificate. Employees are required to complete Form W-4 when hired, and generally, the employer retains the form. However, the form must be filed with the IRS if the employee claims more than ten withholding allowances, or the employee claims exemption from withholding and his or her wages normally exceed $200 per week. A monetary penalty may be assessed against the employer for any form that is not filed when required.

Employees who reside in North Dakota, Wisconsin, or Michigan may claim exemption from withholding Minnesota state tax. To do so, the employee must complete Form MW-R, Reciprocity Exemption from Minnesota Withholding each year. Employers of truck drivers, bus drivers, and railroad workers who cross state BORDERs while working must withhold taxes for the employee's state of residence. Payments to entertainers who are not residents of Minnesota for performances in Minnesota are subject to a two percent compensation tax. This tax must be withheld from the entertainer's pay and remitted to the state by the end of the month following the performance.

Employers must furnish a statement of wages and taxes (federal Form W-2) to employees by January 31st of each year, or, if requested by the employee, within 30 days of termination. The federal copy of Form W-2 must be submitted to the IRS, accompanied by federal Form M-3, Transmittal of Income and Tax Statements. The state copy must be sent to the MDOR by February 28th, accompanied by either Minnesota Form MW-3, Annual Reconciliation of Income Tax Withheld, or Form MW-1A, Annual Return/Reconciliation.

Payroll Tax Return

Generally, employers report FICA taxes and withheld federal income tax together on federal Form 941, Employer's Quarterly Federal Tax Return, which, as the name implies, is filed at the end of each calendar quarter. There are different forms to be used for agricultural and household workers and for employees who are not subject to FICA taxes. Most employers are required to make deposits for payroll taxes before returns are actually due. How often deposits must be made is determined in part by how much tax liability a business has accrued in the past. For example, a business that owed $50,000 or less in payroll taxes during a specific previous 12-month period may be designated a monthly depositor; a business that owed $50,000 to $100,000 during the specific period may be designated a semi-weekly depositor. The depositor designation is reevaluated annually. A business' actual tax liability at the end of each deposit period determines whether it must actually make a deposit. If the amount of accumulated undeposited liability reaches $100,000 in any period, taxes must be deposited the day after that volume is reached, and if the business' deposit status was monthly, it is immediately changed to semi-weekly.

Self-Employment Tax

Self-employment tax is a Social Security and Medicare tax for individuals who work for themselves. This includes sole proprietors and most partners in partnerships without employees. Net earnings of $400 or more are subject to self-employment tax. For 1995, there were ceilings on the amount of earnings subject to the tax: $61,200 for the Social Security portion of the tax; but no ceiling for the Medicare portion. The Social Security portion was assessed at 12.4 percent of earnings, and Medicare at 2.9 percent, for a total self-employment tax of 15.3 percent. Federal Schedule SE is used to calculate self-employment tax, which is then added to one's total tax liability on Form 1040. One-half of the self-employment tax is deductible as an adjustment to gross income on Form 1040.

Unemployment Tax

Both the federal and state governments have programs to help support able workers who lose their jobs. Tax under the Federal Unemployment Tax Act (FUTA) is reported by eligible employers once per year on federal Form 940 or 940-EZ. The form is usually due one month after the end of a calendar year. However, deposits toward the annual payment are required at the end of any quarter in which the employer accrues $100 or more in FUTA tax liability. Penalties may be imposed for late filing and late deposits. Most employers, even those with part-time employees, are responsible for paying FUTA tax. The general rule is that a business is subject to FUTA tax if the business pays wages of $1500 or more in any calendar quarter, or the business had at least one part-time employee in each of 20 different (not necessarily consecutive) calendar weeks. In addition, FUTA tax is due on cash wages of $1000 or more paid in any calendar quarter to domestic workers who work in a private home, local college club, or local fraternity or sorority house.

A business that employs farm workers is subject to FUTA tax on their wages if the wages total $20,000 or more in any calendar quarter, or if there was at least one day in each of 20 different calendar weeks when the business had ten or more at least part-time farm workers. The tax is figured at a rate of 6.2 percent of the wages paid to the employee up to $7000. Tip income reported by an employee to an employer for FICA tax purposes is considered wages for calculating FUTA tax. However, the tax does not apply to some payments, such as Workers' Compensation payments, nor does it apply to certain types of employment, such as earnings paid to cooperative education students. A business is credited for up to 5.4 percent of the amount it pays for state unemployment tax, which can reduce the actual tax liability to 0.8 percent. The IRS administers the FUTA tax.

