New taxes will make leaving Minnesota pay

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The Minnesota Legislature is considering imposing a new capital gains and dividends tax in addition to the state's top marginal income rate of 9.85%. The euphemistically named "preferential rate" would impose a 1.5% additional tax on net long-term capital gains between $500,000 and $1 million.

Coming on top of the 9.85% top marginal income tax rate, the new tax would bring the total tax rate on these capital gains to 11.35%. The proposed legislation would tax capital gains over $1 million at a "preferential rate" of 4% on top of the 9.85% regular tax rate — for a total rate of 13.85%.

For small businesses, this new tax may be a significant incentive to move out of Minnesota. The Small Business Administration defines small businesses by firm revenue ranging from $1 million to more than $40 million and by employment from 100 to more than 1,500 employees, depending on the type of business.

Consider a typical "small business" that has $20 million in annual revenue and $5 million of earnings before interest, taxes, depreciation and amortization (often referred to as EBITDA) and has 300 employees located in Minnesota.

Let's also assume that the owner is thinking about selling this business sometime in the future, and she believes she can sell the business for a multiple of 10 times EBITDA (10 x $5 million = $50 million).

Now let's assume the owner instead decided to move the business to Iowa. In 2023, Iowa's top marginal tax rate will be 6% (recently lowered from 8.53%). Iowa does not have a special capital gains tax.

Now when our hypothetical owner went to sell the business that she had moved to Iowa, she would pay Iowa $3 million on her $50 million capital gain, saving $3.925 million from the tax bill she would have paid had she kept the business in Minnesota. Even if it had cost our hypothetical owner $1 million to move her business across the border to Iowa, she still would have saved nearly $3 million in state income taxes.

Of course, if our hypothetical business owner were to move her business to a no-income- tax state like Florida or Texas, she would save the whole $6.925 million in state income tax.

You might be asking, would a business really move out of Minnesota if Minnesota imposes one of the highest capital gains taxes in the country? The answer, unfortunately, might be yes.

For example, in 2021, Washington state passed a 7% tax on capital gains over $250,000.

On March 27, 2023, Fisher Investments, which manages nearly $200 billion for private investors, institutions and retirement plans, announced that it was moving its headquarters from Camas, Wash., to Plano, Texas, because of Washington's 7% tax on capital gains.

Making it profitable for Minnesota businesses and their employees to move out of state is not good tax policy.