The Timely Filing Requirement Imposed by Oregon DOR in Order for Taxpayers to be Able to use the "Prior Year Tax Safe Harbor" Stricken by the Oregon Tax Court
On September 13, 2013, in Finley v. Oregon Department of Revenue, the Oregon Tax Court granted taxpayer’s Motion for Summary Judgment, and held Oregon Administrative Rule 150-316.587(8)-(A) is invalid to the extent it requires taxpayers to have timely filed their prior year’s Oregon income tax return to be eligible for the “Prior Year Tax Safe Harbor.”
John Rothermich and I represented the taxpayer in this matter. The facts were straightforward. The tax years at issue were 2008 and 2009. The taxpayer was a resident of Oregon during these years.
For tax year 2008, the taxpayer paid his taxes in a timely manner. Unfortunately, he filed his Oregon individual income tax return late.
For tax year 2009, the taxpayer had a substantial increase in his income due to a capital gain-generating transaction. To avoid an estimated tax payment penalty, on December 31, 2009, thinking he qualified for the “Prior Year Tax Safe Harbor,” he made an Oregon estimated tax payment of 100% of his 2008 Oregon income tax liability. Then, he timely filed his 2009 Oregon income tax return, and he paid the additional taxes shown due on the return. Thereafter, the Oregon Department of Revenue sent the taxpayer a nice letter, thanking him for his generous tax payment, but requesting he pay an additional large sum, representing an estimated tax (late payment) penalty. Not being able to resolve the matter with the Department, we filed a complaint in the Oregon Tax Court. The case was ultimately heard by Judge Henry Breithaupt in the Regular Division of the Oregon Tax Court.
The issue before the court was simple. ORS 316.587(8)(b) and OAR 150-316.587(8)-(A)(3)(A) together provide that, if a taxpayer’s prior year Oregon income tax return was for a 12?month period, he/she may avoid an estimated tax payment penalty by paying 100% of the tax shown due on the prior year’s return within the time period prescribed for making estimated tax payments. This rule is commonly known as the “Prior Year Tax Safe Harbor.”
The problem arises with an administrative rule adopted by the Department. OAR 150?316.587(8)-(A)(3)(B) creates an additional requirement for the application of the Prior Year Tax Safe Harbor—it requires that the prior year’s return was timely filed. For the taxpayer in this case, that was a big problem—the prior year’s return was indisputably late. YIKES!
No timeliness requirement is expressed anywhere in ORS 316.587(8). The statute creating the Prior Year Tax Safe Harbor does not expressly grant the Department authority to expand the requirements for its application. The Oregon Legislature has used the phrase “timely filing” throughout the Oregon Personal Income Tax Act contained in Chapter 316 of the Oregon Revised Statutes. Nowhere does the phrase “timely filing” appear in ORS 316.587(8). So, it seems clear that the Oregon Legislature knows how and when to use the phrase.
It should be noted, the Prior Year Tax Safe Harbor contained in the federal counterpart, IRC Section 6654, does not contain a timely filing requirement. In fact, the Service has refused to import such a requirement. See Rev Rul 2003-23, 2003-1 CB 511.
Despite the Department’s arguments in favor of its administrative rule, the Oregon Tax Court concluded that ORS 316.587(8)(b) “is most properly read as not containing any timeliness requirement.…To construe Oregon law consistently with Rev Rul 2003-23 also produces a result that places Oregon taxpayers in the same position regardless of whether the federal estimated tax or the Oregon estimated tax is at issue.” Consequently, the court struck the timely filing requirement from the administrative rule.
The Court’s opinion/order is available HERE.
Faris Fink, Commissioner of the Small Business/Self-Employed Division of the Internal Revenue Service, announced at the AICPA National Tax Conference on November 5, 2013, that his division is moving its audit focus from corporations to pass-through entities (i.e., S corporations, partnerships and sole proprietorships).
Fink was candid when he said his employees do not currently have the skills and knowledge to conduct these examinations. In anticipation of its new focus, however, the Service is developing pass-through entity examination strategies and is training its audit staff to conduct the exams. Practitioners should expect to see significantly more pass-through entity examinations in 2014. One would suspect these examinations, especially early on, will be challenging for taxpayers and their advisors.
Looks Like Oregon Tax Laws are Changing Again
House Bill 3601 A (“HB 3601”) passed the Oregon House of Representatives and the Oregon Senate on October 2, 2013, during a special session. Governor Kitzhaber signed the bill into law on October 8, 2013. The new law is effective January 1, 2014. This is good news for some Oregon taxpayers and bad news for others.
