Minnesota’s Unfinished Business

The implications of Minnesota's failure to enact a federal conformity bill in the 2018 legislative session – already being experienced by the Department of Revenue – will be more fully appreciated when the 2019 tax filing season commences, putting a major unresolved issue right back in the spotlight.  Add in taxation of e-commerce, the scheduled elimination of the provider tax, state budget deliberations, and – perhaps above all – new players in the negotiations and all the ingredients exist for a tax policy year to remember.

Our panel of capitol veterans and state tax experts examined the policy issues and political dynamics that are likely to frame tax debates during the 2019 legislative session.  Moderated by long-time capitol veteran and MCFE board member Rich Forschler, our panelists included Jenny Starr, Minnesota Department of Revenue; Joel Michael, Minnesota House Research; Ann Lenczewski, former chair, House Tax Committee, and Jim Girard, former legislator and commissioner, Minnesota Department of Revenue.

Wayfair and Minnesota

Because of the Supreme Court decision on Wayfair, two laws regarding e-commerce went into effect in Minnesota on October 1.  The first is Minnesota’s economic nexus law for sales and use tax which dates back to 1989 and has been lying dormant for nearly 30 years.  The second and much more recent addition is Minnesota’s “first in the nation” marketplace provider law passed in 2017.  Building on the previous panel’s discussion, panelists began by looking at these issues from a Minnesota perspective.

Jenny Starr began by providing an informational overview of the status of Revenue’s administrative, compliance, and enforcement initiatives regarding e-commerce.  She summarized the details of the two newly-effective laws noting Minnesota’s small seller threshold is different from South Dakota’s (either 100 or more retail sales shipped into Minnesota or 10 or more retail sales shipped into Minnesota totaling at least $100,000 during a period of 12 consecutive months).  With respect to the marketplace provider law, she noted Minnesota has not adopted a notice and reporting requirement.

Revenue, unsurprisingly, has been exceptionally busy in preparing for the implementation of these laws and has created a wide variety of tools and resources to educate businesses and enable them to comply.  This has included webinars for remote sellers with no historical relationship with the state, webinars for in-state firms, and frequently asked questions and answers on the Department’s website, which are continually expanded as issues come up.  Revenue’s website is getting “a lot of action” to access tools such as Minnesota rates and boundaries tables spreadsheet.  The agency is currently beta testing a map application for a sales tax rate look up tool which it plans to release in November.

Starr concluded by noting Minnesota is well positioned for this moment having been a member of SST from the beginning and because the legislature has worked to keep the state in compliance for over 13 years.  That latter task, she added, is no small feat and is a credit to the hard work of tax committee members and Revenue employees.  As a result, Minnesota is one of only 11 states that the Tax Foundation has identified as “green to go” in implementing Wayfair.

Given all this, are there still some issues surrounding Wayfair that may need attention and that the legislature may want or need to address in 2019?  Ann Lenczewski said she definitely thinks issues will come up as taxpayers work through these new realities.  She expected interest in an amnesty program, especially for marketplace providers who want to comply but are having a difficult time doing it.  Small business threshold rules are likely to get some additional scrutiny because she believed the Legislature hasn’t really heard yet from the small business community.  It’s important to understand, she continued, that legislators probably haven’t fully digested the implications of Minnesota’s marketplace provider law for two reasons.  First, it was co-authored by both tax chairs but was not a big feature of the tax bill discussion in 2017.  Moreover, it had a “someday in the future” implementation dynamic that also reduced legislative attention and scrutiny.  She believed these provisions will get more attention as people come forward with their experiences.

Jim Girard agreed there likely will be a call for some type of reexamination, although we don’t know exactly what the concerns will be yet.  One area he has heard perhaps needing some additional attention and clarity revolves around local option sales tax matters.  He reiterated that preparing for this moment has been a bipartisan effort in Minnesota for over 20 years.

