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Revenues from the Minnesota estate tax were $159 million in fiscal year 2013. All revenues from this tax go into the State General Fund.

In 1905 a tax on the estates of decedents was first enacted in Minnesota in the form of an inheritance tax. Minnesota had an inheritance tax until 1979 when it was repealed and an estate tax was adopted. The inheritance tax was imposed on each individual who received property from an estate, and the amount of tax depended upon the amount of property received and the relationship of the recipient to the decedent. The estate tax is imposed on the taxable estate before it is distributed.

Minnesota had a gift tax from 1937 until it was repealed in 1979. A gift tax was once again enacted in 2013. Minnesota does not have a generation-skipping transfer tax.

In 1985 the computation of the Minnesota estate tax was changed to equal the Minnesota portion of the federal tax credit for state death taxes, known as the “pick-up tax”. Minnesota did not adopt the federal changes made to the estate tax in 2001. The state tax is equal to the maximum credit for state death taxes allowed under pre-2001 federal law. In 2013 the estate tax was extended to include gifts made within three years of death.

Tax Base

The tax base for the estate tax is defined for this study as the net estate transferred. It is gross estate less administrative costs and other necessary and reasonable expenses paid before the estate is distributed. Therefore, a tax expenditure is created when a certain component of the estate is exempted or excluded because of its source or when a distribution is deducted from taxable estate because of the identity of the recipient. Preferential valuations are also considered tax expenditures.

Computation of the Tax

An estate tax return must be filed if the decedent’s federal gross estate exceeds $1 million. The Minnesota estate tax is equal to the Minnesota portion of the maximum federal credit for state death taxes under pre-2001 federal law, which is computed as follows:

Gross estate

minus: federal exclusions

equals: federal gross estate

minus: federal exemptions and deductions

equals: federal taxable estate

minus: $60,000

equals: federal adjusted taxable estate

plus: gifts made within three years of death

minus: the farm and small business deduction

equals: Minnesota adjusted taxable estate

times: graduated rates (0.8% to 16%)

equals: maximum credit for state death taxes

times: proportion of Minnesota gross estate to federal gross estate

Estate Tax

PREFERENTIAL VALUATION

3.01 SPECIAL USE VALUATION

Internal Revenue Code, Section 2032A Minnesota Statutes, Section 291.03

Property is generally included in an estate at its fair market value on the date of death. Fair market value is a property’s value based on its best possible use. However, real property which is used in a farm or other closely-held business may be valued at its farm or business use value, even though it is less than the market value. Specified conditions must be met in order to qualify for this treatment. The decrease in value cannot be more than a specified amount which is indexed for inflation and is $1,090,000 for deaths in 2014. The estimates measure the difference between tax liability using the fair market value and the special use valuation.

The special use valuation option was included in Minnesota’s estate tax when it was enacted in 1979. In 1985 Minnesota adopted this provision through the federal pick-up tax.

Fiscal Year Impact

2014 2015 . 2016 2017

State General Fund $400,000 $400,000 $400,000 $400,000

EXCLUSIONS

3.02 LIFE INSURANCE PROCEEDS

Internal Revenue Code, Section 2042 Minnesota Statutes, Section 291.03

In general, life insurance proceeds payable to an estate or to any beneficiaries are included in gross estate. However, the proceeds payable to a beneficiary may be excluded from gross estate if the decedent had forfeited the right to any benefit from or control over the policy. To qualify for the exclusion, the decedent must not have possessed any of the incidents of ownership in the policy at the time of death. The incidents of ownership include the power to change the beneficiary, the power to cancel or surrender the policy, the power to obtain a loan against the policy or to use the policy as collateral, and the right to any of the policy’s economic benefits. The estimates do not include death benefits paid to a spouse because such benefits would also come under the marital deduction (Item 3.04).

This provision was originally enacted in 1951 under the inheritance tax and was carried over to the estate tax in 1979. Minnesota adopted the federal provision in 1985.

Fiscal Year Impact

2014 2015 . 2016 2017

Estate Tax

3.03 SOCIAL SECURITY BENEFITS

Revenue Rulings 57-87 and 67-277 Minnesota Statutes, Section 291.03

Social security lump sum death benefits which are paid to surviving spouses and dependents are exempt from the Minnesota estate tax. The amount of the lump sum benefit is fixed at $255. This exemption was enacted in 1963 under the inheritance tax laws and was carried over to the estate tax without change when the inheritance tax was repealed in 1979. In 1985 Minnesota adopted this provision through the federal pick-up tax.

Fiscal Year Impact

2014 2015 . 2016 2017

State General Fund * * * *

DEDUCTIONS

3.04 MARITAL DEDUCTION

Internal Revenue Code, Section 2056 Minnesota Statutes, Section 291.03

The net value of all property passing from a decedent to a surviving spouse may be deducted from gross estate. The net value of the property is the gross value reduced by the amount of exemptions and deductions associated with the property being passed to the spouse.

A $10,000 marital deduction for the inheritance tax was enacted in 1911. In 1979, when the inheritance tax was repealed, the marital deduction was continued for estate tax purposes, with a maximum deduction of $250,000 or one-half the adjusted gross estate, whichever was greater. An unlimited marital deduction was enacted in 1981. In 1985 Minnesota adopted the federal provision.

Fiscal Year Impact

2014 2015 . 2016 2017

Estate Tax

3.05 CHARITABLE GIFTS

Internal Revenue Code, Section 2055 Minnesota Statutes, Section 291.03

Charitable gifts to certain organizations may be deducted from gross estate. Qualifying recipients include charitable, scientific, literary, educational, and religious organizations and federal, state, and local governments.

An inheritance tax exemption for charitable gifts was enacted in 1911. In 1985 Minnesota adopted the federal deduction for charitable gifts.

Fiscal Year Impact

2014 2015 . 2016 2017

State General Fund $36,700,000 $38,900,000 $42,200,000 $45,100,000

3.06 FARM AND SMALL BUSINESS PROPERTY

Minnesota Statutes, Sections 291.005, Subd. (4)(ii) and 291.03, Subd. 9 and 10

A deduction from adjusted taxable estate is allowed for the value of qualified farm property and qualified small business property. The deduction cannot exceed $4 million.

To qualify, the decedent must have continuously owned the property for the three-year period prior to death, and a family member must use the property in the operation of the trade or business for three years after the death of the decedent. For farm property, the property must have been classified as the decedent’s agricultural homestead for property tax purposes. For small business property, the gross annual sales must have been $10 million or less and the decedent or the decedent’s spouse must have materially participated in the trade or business in the taxable year that ended before the death of the decedent.

In electing to treat the property under these provisions, the estate and the qualified heir must agree in writing to pay a recapture tax equal to 16% of the deduction if the property is not used by a family member for the three-year period.

These provisions were enacted in 2011 and were modified in 2013.

Fiscal Year Impact

2014 2015 . 2016 2017

General Sales and Use Tax Introduction