Issue

How should Minnesota businesses be taxed? Is Minnesota’s business tax system out of date? Should Minnesota adopt a “business activity tax,” a business entity tax, a gross receipts tax or a net receipts tax?

Policy

At present, Minnesota C-corporations pay the corporate income tax while S-corporations, partnerships, sole proprietors and limited liability companies flow business income through a personal income tax return. A business activity tax (BAT) is generally a tax levied on a business that is based on receipts, income or profits and includes corporate income taxes, franchise taxes, single business taxes and gross receipts taxes, among others. In Minnesota, a 1997 bill referred to a tax paid by all businesses regardless of their legal status – C-corporations, S-corporations, partnerships, sole proprietorships, etc. – as a “business activity tax.” Its tax base generally includes compensation, the value of employee benefits, other taxes paid and net income. Deductions could include capital expenditures and a standard exemption. A BAT also includes an apportionment formula for determining how much of a multistate business’s activity should be allocated to Minnesota. The use of “business activity tax” in this policy refers to the 1997 Minnesota legislation, not the broader definition.

A business entity tax (BET) also is paid by all types of businesses. The tax base is federal gross income plus the cost of goods sold less pass-through income – income from partnerships, S-corporations and limited liability companies. This amount is apportioned based on the percentage of a firm’s Minnesota sales to total sales. Unlike a business activity tax, there is no standard exemption or a capital expenditure deduction.

A gross receipts tax operates by taxing all receipts of a business, occurring every time a product changes ownership during all stages of production and distribution. The tax is usually transferred to customers through higher prices for goods and services or to owners/shareholders through lowered returns for businesses.

Minnesota should not enact a BAT or a BET. Our opposition is based on the following reasons:

• Without a significant reduction in the overall level of business taxes, replacing some or all of the state’s current business taxes with a BAT or BET would likely create many winners and losers within the business community.

• The largest component of the BAT base is generally compensation. As such, it is primarily a tax on labor and could discourage employment in the state.

The Chamber opposes the enactment of a gross receipts tax or a net receipts tax. These taxes often favor larger enterprises over smaller ones by encouraging vertical integration, and they favor out-of-state businesses that do not pay these taxes because their product prices will not reflect these built-in costs. Gross receipts taxes are not economically neutral because they distort economic decisions made by individuals and businesses. Finally, gross and net receipts taxes lack transparency, and they do not reflect an ability to pay for government services.

Business Impact

The impact of enacting a business activity tax or a business entity tax is difficult to determine. It depends on whether a business is capital or labor intensive, how it is structured (i.e. C-corporation, partnership, S-corporation, etc.), what taxes are reduced or eliminated to offset a BAT or BET, and whether there was a revenue neutral change.

In 2005, the BAT study authorized by the Legislature was released. It concluded that, in 1999, eliminating the corporate income tax and substituting a business activity tax with a rate of 0.71 percent would reduce the taxes of about 20,000 C-corporations, 4,800 S-corporations and 7,800 partnerships. It also would increase the taxes of about 26,500 C-corporations, 52,700 S-corporations, 23,500 partnerships, 420,500 sole proprietors, 84,400 farmers and 169,600 taxpayers with rental income.

Enacting a gross receipts tax would be detrimental to Minnesota’s business climate. Small and midsize businesses would struggle – more than they already do – to compete with larger firms that have more resources and capacity to vertically integrate their businesses, as well as handle increased costs during production. Moreover, Minnesota businesses that compete in other states and countries would be at a competitive disadvantage compared with similarly situated companies in other states that do not have to pay a gross receipts tax. These taxes distort private-market decisions and provide disincentives for growth and development.