Larry's Tax Law

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.

As reported in my November 2015 blog post, in accordance with Internal Revenue Code (“Code”) Section 280E, taxpayers (for purposes of computing federal taxable income) are prohibited from deducting expenses related to the production, processing or sale of illegal drugs, including marijuana.

A Bit of Welcome Relief?

Measure 91, officially called the Control, Regulation, and Taxation of Marijuana and Industrial Hemp Act, passed by Oregon voters, appears to have alleviated some of the impact of Code Section 280E as it relates to Oregon taxable income. Specifically:

As reported in my November 2013 blog post, for tax years beginning in 2015 or later, under ORS 316.043, applicable non-passive income attributable to certain partnerships and S corporations may be taxed using reduced tax rates.  The reduced tax rates are as follows:

• • 7 percent for taxable income of $250,000 or less;

• • 7.2 percent for taxable income greater than $250,000 but less than or equal to $500,000;

• • 7.6 percent for taxable income greater than $500,000 but less than or equal to $1,000,000;

• • 8 percent for taxable income greater than $1,000,000 but less than or equal to $2,500,000;

• • 9 percent for taxable income greater than $2,500,000 but less than or equal to $5,000,000; and

• • 9.9 percent for taxable income greater than $5,000,000.

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.

CURRENT LAW

In accordance with ORS § 314.402, the Oregon Department of Revenue (“DOR”) shall impose a penalty on a taxpayer when it determines the taxpayer “substantially” understated taxable income for any taxable year. The penalty is 20% of the amount of tax resulting from the understated taxable income. ORS § 314.402(1). For this purpose, a “substantial” understatement of taxable income for any taxable year exists if it equals or exceeds $15,000. ORS § 314.402(2)(a). In the case of a corporation (excepting S corporations and personal holding companies), the threshold is increased to $25,000. ORS § 314.402(2)(b). As perplexing as it may be, these thresholds (established in 1987) are not indexed for inflation.

HOUSE BILL 2488 

House Bill 2488 changes the penalty terrain in Oregon. It was unanimously passed by the Oregon House of Representatives on March 2, 2015. The bill made its way to the Oregon Senate where it was unanimously passed on April 8, 2015. The Governor signed House Bill 2488 into law on April 16, 2015. Although it becomes law on the 91^st day following the end of the current legislative session, taxpayers and practitioners need to be aware, the new law applies to tax years beginning on or after January 1, 2015.

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.”

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.

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: