New tax bracket for state’s highest earners gets first hearing in House

The fifth tier has landed.

After being bandied about in big-picture tax policy discussions for at least a few years – and appearing in Gov. Tim Walz’s tax proposal for this session – it made its House Taxes Committee debut Tuesday.

Currently, Minnesota’s individual income tax system has four tiers, each with its own rate of taxation. But HF1335, sponsored by Rep. Kaohly Vang Her (DFL-St. Paul), would establish a fifth tier for the state’s highest earners. The proposed 12.45% rate would kick in at $250,000 in annual income for those filing as individuals, $400,000 for heads of households, and $500,000 for those married filing jointly.

The bill was held over by the committee for possible omnibus bill inclusion. Its companion, SF1401, sponsored by Sen. Erin Murphy (DFL-St. Paul), awaits action by the Senate Taxes Committee.

The Revenue Department estimates that Her’s proposal would increase state revenue by $700.5 million in tax year 2021 and $721.6 million in tax year 2022. The department said that, for tax year 2021, an estimated 53,030 returns would have an average increase in tax of $13,211 per return.

The highest of Minnesota’s four current brackets is taxed at 9.8%. The rate applies to individual filers making $166,040 or more and married joint filers making $276,000 or more.

“This bill would raise income taxes 2.65% for top earners,” Her said. “This would set the effective tax rate for those earners back to where it was prior to 2017.”

The effective tax rate combines earned income (such as wages) and unearned income, such as stock dividends.

In January, Walz included a fifth-tier income tax in his budget proposal, a rate of 10.85% that would apply to individuals making $500,000 or more and $1 million or more for those married filing jointly. While Walz offered revisions to some of his tax proposals last week, his fifth tier suggestion remains.

Those testifying in favor of the bill focused upon the need for more revenue for schools and low-income housing, while those speaking against it argued it would make taxes on the wealthiest residents the highest in the nation.

Beth Kadoun, vice president of tax and fiscal policy for the Minnesota Chamber of Commerce, said it would raise taxes on businesses, too.

“Over 90% of Minnesota businesses are pass-through entities,” she said. “The vast majority file their taxes as individuals. So, even when their income is reinvested in the business, it’s still taxed.”

Her replied that about three-quarters of those pass-through entities would not meet the income threshold to move into the new bracket.

“The Revenue Department estimates that this will affect 1.8% of all returns,” she said. “This would only affect the wealthiest of these S corporations.”

“I’ve heard bills that I knew were going nowhere, and that’s the category this bill falls into,” said Rep. Greg Davids (R-Preston). “It’s unconscionable to think about any tax increases with the money raining down on our heads from Washington.”

“This economic downturn has increased inequity,” said the committee’s chair, Rep. Paul Marquart (DFL-Dilworth). “Over the past year, 61% of the top earners had a job where they could work from home, while that was true of only 9% of those in the bottom quarter of earners. And the top 1% of earners still have a lower effective tax rate than the lowest earners. … If we want the state to recover and be stronger in the end, we have to look into ongoing revenue into the future.”