July 10, 2013

Additional Minnesota State Tax Withholding Required in 2013 for Certain Employee Benefits

On June 26, 2013, the Minnesota Department of Revenue posted several legislative bulletins describing tax law changes enacted during this year's legislative sessions. This legal update focuses on the 2013 Federal Update, which relates to additional Minnesota state tax withholding that is now required for certain educational assistance, transit and adoption assistance benefits, even though these benefits remain exempt from federal taxation. These changes have a retroactive effective date of January 1, 2013.

Employer Provided Educational Assistance

Under §127 of the Internal Revenue Code, employers may provide tax-free educational benefits of up to $5,250 per year. Earlier this year, federal law permanently extended this tax-favored treatment. However, Minnesota did not adopt this extension and as a result, a majority of employer-provided educational benefits are now taxable in Minnesota. Although §127 educational assistance benefits are no longer exempt from Minnesota state tax, employers can still provide educational benefits under two other sections of the Internal Revenue Code that remain tax-free under Minnesota law.

Under §132(d), employers can provide tax-free working condition fringe benefits, which include educational assistance. However, to meet the requirements of this section, the education must (1) maintain or improve skills needed for an employee's current job or (2) be required by the employer or by law for the employee to retain present salary, status or employment. Also, this exclusion does not apply to education that is necessary to meet minimum job requirements or that qualifies an employee for a new occupation.

Additionally, under §117(d), educational institutions can provide qualified tuition reductions for employees (as well as their spouses and dependent children) who receive education at the educational institution where they are employed. To qualify under this section, the education must be below the graduate level, except for graduate-level teaching assistants.

Transit Benefits

In January 2013, federal law also raised the tax-exempt limit for transit pass/vanpool benefits to $245 per month. Minnesota chose not to match the federal tax treatment of transit pass/vanpool benefits, and instead kept the state tax-exempt limit at $125 per month. As a result, any amount of transit pass/vanpool benefits over $125 per month is now subject to state tax. Please note, however, that Minnesota continues to allow the same maximum tax exemption the federal law allows for parking benefits (which is $245 per month for 2013).

Adoption Assistance

Earlier this year, federal law extended tax-favored treatment of adoption assistance benefits so that employers are allowed to exclude up to $12,970 of qualified adoption assistance benefits from an employee's taxable wages in 2013. Minnesota did not adopt this extension for adoption assistance benefits, which means that any qualified adoption assistance benefits provided to employees are now subject to state tax.

Employer Action

For employers who have already provided these benefits without withholding for the proper amount, the Minnesota Department of Revenue has provided guidance on its website. Employers are asked to notify employees of these changes and to explain that employees will be responsible for paying taxes with respect to the benefits provided. More information about these changes is available at the Minnesota Department of Revenue website.

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