Larry's Tax Law

In 2015, the U.S. Tax Court issued its ruling in the case of David W. Laudon v. Commissioner, TC Summary Option 2015-54 (2015).[1] The case may not raise or even resolve any novel tax issues, but it reminds us of what is hopefully the obvious relative to the deductibility of business expenses. The Court’s opinion and its recitation of the underlying facts, however, make for an extremely interesting and entertaining read.

For more than a year, I have been discussing the potential that Oregon lawmakers will pass a corporate gross receipts tax. On May 26, 2017, we discussed recent events that would lead a reasonable person to believe that the dream of a corporate gross receipts tax was definitely alive and well in Oregon. In fact, the passage of it certainly appeared to be gaining steam in the legislature. Maybe that is not the case – at least for now.

Late yesterday, Oregon Democrats announced that they are abandoning any efforts to enact a corporate gross receipts tax this year as they have been unable to garner adequate legislative support to pass such a measure. Article IV, Section 25 of the Oregon Constitution requires a three-fifths majority of all members elected to each house of the legislative assembly to pass bills for raising revenue and that the presiding officer of each respective house sign the bill or resolution. So, it appears a three-fifths vote in favor of a corporate receipts tax in each the house and the senate is not currently attainable.

After Oregon Measure 97’s drubbing at the polls in November 2016, for many, it suggested the quashing of any notion of a gross receipts tax in the state.  For Oregon Senator Mark Hass (D) and Representative Mark Johnson (R), it got them thinking creatively about alternatives to such an approach, spawning Legislative Concept 3548, and subsequently, the births of Senate Joint Resolution 41 and House Bill 2230.  Both resemble the now defunct Measure 97—and in the same way can be viewed as a hidden sales tax, essentially.  While finding a palatable path to reform is certainly a tall order, the new tax proposals could pose a serious threat to the Oregon business community and present a thorny solution to addressing the state’s budgetary needs. 

In an April 2017 State Tax Notes article, titled “The Idea That Would Not Die: Beyond Oregon’s Measure 97,” my colleague Michelle DeLappe and I discuss these new Oregon tax proposals and their key differences with Measure 97, the benefits and shortcomings of a gross receipts tax, and the likelihood of a gross receipts tax in Oregon becoming a reality.

As I reported previously, Oregon Measure 97 was overwhelmingly defeated by voters in the state’s general election this past November. It certainly appeared that the voters spoke loudly and clearly on November 8, 2016, when they voted to defeat the ill-designed amendments to the Oregon corporate minimum tax regime contained in Measure 97. Flaws in the legislation included:

1. Measure 97 contained a corporate alternative tax based on Oregon gross receipts – a tax that has no relationship to profits.
2. Measure 97 proposed a corporate alternative tax applicable only to C corporations. S corporations, entities taxed as partnerships and Oregon benefit companies would have escaped the proposed tax altogether.
3. While Oregon benefit companies would have escaped the proposed tax, non-Oregon benefit companies were to be subject to the tax. As a result, Measure 97 was clearly in conflict with the Interstate Commerce Clause.

Enter Legislative Concept 3548

On February 13, 2017, Oregon Senate Finance Committee Chairman Mark Hass (D) requested that Legislative Concept 3548 (“LC 3548”) be released. LC 3548 is a legislative referendum to amend the Oregon Constitution in order to create a “Business Privilege Tax” based on gross receipts. It looks a lot like Measure 97. There are, however, some key differences, including:

The proposed $3 billion per year tax-raising bill, Oregon Measure 97, was defeated yesterday by a 59% to 41% margin. The fight was long and bloody. Media reports that opponents and proponents together spent more than $42 million in their campaigns surrounding the tax bill.

So, What Now?

The defeat of Measure 97 eliminates the proposed 2.5% gross receipts alternative corporate tax applicable to C Corporations with annual Oregon gross receipts over $25 million. Oregon C Corporations, however, are still faced with a minimum tax based on Oregon gross receipts. The minimum tax applicable to Oregon’s C Corporations is based on gross revenues as follows:

C Corporations with Oregon annual revenues greater than $25 million may face a new minimum tax obligation – 2.5 percent of the excess – if Measure 97 passes. If a business falls within this category, there may be ways to mitigate its impact. The time to start planning, however, is now.

Background

Oregon taxes corporations under an excise tax regime.  The Oregon corporate excise tax regime was adopted in 1929.  The original legislation included what is commonly called a “minimum tax” provision.  In accordance with this provision, corporations subject to the Oregon excise tax are required to pay the greater of the tax computed under the regular corporate excise tax provision or the tax computed under the “minimum tax” provision.  Accordingly, the “minimum tax” is an “alternative” tax; it is not an “additional” tax as many commentators have recently asserted.

Originally, the Oregon corporate “minimum tax” was a fixed amount – $25.  As a result of the lobbying efforts of Oregon businesses, the “minimum tax” was eventually reduced to $10, where it remained for almost 80 years.

In 2010, Oregon voters dramatically changed the corporate “minimum tax” landscape with the passage of Measure 67.  The corporate “minimum tax” (beginning with the 2009 tax year), is no longer a fixed amount.  Rather, it is now based on Oregon sales (gross revenues).  The “minimum tax” is now:

Oregon Sales

Minimum Tax

< $500,000

$150

$500,000 to $1 million

$500

$1 million to $2 million

$1,000

$2 million to $3 million

$1,500

$3 million to $5 million

$2,000

$5 million to $7 million

$4,000

$7 million to $10 million

$7,500

$10 million to $25 million

$15,000

$25 million to $50 million

$30,000

$50 million to $75 million

$50,000

$75 million to $100 million

$75,000

$100 million or more

$100,000

S corporations are exempt from the alternative graduated tax system.  Instead, they are still subject to a fixed amount “minimum tax,” which is currently $150.

