For Minnesota business owners, estate tax is a key consideration. Unlike many states, Minnesota imposes its own estate tax in addition to the federal estate tax, which can create challenges for small business owners and family-owned businesses. Fortunately, the Qualified Small Business Deduction can provide a powerful opportunity to reduce or even eliminate a portion of your Minnesota estate tax liability.
What is the Qualified Small Business Deduction?
The Qualified Small Business Deduction is designed to help preserve family-owned businesses and other small businesses. In 2025, if a Minnesota resident’s gross estate exceeds $3 million, the estate’s personal representative or executor is required to file a state estate tax return. However, filing a Minnesota estate tax return does not necessarily mean the estate will owe tax. In many cases, the executor can apply deductions that reduce the value of the estate below the $3 million threshold. The estate does not owe tax if this happens. Through the Qualified Small Business Deduction, Minnesota business owners can transfer an additional $2 million in eligible assets without paying estate tax.
As of 2025, the deduction applies to decedents who died after June 30, 2011, owned a qualified small business, and transferred the business to a qualified heir at the time of their death.
Eligibility Requirements for the MN Qualified Small Business Deduction
To meet the requirements for the Minnesota Qualified Small Business Deduction in 2025, small business properties must meet all of the following requirements:
- The estate must include the property’s value, after deducting debts, expenses and bequests to a surviving spouse, in the decedent’s federal adjusted taxable estate.
- The property must consist of trade or business assets, or ownership interests (like stock) that are not publicly traded.
- The decedent or the decedent’s spouse must have materially participated in the business during the taxable year before the decedent’s death. Material participation generally means regular, continuous, and substantial involvement in business operations, as defined by the IRS. (Internal Revenue Code, § 469(h).)
- The business must have had gross annual sales of $10 million or less in the last taxable year before the decedent’s death.
- Cash, cash equivalents, publicly traded securities, or assets not used in the operation of the business cannot be included in the deduction.
- The decedent or the decedent’s spouse must have owned the property continuously for three years ending with the decedent’s death.
- A qualified family member must materially participate in the business for three years following the decedent’s death, as specified by the IRS (Internal Revenue Code, § 469(h).)
- The estate and the qualified heir must agree to pay recapture tax, if applicable.
Because of these stipulations, documentation and planning are critical to claiming the deduction.
Defining a Qualified Heir for Minnesota’s Small Business Deduction
For the purposes of the Minnesota Qualified Small Business Deduction, a qualified heir is limited to certain family members who inherit qualified property when the decedent passes away. To be considered a qualified heir, the individual must be one of the following:
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- An ancestor of the decedent, such as a parent or grandparent
- The decedent’s spouse
- A lineal descendant (e.g. child, grandchild, etc.) of the decedent, the decedent’s spouse, or the decedent’s parents
- The spouse of any lineal descendant
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This definition is important because only a qualified heir can receive certain estate tax benefits tied to the small business, like the Qualified Small Business Deduction.
What Minnesota’s Recapture Tax Means for Heirs
Minnesota imposes a 16% recapture tax if heirs fail to maintain ownership or participation in the qualified small business for three years after the decedent’s death. The tax applies if an heir disposes of interest in the qualified business (except if it is transferred to another qualified family member) or if a family member is not involved in the operations of the business on a standard, continual, and significant basis.
Next Steps: Claiming the Minnesota Qualified Small Business Deduction
Understanding the Minnesota Qualified Small Business Deduction is crucial for executors and heirs. To claim it, they must meet all requirements and submit Schedule M706Q, Election to Claim the Qualified Small Business and Farm Property Deduction with the Minnesota estate tax return. Careful planning can help minimize taxes and protect family businesses. Boulay’s Estate and Trust team can guide you through the process to ensure your deductions are properly claimed.