Tax Law Alert: Oregon's 2013 Special Legislative Session Passes Changes to Oregon Tax Law

by Stoel Rives LLP
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The special legislative session called by Governor Kitzhaber adjourned on October 2, 2013, after passing a "grand bargain" primarily implementing cost and benefit reductions to Oregon's public employees retirement system (PERS), increasing funding of education, and adopting tax changes. The tax portion of the grand bargain (HB 3601) contains several provisions, including reduced Oregon tax rates on nonpassive flow-through income from partnerships (including LLCs taxed as partnerships) and S corporations, a change in the corporation excise and income tax brackets that increases the tax on taxable income between $1 million and $10 million, and the creation of an Oregon interest charge domestic international sales company (IC-DISC) regime. Governor Kitzhaber is expected to sign the five bills making up the grand bargain, including HB 3601.

The tax provisions of the grand bargain include:

  • Reduced Oregon Tax Rate on Nonpassive Flow-Through Income from Partnerships and S Corporations. For tax years beginning on or after January 1, 2015, taxpayers subject to the Oregon personal income tax may elect to have nonpassive income attributable to any partnership or S corporation (after reduction for nonpassive losses) taxed at the following rates:

 

If income is more than

But not more than

The tax rate is

----

$250,000

7.0%

$250,000

$500,000

7.2%

$500,000

$1,000,000

7.6%

$1,000,000

$2,500,000

8.0%

$2,500,000

$5,000,000

9.0%

$5,000,000

----

9.9%

  • The term "partnership" includes a limited liability company (LLC) or other entity taxed as a partnership.  However, the new reduced rates will not apply to a single-member LLC that is disregarded as an entity separate from its owner. As a result, Schedule K-1 income reported on Schedule E generally will receive more favorable tax treatment than either Form W-2 wage income or income from a sole proprietorship (including from a single-member LLC) reported on Schedule C.
  • "Nonpassive income" is as defined in the Internal Revenue Code and does not include wages, interest, dividends or capital gains. In calculating the amount of income not subject to the special rates, taxpayers must use the subtractions, deductions and additions otherwise allowed.  On the other hand, in calculating the amount of income subject to the special rates, depreciation adjustments directly related to the partnership or S corporation are the only additions or subtractions allowed.
  • A taxpayer can elect to use the alternative rates only if: (1) the taxpayer materially participates in the day-to-day operations of the trade or business; (2) the partnership or S corporation employs at least one person who is not an owner, member or limited partner of the partnership or S corporation; and (3) those non-owner employees perform at least 1,200 aggregate hours of work in Oregon by the close of the tax year, taking into account for this purpose only hours worked by an employee in weeks in which the employee works at least 30 hours.
  • A nonresident may apply the reduced rates only to "income earned in Oregon." A part-year resident must calculate the tax due using the reduced rates by first applying those rates to the taxpayer's qualifying nonpassive income, and then multiplying that amount by the ratio of the taxpayer's nonpassive income in Oregon divided by nonpassive income from all sources. A nonresident joining in the filing of a composite return is not eligible for the reduced rates.
  • The bill directs the Legislative Revenue Officer to calculate projected and actual ratios of revenue loss to total state income.  To the extent the actual ratios deviate from the projected ratios by specified thresholds, the special tax rates will be adjusted for tax years beginning after 2018 and again after 2022.
  • Change in the Oregon Corporation Excise Tax Brackets. For tax years beginning on or after January 1, 2013, the Oregon corporation excise tax brackets have been changed so that the 7.6% top marginal rates apply to taxable income in excess of $1 million, rather than taxable income in excess of $10 million.  This change also applies to the Oregon corporation income tax, which adopts by reference the Oregon corporation excise tax brackets and rates. 
  • Creation of an Oregon IC-DISC Regime. Prior to the special session, Oregon did not conform to the federal tax regime applicable to an IC-DISC. Instead, Oregon law treated an IC-DISC in the same manner as any other corporation and disregarded transactions between a taxpayer and an IC-DISC if the two were related. For tax years beginning on or after January 1, 2013, the new law changes this treatment for IC-DISCs formed on or before January 1, 2014 (the date HB 3601 takes effect). For these IC-DISCs:
    • The Oregon minimum tax does not apply.
    • A 2.5% tax rate applies to commissions received by the IC-DISC, rather than the marginal tax rates that generally apply to corporations.
    • A related taxpayer is allowed a deduction for commissions paid to the IC-DISC.
    • The federal taxable income of a shareholder subject to the Oregon personal income tax is reduced by the amount of any dividend paid by the IC-DISC.

It appears that some of the new benefits of the Oregon IC-DISC regime (the 2.5% tax rate and the deduction allowed to a taxpayer) may apply only to commission-based IC-DISCs, and not to buy/resell IC-DISCs.

  • Elimination of Personal Exemption for Higher-Income Taxpayers. Oregon generally provides a personal exemption credit equal to an inflation-adjusted amount (for 2013, $183) multiplied by the number of personal exemptions allowed to the taxpayer. Prior to the special session, the credit was reduced if the taxpayer's income exceeded a threshold amount. For tax years beginning on or after January 1, 2013, the credit has been eliminated for taxpayers whose federal adjusted gross income exceeds $200,000 (for joint return filers, a surviving spouse or a head of household) or $100,000 (for single filers, including married filing separately).
  • Senior Medical Expense Deduction Means - Testing and Increased Age Threshold. For tax years beginning on or after January 1, 2013, the reduction in Oregon taxable income allowed to seniors for nondeductible medical expenses is phased out for adjusted gross incomes between $100,000 and $200,000 (for joint return filers, a surviving spouse or a head of household) or $50,000 and $100,000 (for single filers, including married filing separately).  The minimum age for eligibility will rise incrementally from 62 for 2013 to 66 starting in 2020.

IRS Circular 230 notice: The information contained herein was not intended or written to be used, and cannot be used, by you or any other person (i) in promoting, marketing or recommending any transaction, plan or arrangement or (ii) for the purpose of avoiding penalties that may be imposed under federal tax law.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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