MINNESOTA GIVES TAX BREAK TO NONRESIDENTS 

TAX PLANNING OPPORTUNITY FOR MINNESOTANS RETIRING OUT OF STATE

07-24-00:  The Minnesota legislature made an important change to state tax laws this year for former Minnesotans who have become nonresidents at the time they receive income from services previously performed in Minnesota. Responding to a 1999 Minnesota Supreme Court decision, the 2000 Minnesota legislature has amended state tax laws to provide that income from services performed in Minnesota will no longer be subject to Minnesota taxation if the taxpayer was a resident when performing the services but was a nonresident during the entire taxable year in which the income is received.

This important change, which applies to income received on or after May 15, 2000, may present important tax planning opportunities for Minnesotans retiring to other states who have nonqualified stock options or significant amounts of other nonqualified deferred compensation.

The Benda Decision

The 2000 legislation derived from the 1999 Minnesota Supreme Court decision Benda v. Girard, 592 N.W.2d 452 (Minn. 1999). In Benda, the Supreme Court held that Minnesota may not tax compensation paid to nonresidents for services performed in Minnesota if those services consist of managerial or executive activities performed for a corporate employer. That decision presented certain refund and planning possibilities for executive employees who were not residents of Minnesota or who intended no longer to be residents of Minnesota at the time that they received income from the exercise of nonqualified stock options or from nonqualified deferred compensation.

The longstanding tax statute under review in Benda was that which makes taxable in Minnesota income earned by a nonresident from labor or personal or professional services if the labor or services are performed within Minnesota. The Minnesota Supreme Court interpreted this provision to mean that only income from labor performed directly for customers or clients by nonresidents is subject to tax in Minnesota; hence income from managerial or executive activities performed by a nonresident manager or executive for an employer was not subject to tax. Although Benda did not deal with deferred compensation or the exercise of nonqualified stock options, it was clear under that decision that, if an individual was a nonresident of Minnesota at the time that he or she recognized income from deferred compensation or nonqualified stock options, that income was not taxable by Minnesota so long as the services performed in Minnesota had been managerial or executive in nature.

The Benda decision represented a departure from the common understanding of the taxation of income from personal services rendered in Minnesota by nonresidents, and from the Department of Revenue's position in this matter.

The 2000 Legislative Response

The 2000 Minnesota legislature responded to Benda by eliminating the managerial/nonmanagerial distinction and clarifying that all nonresidents are generally taxable on income derived from services performed in Minnesota. In addition, however, the legislature granted relief under certain circumstances to former residents who receive deferred compensation for Minnesota services after their Minnesota residency has ended.

If an employee who was a resident of Minnesota while performing services in Minnesota subsequently receives income treated as wages for federal income tax purposes during a taxable year when he or she is no longer a resident of the state, that income will not be subject to Minnesota taxation. This can arise, for example, in the case of nonqualified deferred compensation or in the case of nonqualified stock options, the exercise of which occurs after termination of employment at a time when the employee has moved out of Minnesota. Because of the requirement that the individual not be a resident of Minnesota during any portion of the taxable year during which the income is received, it would be important, in the case of nonqualified stock options, that the exercise date occur during a taxable year after the individual has moved out of Minnesota and has established residence in another location.

These changes are effective with respect to wages paid on or after the date of enactment of the omnibus tax bill, which was May 15, 2000. However, the employer's obligation to withhold Minnesota taxes with respect to amounts that become taxable as a result of the changes is effective only for wages paid after December 31, 2000.

We thank NASPP member Bruce Shnider of Dorsey & Whitney (Minneapolis) for bringing this to our attention.