How does the Minnesota individual income tax apply to pension income?
Minnesota taxes pension income, whether derived from governmental or
private pensions, on the same basis as wages, interest, dividends, and other
income, but Minnesota allows an income tax subtraction for military retirement pay,
including pensions paid to survivors of military retirees. The Minnesota tax does not allow
an exclusion, deduction, or credit for any other type of pension income.
Minnesota also follows the federal income tax rules in taxing Social Security
benefits. See a description of these rules.
When did Minnesota exclude public pension income from the income tax?
||Minnesota income tax as enacted included an
exclusion for public pension income. The exclusion was limited
to the pensions of federal and Minnesota state retirees, with no limit on the
amount of benefits, the recipient's age, or the amount of other income received.
||The pension exclusion was extended to railroad retirement benefits.
||The pension exclusion was extended to payments made by Minnesota political or governmental subdivisions.
||The pension exclusion was extended to pensions paid by other states and local governments in other states.
||The pension exclusion was extended to payments made by volunteer firefighters' relief associations.
||The pension exclusion, until now limited to public pensions, was extended to all pensions,
but subject to a maximum amount and subject to reduction for income from other sources.
||The pension exclusion was limited to taxpayers age 65 or older or disabled (except for specified
public safety retirees).
||The pension exclusion was repealed, effective for tax year 1987.
||A pension exclusion was enacted for military retirement pay,
including survivor benefit plan payments, effective for tax year 2016.
What was the rationale behind the original exclusion?
The original exclusion likely was based on three considerations.
- First, it was accepted constitutional doctrine in the 1930s that states had no power to tax
federal government salaries and pensions under the doctrine of intergovernmental tax immunity.
Thus, federal pensions would be beyond the constitutional scope of a state tax. This practice
continued, even after the federal court decisions and legislative changes made it clear that states
could tax federal employees on a nondiscriminatory basis.1
- Second, exclusion of Minnesota state government pensions (and later local government pensions) was
probably intended to grant equal treatment with federal employees and to provide a convenient,
off-budget manner of paying slightly more generous benefits to public retirees.
- Third, the exclusion of railroad retirement benefits was also based on
intergovernmental tax immunity. Federal law continues to explicitly prohibit
state taxation of some portions of railroad retirement pensions.
How did the exclusion change over time?
During the 1970s the legislature made a series of changes which fundamentally changed the
nature of the pension exclusion. These changes can be divided into four categories. The changes
were often interrelated. For example, limitations were imposed as a trade-off for expansion of
eligibility. The general trend was to expand and equalize the availability of the pension exclusion during
the late 1970s. By contrast, the legislature during the 1980s generally restricted the exclusion to
limit the revenue loss, to reduce tax rates, and impose more nearly equal tax burdens on pension
recipients and other taxpayers (particularly the non-aged).
- The exclusion was extended to recipients of private pensions. Changes in both
public and private pension practices during the 1960s and 1970s made it increasingly apparent
that limiting the exclusion to governmental employees was anachronistic. The pensions of
governmental employees became increasingly generous. More private employers began providing
pensions. Governmental employees were increasingly covered by Social Security and the
exclusion could not be justified as compensating for the fact that government
pensioners did not receive nontaxableSocial Security benefits.
- Limits were placed on the dollar amounts of the exclusion. These limits began at
$7,200 per recipient and were expanded ultimately to $11,000.2
These restrictions served to equalize somewhat the tax
benefits of receiving pension income and to hold down the revenue loss resulting from the exclusion.
- Limits were imposed on the basis of the taxpayer's other income. These restrictions
were intended to target most of the benefit of the exclusion to lower income recipients and to
reduce the state revenue loss from the exclusion. The legislature also enacted provisions that
reduced the exclusion by the amount of nontaxable Social Security and railroad retirement
benefits. These restrictions were intended to equalize somewhat the tax burdens of recipients of
taxable pensions and nontaxable Social Security benefits. The restrictions proved politically
unpopular in the face of charges that they "taxed Social Security" and were quickly repealed in the late 1970s.
- Age restrictions were placed on the exclusion, limiting it to recipients age 65 or
older. This age limit did not apply to state and local police and fire pension recipients
who often retire at younger ages.
When was the general exclusion last in effect?
A general Minnesota pension exclusion was last in effect for tax year 1986. The exclusion
permitted recipients to subtract up to $11,000 of pension income. Pension income was defined as
any distribution from a governmental or qualified plan and, thus, included individual retirement
accounts, self-employed retirement plans (Keogh Plans), and deferred compensation plans (such
as 401(k) plans), as well as standard employer provided pension and profit sharing plans.
The $11,000 maximum applied to single and married joint filers equally.3
The $11,000 maximum was reduced by the amount of
the taxpayer's adjusted gross income (AGI) in excess of $17,000. For a married couple, the
income offset was based of their joint income. Thus, no pension exclusion was available to an
individual or married couple with AGI in excess of $28,000.
As a general rule, only taxpayers aged 65 or older were allowed to claim the pension
exclusion. However, an exception was made for recipients of Minnesota state or local pensions
for police, fire, and correctional employees. Similar exceptions were not made for law
enforcement or correctional retirees who were employed by the federal government.
The tax savings resulting from the pension exclusion equals the taxpayer's marginal tax rate
multiplied by the amount of the exclusion. In 1986, with a top marginal rate of 9.9 percent, the
pension exclusion would yield a maximum tax savings of $1,089.
1 See 4 U.S.C.A. § 111 (federal consent to nondiscriminatory
state taxation of compensation of federal employees).
2 The $11,000 was initially a per recipient limit
(i.e., a married couple with each spouse receiving a pension could claim up to $22,000), but was later restricted
to a total of $11,000 for a married couple.
3 This result was a vestige of Minnesota's pre-1985 system of
separate (or combined) filing for married couples. Under this system, each spouse was allowed a $11,000 exclusion and the income off-set
was calculated only on the basis of the spouse's income. With the adoption of joint filing in 1985,
the $11,000 amount was applied to the combined pensions of a married couple; the income offset
was calculated on the basis of their joint income. This was done regardless of whether they
elected to file a separate return.