The most significant impact of HB 3601 is found in six provisions, namely:
I. Corporate Excise Tax Rates. The corporate excise tax rates are increased. Effective for tax years beginning in 2013 or later, a 6.6% tax rate applies to the first $1,000,000 of taxable income and a tax rate of 7.6% applies to any excess taxable income. Under current law, the 6.6% tax rate applies to the first $10,000,000 of taxable income and the 7.6% tax rate applies to any excess taxable income. This change in current law represents a substantial increase in tax for many corporate taxpayers.
II. IC-DISCs. Except as expressly provided by Oregon law, DISCs are taxed in Oregon like corporations. ORS 317.635(1). HB 3601 exempts existing Interest Charge DISCs (i.e., IC-DISCs formed on or before the effective date of the act) from the Oregon corporate minimum tax under ORS 317.090. HB 3601 also causes any commissions received by DISCs to be taxed at 2.5%, and allows a deduction for commission payments made to existing DISCs.
III. Dividends Received from DISCs. HB 3601 allows a personal income taxpayer to subtract from income any dividend received from a DISC formed under IRC § 992.
IV. Personal Exemption Phase-Out. HB 3601 denies personal income taxpayers from claiming the personal exemption credit(s) (current $90 per exemption) if federal adjusted gross income is $100,000 or more for a single taxpayer and $200,000 or more for a married filing joint taxpayer.
V. Senior Health Care Costs. HB 3601 provides a small deduction for “senior” health care expenses not compensated by insurance. The bill, however, adds a phase-out for taxpayers with federal adjusted gross income over certain thresholds. Likewise, the definition of a “senior” starts out at age 62 for the 2013 tax year and increases each year thereafter by one year until tax year 2020.
VI. Reduced Tax Rates for Applicable Non-passive Income. For tax years beginning in 2015 or later, applicable non-passive income attributable to certain partnerships and S corporations will be taxed as follows:
- 7% for taxable income of $250,000 or less;
- 7.2% for taxable income greater than $250,000 but less than or equal to $500,000;
- 7.6% for taxable income greater than $500,000 but less than or equal to $1,000,000;
- 8% for taxable income greater than $1,000,000 but less than or equal to $2,500,000;
- 9% for taxable income greater than $2,500,000 but less than or equal to $5,000,000;
- 9.9% for taxable income greater than $5,000,000; or
- Upon election of the taxpayer, the rates otherwise prescribed by ORS 316.037 (which provides for a 9.9% rate on taxable income over $125,000).
To qualify for this reduced rate structure, which is subject to adjustment, taxpayers must make an irrevocable election on their original return (presumably on the 2015 return, but administrative rules yet to be issued by the Department of Revenue should clarify the election process and timing requirements). In addition, the reduced rate structure only applies to “non-passive” income attributable to a partnership or S corporation in which the taxpayer materially participates in day-to-day operations of a trade or business. Last, to qualify the entity must employ at least one non-owner and an aggregate of at least 1200 hours of work must be performed in Oregon during the taxable year by the non-owner employee(s). For the purpose of computing the number of hours worked in Oregon during the taxable year, only hours during weeks in which the non-owner worker(s) performed 30 hours or more of services may be counted.
This last provision of HB 3601 is the most interesting. It appears that disregarded entities (i.e., single-member limited liability companies) are not eligible for the reduced tax rates. Why? It is not clear why the legislature omitted these entities.
For many disregarded entities with sufficient Oregon income, it may be worth converting the entities to S corporation status or adding an additional owner in order to qualify for the reduced rate structure. I assume the sole member of many otherwise qualifying limited liability companies may be willing to convert to S corporation status or add an owner with a small ownership interest (e.g., spouse or current employee) in late 2014 to become eligible for the reduced rate structure.
For example, if the pass-through taxable income of a disregarded entity is $7,000,000, the Oregon tax savings attributable to converting to S corporation status or adding an additional member would be around $74,000 per year. Is that enough incentive for the sole member of a limited liability company to convert to S corporation status or add another member? Only time will tell.
This last provision of HB 3601 creates a tax inequity among entities operating businesses in Oregon. While many taxpayers believe the Oregon corporate minimum tax contained in ORS 317.090 is unfair as it only adversely impacts C corporations, the reduced rate structure for qualifying S corporations and partnerships is likewise unfair as it ignores another flow-through entity, the single-member limited liability company.
Keep your eye on the ball! The provisions of HB 3601 are effective January 1, 2014.
Larry J. Brant is a Shareholder in Garvey Schubert Barer, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; New York, New York; Washington, D.C.; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "Evaluating the Built-in Gains Tax for C to S Conversions After TCJA," New York University Tax Conferences in July – Advanced Conference on Subchapter SNew York, NY, 7.26.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationNew York, NY, 10.21.18-10.26.18
- Portland, OR, 11.5.18
- "The Tax Cuts and Jobs Act – What It May Mean to Your Clients," Estate Planning Council of Portland Mini-SeminarPortland, OR, 11.7.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationSan Diego, CA, 11.11.18-11.16.18