As discussed in recent blog posts, the Oregon Legislative Assembly recently enacted a Corporate Activity Tax (“CAT”). Governor Kate Brown signed the legislation into law, effective January 1, 2020. Put in simplest terms, the CAT is a gross receipts tax on businesses with greater than $1 million of “commercial activity sourced to this state.”
Given the broadness of the new law and the many anticipated difficulties that taxpayers, tax advisors and the government will likely encounter determining what constitutes “commercial activity sourced to this state,” the need for the Oregon Department of Revenue (the “Department”) to adopt administrative rules on the new law is evident.
As we reported in our June 4 blog post, Oregon lawmakers had recently enacted a “corporate activity tax” (“CAT”) that applies to certain Oregon businesses. The new law, absent challenge, becomes effective January 1, 2020.
We also recently reported that a prominent group of Oregon businesses planned to challenge the CAT. It appears, however, that the momentum for a challenge has recently died.
In this blog post, we discuss the reasons causing the death of the challenge. In addition, we cover some technical changes in the new law that are currently awaiting Governor Kate Brown’s signature.
We are taking a break from our multi-post coverage of Opportunity Zones to address a recent, significant piece of Oregon tax legislation.
On May 16, 2019, Governor Kate Brown signed into law legislation imposing a new “corporate activity tax” (“CAT”) on certain Oregon businesses. The new law expressly provides that the tax revenue generated from the legislation will be used to fund public school education.
Although the new tax is called a “corporate” activity tax, it is imposed on individuals, corporations, and numerous other business entities. The CAT applies for tax years beginning on or after January 1, 2020.
To help defray the expected increased costs of goods and services purchased from taxpayers subject to the CAT that will assuredly be passed along to consumers, the Oregon Legislative Assembly modestly reduced personal income tax rates at the lower income brackets.
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
- "Tax Law Update for Family Law Practitioners," Oregon State Bar - Family Law Section 2019 Annual ConferenceSunriver, OR, 10.11.19
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," New York University 78th Institute on Federal TaxationNew York, NY, 10.20.19-10.25.19
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," Oregon Society of Certified Public Accountants (OSCPA) 2019 Northwest Federal Tax ConferencePortland, OR, 10.28.19
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," New York University 78th Institute on Federal TaxationSan Francisco, CA, 11.10.19–11.15.19
- "The Oregon Corporate Activity Tax," Oregon Society of Certified Public Accountants (OSCPA) 2020 OSCPA State & Local Tax ConferencePortland, OR, 1.6.20