Joel Michael noted that Minnesota’s marketplace provider law was passed in a totally different “pre-Wayfair” context.  He suggested there needs to be a conversation about how to make it work well in this new environment.  As the law stands now, there is the potential for multiple entities to be deemed sellers who would each have collection obligations, so it’s important to clarify this in a way that works best for everybody – sellers, the Department of Revenue, and marketplace providers.  Although Revenue is aware of and working to resolve matters like this, it may be necessary to tweak the statutory language for transparency and clarity purposes.

“If At First You Don’t Succeed…”

Federal conformity retreated from the public consciousness following the 2018 tax bill veto, but will be back on the stage in the 2019 session.  Especially with elections looming, predicting what will happen regarding this issue is at best risky and at worst a waste of time.  But the administrative, policy and political dynamics underlying the debate are worth considering.

Jenny Starr began with an informational update on Revenue’s preparations for the 2019 tax filing season.  She provided an overview of the process and timeline the Department uses to update its filing system – from synthesizing law changes immediately following session’s conclusion through tax form and instruction updates, processing system testing, and software vendor certification all the way to the opening of the filing season.  Normally the Department updates 80 forms (and 100 more in the special taxes division), but this year required the special development of a number of new schedules and worksheets.  To the enormous credit of the dedicated Department staff, all deadlines were successfully met.  In addition, the Department has invested in a wide variety of educational resources to deal with conformity-related issues.  This includes publishing a list of over 50 “frequently asked questions” and participating in numerous educational sessions, listening sessions, and continuing legal education programs.  The result – “we will have the filing system in January, it will work, and it’s going to be successful.”

How are taxpayers going to react to the 2019 filing season?  Jim Girard said “it depends on who you are.”  In his view, filers who use software will probably not experience a particularly noticeable difference.  Taxpayers who use an accountant are likely to notice bigger bills as two different tax systems have to be reconciled.  Those who do their own taxes are in for a rude awakening and their frustration and confusion will likely be compounded by the likelihood that tax preparers’ time will be in short supply as the additional complexity will limit their ability to take on new clients.  He noted it is abundantly clear that it’s too late to address 2018 returns.  Any conformity effort will be prospective for tax year 2019.

Ann Lenczewski predicted lots of frustration and confusion for the business community and an “expensive hassle,” noting existing disconnects in Minnesota business returns are only going to get worse.  On the individual side, the Department’s recent ruling allowing inconsistent election of deductions will likely help many Minnesotans who otherwise would be looking at a state income tax increase.  However, she speculated that many suburban, upper middle-class Minnesotans are positioned to experience big tax increases because of SALT deduction caps.  As a result, the bipartisan group of legislators representing these taxpayers are most likely to get the discussion moving.

Joel Michael called the prospects of an early conformity bill “miniscule” for several reasons.  Early conformity bills in the past have focused on federal extenders, but this is a very different situation.  Moreover, the “ship for tax year 18 has sailed”, yielding no advantage for an early bill.  And perhaps most significantly, lawmakers are protective of every bit of leverage that can be used during end of session negotiations.

Are there one or two conformity issues that absolutely must be addressed?  From an administrative perspective, Jenny Starr flagged the massive complexity in depreciation and Section 179 expensing.  Joel Michael and Ann Lenczewski concurred, saying business provisions with multi tax year effects need to be at the top of the priority list – like cost recovery/bonus depreciation, like kind exchanges, and net operating losses.  Those things are “a nightmare” if we are not in alignment.  Jim Girard agreed but added that the whole foreign earnings issue is not going away and the legislature will have to address it somehow.

Will the dynamics behind last year’s ill-fated conformity effort – specifically the reluctance to reexamine various tax preferences eliminated in the TCJA – likely be repeated this coming year?  Jim Girard remarked that he believed a lot of opportunities were missed last year to simplify filing and address some needed administrative clean-up issues while “blaming it on the feds.”  However, he continued, anytime you simplify the system some shifting of burden is guaranteed to take place and the Legislature has a long history of requiring that any burden shifts be paid for.  He suspects that’s unlikely to change in 2019.

