Redpath Insights

Down, but Not Out

by Gloria McDonnell, CPA

May 13, 2015 โ€” Normally, the buzz around my house this time of the year would be regarding the Kentucky Derby, which takes place on the first Saturday of May every year. This year, however, the buzz is all about the much talked-about and long-anticipated boxing bout between Mayweather and Pacquiao. Like him or not, my bets are on Mayweather. I am anticipating that, after a couple of rounds, Pacquiao is going to feel pretty beat up!

As I offered my prediction for the fight, I couldnโ€™t help but think of the business owners I work with who are feeling pretty โ€œbeat upโ€ after completing โ€œround twoโ€ with the new tax rates in Minnesota. April 15th, 2015, marked the second year in which taxpayers were faced with the stark reality of their tax billโ€”both for living and for operating a business in Minnesota. During the 2013 legislative session, a new fourth tier was added to the tax rate structure, increasing the top tax rate for individual taxpayers from 7.95 percent to 9.85 percent.  This is almost a 25 percent increase! This increase impacts over 21,000 businesses who pay taxes in Minnesota.

Most of these businesses are organized as sole proprietorships, limited liability companies, S corporations, or partnerships. In fact, 92 percent of Minnesotaโ€™s businesses operate under one of these structures. This means the net profit of the business is passed through to the individual owners, and is reported and taxed on their individual income tax returns. Most often, this net profit is not distributed to the business owners in the form of cash or property, but they do pay tax on it all the same.

Most business owners donโ€™t distribute the net profit because they want to retain it in the business to facilitate growthโ€”through equipment purchases, facility expansion, job creation, and the provision of competitive pay and benefits. However, the increased tax rate in Minnesota is packing a mighty punch against business owners, and is hindering their ability to grow their businesses the way they would prefer. The high state taxes impact their ability to compete with similar businesses just across the border โ€ฆ any border! The state tax rate in surrounding states is lower (and in some cases, much lower) than the tax rate in Minnesota. Neighboring states would love to have our Minnesota businesses move across the border!

It is time to recognize this threat and enact some tax relief to the many Minnesota businesses that operate as sole proprietorships or pass-through entities. In light of the recent news that one of Minnesotaโ€™s largest employers is announcing massive lay-offs, we certainly donโ€™t want to see some of our businesses move across the border to a seemingly more business friendlyโ€”and lower taxโ€”state.

The high tax rate doesnโ€™t only deliver a blow to the business owners, it also impacts people who may be considering an entrepreneurial investment in a Minnesota business, or much needed talented employees considering a move to Minnesota for a job opportunity. The high taxes the investors or employees will pay on their Minnesota income is a real cost they will factor into their decision of whether or not to invest inโ€”or relocate toโ€”the state. Numerous studies by non-partisan economists indicate that high corporate and personal income tax rates are very harmful to economic growth because capital is very mobile and very sensitive to high tax rates. For manufacturers, as well as businesses in many other industries, the work force is a top concern for the future. Our businesses are vying for the same talent as are their competitors in neighboring states. Taxes have a huge impact on employeesโ€™ decisions regarding a new job opportunity.

The new 9.85 percent tax rate ranks Minnesota the second highest in the nation for some incomes, and the fourth highest for state tax rates in the nation overall   Enacting a subtraction for pass-through income would greatly alleviate the burden on our Minnesota businesses.

In fact, such a subtraction was a recommendation of the Governorโ€™s 21st Century Tax Reform Commission 2009 report. Research shows that higher marginal tax rates on income from pass-through businesses negatively impact investment and hiring. Reducing the tax burden on our pass-through businesses would help them remain competitive with border states when it comes to capital infusion or talent recruitment. The investment in business expansion has a positive impact on the local community and the state. Allowing business owners to invest more in their business and their employees is a win for everyone!

So โ€ฆ what now? Round two is over. You may feel down, but you are not out! It is time for Minnesota business owners to unite and make their voices heard! Take an active role in the organizations that support your industry. Letโ€™s work together to make Minnesota a business-friendly state for the good of allโ€”the business owners, the employees, the local communities, and the state.

Gloria McDonnell, CPA

Gloria McDonnell, CPA

Gloria McDonnell is the tax operations director and serves on the leadership team at Redpath and Company. She specializes in corporate and individual tax planning and compliance, multi-state taxation, international tax, and tax research. Gloria works with closely-held businesses in a variety of industries, and has provided business tax accounting services since 1989, and has been at Redpath and Company since 1991.