A federal appeals court yesterday upheld the constitutionality of tuition tax deductions for Minnesota parents of private and parochial school students, setting up a possible Supreme Court test next year at the same time Congress is considering President Reagan's tuition tax credit proposal.

A three-judge panel of the 8th U.S. Circuit Court of Appeals held unanimously that the Minnesota deductions do not breach the First Amendment wall separating church and state.

The Minnesota plan allows tax deductions of up to $700 from state income taxes for expenses incurred by parents of both public and private school students. The private school parents are the main beneficiaries, however, because their tuition payments alone overwhelm the minimal shop, art and other fees paid in public schools.

The court conceded that the law provided "an indirect state subsidy of tuition which can be viewed as an incentive to parents to send their children to sectarian schools."

But the court said the extension of the deductions to public school parents made it a "neutral" law, rather than one singling out a religious group for special benefits. "We find that any benefit to religion or involvement between church and state is so remote and incidental that the challenged deduction" does not violate the Constitution, Judge Donald P. Lay wrote for the panel, which included Judges J. Smith Henley and Richard S. Arnold.

The court noted that its ruling conflicted with one last year in Rhode Island and specifically noted that "the Supreme Court must decide" the question now.

William I. Kampf, a St. Paul lawyer representing the challengers of the law, said he would appeal to the Supreme Court without asking the full 8th Circuit court for a ruling. "I'm going to Washington," he said.

The court's last full opinion on tax benefits for parents of religious school students was in 1973, when the justices struck down a New York program as unconstitutional by a 6-to-3 vote. Two of the justices in the majority on that case, William O. Douglas and Potter Stewart, have been replaced.

Reagan unveiled a tuition tax credit proposal earlier last month before a group of Roman Catholic educators. Under the plan, parents who send their children to private or parochial schools would be able to subtract the cost of tuition from their final tax bill.

Minnesota's plan, in force for six years, allows a maximum tax deduction (from gross income) of $700 for parents of secondary school students and $500 for parents of elementary school students. An estimated 97 percent of those taking the deduction had children in sectarian schools, according to Kampf.

Dennis Erno, assistant Minnesota commissioner of revenue, said 86,000 Minnesotans now claim total deductions of $32 million at a cost to the state treasury of $4 million. The average amount deducted is $371, he said.

Erno said the law carefully forbids deductions of the costs of supplies and books for expressly religious classes.

But the panel said it was "well aware that we are not dealing with secular textbooks or bus rides, but with tax benefits for tuition payments to elementary and secondary institutions, some of which provide religious training along with secular education.

"Nonetheless . . . the Minnesota statute has not singled out a class of citizens for a special economic benefit," the court said yesterday in Mueller vs. Allen. "It is neutral on its face and, under the facts presented here, we cannot reject this facial neutrality as mere window dressing."