Joel Michael expressed hope that this prediction is wrong and that the 2019 legislature “will look at federal changes with a more discerning eye” this time around when deciding how to tackle conformity.  He noted the governor always sets the tone of the debate and suspected the political aura surrounding the TCJA’s passage likely had a major impact on Governor Dayton’s proposal to reflexively preserve all the preferences and deductions being eliminated at the federal level in the state’s tax code.  The irony, he noted, is that a progressive Democrat would be expected to support some of the TCJA’s changes, like limiting the mortgage interest deduction and the property tax deduction.  Noting his personal policy bias is toward promoting greater simplicity and ease of administration, he said three things animate debates – politics, personality, and policy.  The personalities will change, the intensity of the politics have faded a bit over time, and so he hopes this creates an opportunity for the conformity policies to be more carefully and thoughtfully vetted in 2019.

Other Matters?

With respect to tax administration, Jenny Starr said the Department’s technical bill may include some cleanup efforts with respect to the state’s economic nexus and marketplace provider laws.  On an internal note, she commented that the additional work triggered by non-conformity created significant opportunity costs for the Department in other administrative matters.  For example, the Department was committed to speeding up the publication of Revenue Notices but attorney staff had to be diverted to other work.  Similarly, both individual and corporate audits have slowed because auditors were moved to teams working on forms and instructions.

In the legislature, Ann Lenczewski flagged the provider tax, which is scheduled to phase out completely after 2019, as being a guaranteed topic of discussion.  Dedication of auto repair taxes and rural homeowner property tax relief are two other areas she anticipated will get attention.  One process issue she suggested keeping an eye on is the creation of the new Legislative Budget Office, which will now be engaged in the same type of fiscal note creation as Minnesota Management and Budget raising the prospects of “dueling numbers” on which to construct policy.

Jim Girard said the likelihood of retaining some type of divided government is high and what happens with the provider tax – worth about $700 million in revenue – will have a major impact on all other tax debates in the 2019 session.  At the same time, from what he has observed, there has been curiously little discussion of the nuts and bolts of tax policy in campaign races.  People may start talking about tax issues once they start filing, but right now issues like health care and education are dominating local debates.

Joel Michael agreed that the campaigns have offered little insight into what might be coming from them regarding tax issues.  He did note that a budget surplus in November is practically guaranteed and a tax cut will be on the agenda.  With respect to the provider tax, he reflected on the fact that like most states Minnesota’s tax system doesn’t grow as fast as the economy grows for many reasons, most of which have to do with our tax bases.  However, the provider tax is one tax that has been growing and its elimination will change the responsiveness of our overall tax system.  He continued, noting that the health care sector generally escapes a lot of taxation that other business sectors do not.   Most hospitals are non-profit and therefore exempt from property taxes and business entity taxes.  Health care services taxed under the provider tax are exempt from the higher rate sales tax.  Employer paid health care benefits are not subject to income tax.  When one buys health insurance under a plan other than an indemnity insurer you pay half the rate of the insurance premium tax, and if you are covered by an employer’s self-insured plan there’s no tax at all.  (We also note all prescription and over-the-counter drugs, medical devices and their replacement parts, and prescription eyeglasses / contact lenses are exempt from the sales tax – ed.)  As a result, a large and growing sector of the state’s economy is paying a relatively low percentage of state and local taxes – while at the same time much of our spending is driven by health care costs.  That puts us in what he described as a “budget vice” which is an underlying subtext to the debate nobody is likely paying attention to.

Having sold our crystal ball on eBay a few years back, we have few predictions of our own to add to our panelists’.  What clearly runs through their comments, though, are some important realities about the intersection of politics and policy.  Deadlines force choices.  Constituent complaints are an effective way to grab legislators’ attention.  And the changing nature of the tax landscape will force everyone to think long and hard about how to best position Minnesota for continued success.