As an example, under the current corporate “minimum tax” provision, a corporation with Oregon gross sales of $150 million, but which, after allowable deductions, has a net operating loss of $25,000, would be subject to a minimum tax of $100,000.  Many corporations operating in Oregon, which traditionally have small profit margins (i.e., high gross sales, but low net income), found themselves (after Measure 67 was passed) with large tax bills and little or no money to pay the taxes.  Three possible solutions for these businesses exist:

• • Make an S corporation election (if eligible);

• • Change the entity to a LLC taxed as a partnership (if the tax cost of conversion is palatable); or

• • Move all business operations and sales outside of Oregon to a more tax-friendly jurisdiction.

Several corporations in this predicament have adopted one of these solutions.

Initiative Petition 28/ Measure 97

Measure 97 will be presented to Oregon voters this November.  If it receives voter approval, it will amend the “minimum tax” in two major ways:

• • The “minimum tax” will remain the same for corporations with Oregon sales of $25 million or less.  For corporations with Oregon sales above $25 million, however, the “minimum tax” (rather than being fixed) will be $30,001, PLUS 2.5 percent of the excess over $25 million.

• • The petition specifically provides that “legally formed and registered benefit companies” as defined in ORS 60.750 will not be subject to the higher “minimum tax.”  Rather, they will continue to be subject to the pre-Measure 97 “minimum tax” regime (as discussed above).  Caveat: The exception, as drafted, appears to only apply to Oregon benefit companies; it does not extend to foreign benefit companies authorized to do business in Oregon.

Measure 97 expressly provides that all increased tax revenues attributable to the new law will be used to fund education, healthcare and senior citizen programs.  As a result, many commentators believe the initiative has great voter appeal and will likely be approved by voters.  If Measure 97 is passed, it is slated to raise over $6 billion in additional tax revenue per biennium.

In general, the Oregon income tax laws are based on the federal income tax laws. In other words, Oregon is generally tied to the Internal Revenue Code for purposes of income taxation. As a consequence, we generally look to the federal definition of taxable income as a precursor for purposes of determining Oregon taxable income.

What does this mean to taxpayers in the trade or business of selling recreational or medical marijuana in Oregon?

Currently, it appears these taxpayers are stuck with the federal tax laws. Consequently, unless the Oregon legislature statutorily disconnects from IRC § 280E, for Oregon income tax purposes, all deductions relating to the trade or business of selling medical or recreational marijuana will be disallowed.

I suspect the result of IRC § 280E and its impact on Oregon income taxation will be that many taxpayers in this industry will go to lengthy efforts to capitalize expenses and add them to the cost of goods sold. Caution is advised. The taxing authorities will likely closely scrutinize this issue.

As a general rule, in accordance with IRC § 162(a), taxpayers are allowed to deduct, for federal income tax purposes, all of the ordinary and necessary expenses they paid or incurred during the taxable year in carrying on a trade or business.  There are, however, numerous exceptions to this general rule.  One exception is found in IRC § 280E.  It provides:

“No deduction or credit shall be allowed for any payment paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any state in which such trade or business is conducted.”

Please join me for the NYU 73RD Institute on Federal Taxation.  This year’s Institute will be held in San Diego at the Hotel Del Coronado November 16 – 21, and in New York City at the Grand Hyatt New York October 19 – 24.  Please see the attached brochure.  The coverage of tax topics is both timely and broad.  This year’s presentations will cover topics in the areas of:  executive compensation and employee benefits; partnerships and LLCs; corporate tax; closely held businesses; and trusts and estates.  What is so terrific about the Institute, in addition to a wonderful faculty and the interesting current presentation topics, you can choose the presentations you want to attend.  In other words, you can pick and choose the topics that relate to your tax practice.

This is my second time speaking at the Institute.  My topic this year is: "Developments In The World Of S Corporations."  I plan to deliver a White Paper that will provide attendees with an historic overview of Subchapter S and a look through a crystal ball at the future of Subchapter S, including a review of the recent cases, rulings and legislative proposals impacting Subchapter S.

I hope to see you in either San Diego or New York.

Best,

Larry

The IRS will strike down transactions among related parties that lack economic outlay. At least two recent US Tax Court cases are illustrative of the issue.

Kerzner

Kerzner v. Commissioner, T.C. Memo 2009-76 (April 6, 2009). The Service beat the taxpayers in this case by a nose. Mr. and Mrs. Kerzner were equal partners in a partnership that owned a building. The partnership leased the building to an S corporation which was owned equally by two shareholders, Mr. and Mrs. Kerzner. Over the years, the partnership loaned the Kerzners money. In turn, they loaned the money to their S corporation, which used the money to pay rent to the partnership.

At the end of each year, promissory notes were drafted to document the loans; some of the notes stated an interest rate, some did not. Even though the notes required payment of principal, virtually no payments were ever made because the notes each year were replaced with new notes before any payment was due.

The S corporation had large losses. The Kerzners claimed basis in the loans to the corporation and took the losses on their individual tax returns. Upon audit, the Service claimed the loans lacked economic substance and did not give the Kerzners basis to absorb the losses.