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 91st 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.
MECHANICS OF THE NEW LAW
House Bill 2488 changes the penalty regime from a penalty for a “substantial” understatement of taxable income to a penalty for a “substantial” understatement of net tax.
A “substantial” understatement of net tax occurs if there is an understatement of the tax due on or measured by net income that exceeds: (i) $2400 for personal income tax; and (ii) $3500 for corporate tax (other than S corporations and personal holding companies). If there is a “substantial” understatement of net tax, the penalty to be imposed is 20% of the underpayment of tax. Unlike the current law, the new law indexes the penalty for inflation.
REASONS FOR CHANGE
The concept of taxable income, for purposes of Oregon taxation, is based upon federal taxable income. Consequently, according to the DOR, taxpayers who file part-year resident returns may understate Oregon taxable income without being subjected to the penalty if federal taxable income is accurately reported. Basing the penalty trigger on the understatement of Oregon tax eliminates this loophole. This appears to be a simple “fix” to the perceived problem.
As stated above, while the new penalty becomes law in Oregon on the 91st day following the end of the current legislative session, it will apply to all tax years beginning on or after January 1, 2015. Lack of knowledge about this law change may create a trap for the unwary. Consequently, a good understanding of the new penalty regime is warranted.
For copy of enrolled House Bill 2488, please see link here.
As I reported late last year (in my November 25, 2014 blog post), former House Ways & Means Committee Chairman David Camp proposed to repeal IRC § 1031, thereby eliminating a taxpayer’s ability to participate in tax deferred exchanges of property. The provision, a part of Camp’s 1,000+ page proposed “Tax Reform Act of 2014,” was viewed by some lawmakers as necessary to help fund the lowering of corporate income tax rates.
The Obama Administration responded to former Chairman Camp’s proposal, indicating its desire to retain IRC § 1031. The Administration, however, in its 2016 budget proposal, revealed its intent to limit the application of IRC § 1031 to $1 million of tax deferral per taxpayer in any tax year. The proposal was vague in that it was not clear whether the limitation was intended to apply to both real and personal property exchanges.
Despite former Chairman Camp’s proposal and the Obama Administration’s response, many commentators believe IRC § 1031 will remain unscathed. In other words, tax reform will not touch it in any material manner. In prior blog posts, I have expressed some doubt that they are correct.
Keep in mind, the repeal of IRC § 1031 is not a new concept. In fact, former Senate Finance Committee Chairman Max Baucus proposed, as part of his cost recovery and tax accounting reform discussion, the repeal of IRC § 1031. Senator Baucus’s proposal was originally published and circulated to lawmakers back in November 2013. Fast forward almost 18 months: lawmakers are still considering the repeal of IRC § 1031.
On March 17, 2015, EY LLP issued a 42-page report entitled the “Economic Impact of Repealing Like-Kind Exchange Rules.” The report, prepared on behalf of the “Section 1031 Like-Kind Exchange Coalition” (“Coalition”) examines the macro economic impact a repeal of IRC § 1031 would have on our economy.
The report reveals some interesting economic data relating to a repeal of IRC § 1031. EY concludes a repeal would result in businesses holding property longer, businesses relying more heavily on debt financing, and a less productive employment of capital into our economy. The results would lead to:
- Our gross domestic product declining by $8.1 billion a year;
- Investment in the economy declining by $7 billion a year; and
- Annual income from labor declining by approximately $1.4 billion a year.
EY makes a very important and practical observation. The report reveals that, while the repeal would help fund reducing corporate income tax rates, individuals and individual owners of pass-through entities, who are helping pay for the corporate rate reduction and who currently participate in a bulk of all exchanges, would not directly benefit from reduction in corporate tax rates. In fact, according to a report published by the Treasury Office of Tax Analysis (“OTA”) in 2014, the bulk of tax deferred exchanges are completed by individuals and entities taxed as partnerships. Looking at tax year 2007, the OTA found total tax deferral from exchanges for the year amounted to $82.6 billion, of which $56.8 billion or 69% was attributable to individuals and entities taxed as partnerships. So, EY’s conclusion appears to be well supported.
According to EY, several industries would be adversely impacted by the repeal of IRC § 1031. These industries not surprisingly include: construction, real estate, transportation and civil engineering.
Obviously, proponents of IRC § 1031 are not convinced that tax reform will leave their code provision unscathed. If such was not the case, the Coalition would not have engaged EY to undertake the study and issue its report. One thing is certain--the debate over IRC § 1031 is ongoing. Will changes to the code section be included in tax reform? Stay tuned!
Larry J. Brant
Larry J. Brant is a Shareholder in Foster Garvey, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; Washington, D.C.; New York, New York, Spokane, Washington; 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
- "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, 11.14.19
- "The Oregon Corporate Activity Tax," Oregon Society of Certified Public Accountants (OSCPA) 2020 OSCPA State & Local Tax ConferencePortland, OR, 1.6.20
- "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," The J. Nelson Young Tax InstituteChapel Hill, NC, 4.23.2020-4.24.2020