The state has its own unemployment program and corresponding taxes. Any employer that conducts business in Minnesota is required to submit Form DJT-13, Report to Determine Liability, to the Minnesota Department of Jobs and Training (MDJT) within a month of initiating business in the state. The MDJT then informs the business whether it is liable for the tax. Liability is based on the number and type of employees, the amount of wages paid, and other factors. The tax rate for new employers is generally the state's benefit cost rate, which is 1.9 percent. Construction businesses are assigned a separate rate, which cannot be less than 1.0 percent or more than 9.0 percent. The maximum benefit cost rate for all other businesses is 5.4 percent. Once a business has paid unemployment tax for a period of time, the tax rate will be based on the business's experience. Minimum experience rates range from 0.1 percent to 0.6 percent. The maximum experience rate is 9.0 percent. An employer's experience rate is redetermined annually, just after June 30th.

If the state unemployment fund falls below a certain amount as of June 30th of any year, a business becomes liable for a "solvency assessment" of 10 to 15 percent of its regular annual contributions. The assessment is payable with the following year's contributions. All employers that pay unemployment tax are also liable for a special assessment for the Dislocated Worker Fund, calculated as 0.1 percent of taxable payroll. The tax is due on the first $15,100 of each covered employee's earnings (base wages). Wages include cash wages, salary, commissions, S corporation dividends when credited to shareholders as services, and the reasonable value of meals and housing provided to an employee. Wages contributed to deferred income plans, such as a "401(k)" plan, and "cafeteria" or flexible benefit plans are also taxable. Certain payments are not taxable, such as Workers' Compensation and retirement payments. Minnesota requires that businesses pay unemployment taxes quarterly. The quarterly tax return has two parts: the Contribution Report contains summarized information; the Wage Detail Report shows information for each employee. There are penalties and fines that can be imposed on businesses that fail to file on time, do not pay the necessary employment taxes, or fail to keep accurate employment records. MDJT audits employer records periodically. The business can deduct unemployment taxes as business expenses.

Acquired Businesses

A firm that acquires an existing business that has been subject to unemployment tax is required to file Form DJT-13S, Report to Determine Succession. The new business may be eligible to have an experience rate computed based on all or part of the predecessor's experience; in some cases, an acquired business may be required to use the predecessor's experience rating. By statute, an individual or business that acquires all or part of an existing Minnesota employer's business or assets is jointly and severally liable for the predecessor's unpaid tax, interest, and liabilities.

Sales and Use Taxes

Minnesota sales tax is due on the gross receipts from selling, leasing, or renting tangible personal property at the retail level. Some services, such as building cleaning, lawn and garden maintenance, and tailoring, are also subject to state sales tax. Generally, retail sales do not include transactions where the customer buys items either to resell them or to incorporate them into something new for sale at retail. A general sales tax rate of 6.5 percent applies to most retail sales. Some exceptions to this are alcohol sales, which are taxed at a rate of 9 percent, and sales of some farm machinery, logging equipment, and agriculture production equipment, which are taxed at a 2.5 percent rate. The use tax applies to purchases of goods that are not subject to Minnesota sales tax but will be stored, used, or consumed in the state. This includes items that are purchased outside of Minnesota, items that were originally purchased for resale but then used directly, and items that are purchased in Minnesota where sales tax is not collected. Items become subject to the use tax when they enter Minnesota, are taken from inventory for use, or are purchased from a Minnesota seller. The use tax rate is the same as the sales tax rate, 6.5 percent.

Anyone who makes retail sales or who provides taxable services in Minnesota must have a sales and use tax permit. This includes any seller located outside of Minnesota who:

Is a corporation authorized to do business in Minnesota
Has a place of business in Minnesota, either directly or by a subsidiary
Has any type of temporary or permanent agent in Minnesota for any purpose, including repair, delivery, or installation of taxable items
Solicits sales of tangible personal property in Minnesota

Businesses obtain the sales and use tax permit from the MDOR using Form ABR, Application for Business Registration. Generally, sales and use tax returns are due monthly. A business may file annually if it averages less than $25 per month in taxes, or quarterly, if less than $250 per month. However, it must file Form ST-12, Application to File Quarterly or Annual Returns, to obtain authorization. MDOR provides preprinted sales-tax returns to permit holders. The return, Form ST-1, must be postmarked by the 20th day of the month following the end of a reporting period to be considered timely. A business is required to collect sales tax even if it has not yet received its permit.

