(Part 2 of 2)
By Natalie A. Roberts
The State of Minnesota imposes both income taxes and estate (sometimes called “death”) taxes. In Part 1, we looked at income taxes, which are state-level taxes imposed on the taxable income of a Minnesota resident or part-time resident. This article will briefly examine the issue of residency for purposes of estate tax.
The Big Picture
Most of us are aware that the federal government imposes income taxes. The federal government also imposes “transfer taxes,” which are made up of estate tax, gift tax, and generation-skipping transfer tax (GSTT).
When we die, the Internal Revenue Code (the Code) imposes a tax on the taxable estate of the “decedent” (the person who died) which is transferred at death. The gross estate is the value of all of the property includible in the estate. That value is then adjusted for certain allowed deductions, and that gives you the taxable estate. At the federal level, your taxable estate consists of the combined value of all of the property you transferred during your life (taxable gift transfers[1]) and at death (death transfers), after adjustment for any deductions, etc.[2] The good news is that the Code permits everyone to take a “unified credit” against the tax imposed on their taxable estate when they die. Currently, this credit is over $11 million per person and $23 million per couple. Most of us do not die leaving estates that will be subject to federal estate and gift tax. [3]
The State of Minnesota does not impose a gift tax, but has a three-year “clawback rule” for lifetime gifts, which is discussed further below in this article. Minnesota does impose a tax on the transfer of property at death. This is commonly referred to as a “state-level estate tax”. Not all states have a state-level estate tax. Florida, for example, does not have an estate tax separate from the federal estate tax.
Minnesota Estate Tax
Minnesota imposes a tax of between 13 and 16 % on a taxable estate, once the value of the Minnesota gross estate[4] exceeds $3 million.[5] Thus, even if your estate is not large enough to subject you to federal estate tax, you may be liable for Minnesota estate tax. If the taxable estate of a Minnesota resident is valued at over $3 million, the estate must file an estate tax return.
The Minnesota Gift “Clawback Rule”
If a decedent has made a gift within three years prior to the date of death, Minnesota includes the value of the gifted property when determining the taxable estate for Minnesota estate tax purposes. Therefore, giving away your property within the three years before you die will not reduce your liability for state level estate tax in Minnesota.
How do residency and domicile factor into the liability for Minnesota estate tax?
The Minnesota estate tax is applied as follows:
Residents:
- At death, Minnesota residents are taxed on the value of all of their real property (e.g. real estate) transferred at death if that real property is located in Minnesota.
- Minnesota residents are also taxed on the value of all of their tangible personal property (meaning physical property other than real estate) transferred at death.
- Finally, Minnesota residents are also taxed on the value of all of their intangible personal property wherever it is located, if it is transferred at death! Intangible personal property is an item of individual value that cannot be physically touched or held. Some intangible property might have a paper embodiment, (such as stocks, bonds, or certificates), but other intangibles may only exist electronically or without any physical attributes, such as intellectual property, or a bank or investment account.
Non-Residents:
- Minnesota non-residents are taxed on the value of their transfers at death of:
- tangible Minnesota property, including real estate, and tangible personal property such as vehicles, boats, furniture, jewelry, and so forth, if it is normally kept or located in Minnesota, and
- similar tangible property held in pass-through entities such as a trust, S corp, partnership or limited liability company. So, if you own an LLC that owns a cabin, the cabin ownership is attributed to the owner of the LLC, even though the person is not a resident of Minnesota. (In other words, you cannot convert a tangible piece of real estate into an intangible asset by putting it in an LLC.)
- Minnesota non-residents are not taxed on the value of real property that is not located in Minnesota which is transferred at death.
- Minnesota non-residents are not taxed on the value of property transferred at death if it is tangible personal property that is not normally kept or located in Minnesota.
- Minnesota non-residents are not taxed on the value of property transferred at death if the property consists of intangibles not normally kept or currently located in Minnesota at the time of death.
- Note that non-residents may be exempt from federal estate tax but not exempt from Minnesota estate tax!
Since Minnesota residents and non-residents are treated differently with regard to estate tax liability, the baseline question here is whether you are a resident of Minnesota.
How Residency is Determined for Purposes of Minnesota Estate Tax
In my prior article, I explained how Minnesota determines “residency” for income tax purposes. You may recall that there were two residency tests.
For estate tax purposes, on the other hand, there is only one residency test: the domicile of the decedent. A non-resident is a person who is not domiciled in Minnesota. Although the term domicile is not defined in a statute, the Minnesota Department of Revenue and the courts seem to assume that the income tax definition of domicile applies to estate taxation as well. This single test has two prongs.
Domicile requires both:
- physical presence, and
- intent.
Physical presence is satisfied when a person is bodily present in Minnesota. Intent is satisfied when the person intends to make Minnesota their permanent home for a fixed or indeterminate period of time. Intent is a subjective test, and the Minnesota Department of Revenue cannot look inside someone’s mind. Therefore, intent is determined based on a number of objective factors, which examine a person’s actions to determine intent.
You may recall that Minnesota utilizes a non-exclusive list of twenty-six factors that provide guidance on whether an individual is domiciled in the state. No single factor determines domicile. Domicile is determined on a case-by-case, fact-intensive examination of the person’s actions.
One difficulty here is that, while income tax applies to only one taxable period—the taxable year in question—there is no tax period for purposes of estate tax, which makes it unclear how to apply any time element when determining estate tax. Yet since the definition of domicile includes the intent of the individual, it would seem that the decedent’s intent at the time he or she died, would be determinative.
A person can have only one domicile. There is a legal presumption that you do not intend to change your domicile until you establish a new domicile. However, this presumption is primarily applied when someone is leaving Minnesota for state where taxes are lower. A second presumption is that your domicile is where you live.
A legal presumption operates to shift the burden of proof to the person attempting to overcome the presumption, whether that is the Department of Revenue or the taxpayer.
How the Minnesota Estate Tax is Computed
The tax is computed based on the value of entire Minnesota taxable estate, (including the non-Minnesota property) plus the value of any gifts given within the 3 years preceding death, and then multiplying that value by a fraction: The Minnesota gross estate divided by the Federal gross estate.
The tax must be paid within 9 months of the decedent’s death.
*****
If you need advice concerning whether you or a loved one is considered a Minnesota resident/domiciliary for Minnesota estate taxation purposes, please reach out to me at nroberts@flagshiplawpllc.com.
[1] As most of you are aware, annual transfers of $15,000 are permitted tax-free. This is called the “annual exclusion amount.” When you give a gift, you are the “donor,” and the person who receives the gift from you is the “donee.” We each are allowed a $15,000 excludable transfer to an unlimited number of donees annually. A married couple can gift up to $30,000 per donee, annually. Gifts in excess of the annual exclusion amount require the donor to file a gift tax return for the year of the gift. All of this, again, is federal tax law.
[2] The federal government imposes a tax rate of up to 40% on the value of the taxable estate. The tax is reduced by the unified credit against tax, commonly (and loosely) referred to as the “exemption amount.”
[3] There is also a credit against GSTT, but that is beyond the scope of this article.
[4] The gross estate includes virtually all property you own or have any interest in at the time of your death. That includes your non-probate assets, such as real estate transferred by deed, retirement accounts, investment accounts, and life insurance products. However, the gross estate value will be reduced by allowed deductions, so the net taxable estate may fall below $3 million.
[5] The $3 million exemption amount is potentially increased by $2 million for qualified far land and small business assets, but only for Minnesota residents. Unlike the federal unified credit, one spouse may not use the other spouse’s MN estate tax exemption amount.