Exemptions

Certain customers are not required to pay Minnesota sales tax at the time of purchase. The MDOR requires that these customers present a properly completed exemption certificate to the seller. Certificates are subject to inspection by MDOR, and thus, the seller should keep them on file to substantiate sales where tax was not collected. Customers who frequently make exempt purchases can obtain a blanket exemption certificate that applies to future purchases.

Local Sales Tax

In addition to the sales tax imposed by the state, a number of cities have been granted authority to impose local sales taxes as well. Also, all towns or cities in Minnesota have the right to impose a "lodging tax" on hotels and motels for the purpose of funding a convention or tourism bureau to promote tourism to the city. Bloomington, Duluth, Minneapolis, Rochester, St. Cloud, and St. Paul impose a lodging tax. Duluth, Minneapolis, Rochester, St. Cloud, and St. Paul also impose general sales taxes. Minneapolis also taxes restaurants and liquor in its downtown area. Permits and filing forms for the sales taxes imposed by Minneapolis, Rochester, and St. Cloud are obtained from the MDOR, Business Tax Unit; information on sales taxes in the other cities is available directly from the cities.

Other Taxes

Business owners also need to be aware of a variety of miscellaneous taxes.

Other State Taxes

An excise tax of 6.5 percent is assessed on the sale of most motor vehicles. A lower or special rate may apply to passenger vehicles ten years old or older, collector vehicles, and certain other vehicles. This tax is administered by the Minnesota Department of Public Safety, Driver and Vehicle Services Division. Any business that generates more than 100 pounds of hazardous waste per year is subject to a hazardous waste tax based on the quantity of waste and the disposal method used. For a discussion of hazardous waste, see the Land Use & Environmental Law Chapter. The rate for very small quantity generators is a flat $50; the tax for other generators begins at $200 for small quantities and at $500 for large quantities. The tax is payable annually to the MDOR, using Form HZ-1, Minnesota Hazardous Waste Tax Generator Annual Tax Return. Tax revenues are used to clean up hazardous waste in the state. Businesses that sell gasoline, propane, or diesel fuel and wholesalers and distributors of cigarettes and alcohol are responsible for collecting appropriate taxes for those items from customers and remitting the taxes to the state.

Other Federal Taxes

The federal government assesses various excise taxes. For example, excise taxes are imposed on the sale, use, or lease of the following articles by the manufacturer, producer, or importer: sport fishing equipment, electric outboard motors and certain sonar devices, bows and arrows, highway-type tires, gas guzzling automobiles, certain vaccines, coal, and alcohol sold as fuel but not used as fuel. There are environmental excise taxes, such as taxes on the sale or manufacturing use of certain ozone-depleting chemicals, and there are luxury taxes, such as a tax on the sale of passenger vehicles that cost over $30,000.

Many of these taxes are reported with federal Form 720, Quarterly Federal Excise Tax Return. Although the return is filed quarterly, the taxes generally must be deposited before the return is due. There are additional excise taxes that are reported separately from those described above. For example, certain heavy vehicles are subject to a federal highway use tax. This includes buses, truck tractors, and trucks with gross vehicle weights of 55,000 pounds or more. Pickup and panel trucks are not subject to the tax. Generally, the vehicles must be used on public roads more than 5,000 miles per year. This tax is reported on IRS Form 2290, Heavy Vehicle Use Tax Return. There are also taxes on alcohol, tobacco, and firearms that are filed with the Bureau of Alcohol, Tobacco, and Firearms.

Resources

Internal Revenue Service, Minneapolis Office, (612) 644-7515 or 1-800-829-1040 (monthly workshops presented by IRS, Minnesota Department of Revenue, and Minnesota Department of Jobs and Training).

Minnesota Department of Jobs and Training, 390 Robert Street North, St. Paul, MN 55101, (612) 296-6141 (Unemployment Insurance Information for Employers, DJT-130).

Minnesota Department of Revenue, Mail Station 4453, St. Paul, MN 55146-4453, (612) 296-6161 or 1-800-657-3777 (free pamphlet: Taxpayer Bill of Rights (state version)).

Internal Revenue Service, 1-800-TAX-FORM (829-3676) (free publications: Employer's Tax Guide (Cicular E, Pub. No. 15); Taxpayer Bill of Rights).