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:
- Section 71 of Measure 91 provides that Code Section 280E does not apply for purposes of determining Oregon taxable income or loss under our corporate income tax regime. This provision sets forth no specific effective date. So, in accordance with Sections 81 and 82 of Measure 91, it became effective on July 1, 2015.
- Section 74 of Measure 91 provides that Code Section 280E does not apply for purposes of determining Oregon taxable income or loss under our individual income tax regime. This provision of Measure 91 specifically provides that the change became effective for tax years beginning on or after January 1, 2015.
So, following the passage of Measure 91, were there any Oregon tax problems plaguing the cannibals industry? The short answer is: Maybe.
Measure 91 generally only applies to the recreational marijuana industry. Even though nothing in Measure 91 says Sections 71 and 74 are limited to recreational marijuana, maybe an argument could be made that these provisions did nothing to alleviate the Code Section 280E issue for medical marijuana business activities.
Don’t despair; Oregon lawmakers came to the rescue. The law is now clear (at least as clear as a law can be) that, with respect to the Oregon individual income tax regime, folks in both medical and recreational marijuana businesses may deduct (for Oregon purposes only) expenses that would be otherwise be nondeductible under Code Section 280E.
House Bill 4014 Is Signed Into Law
On March 3, 2016, Oregon Governor Kate Brown signed House Bill 4014 into law. The bill, which spans numerous pages, deals with several issues related to the Oregon cannabis industry, including the application of Code Section 280E to both the recreational and the medical marijuana industries.
The provisions of House Bill 4014 relating to Oregon income taxation are contained in: Sections 28, 28a and 29.
SECTION 28 of House Bill 4014 amends ORS 316.680 by adding subsection (i) providing that there shall be subtracted from federal taxable income:
“Any federal deduction that the taxpayer would have been allowed for the production, processing or sale of marijuana items authorized under ORS 475B.010 to 475B.395 but for section 280E of the Internal Revenue Code.”
SECTION 28a of House Bill 4014 amends ORS 316.680 by adding subsection (i) providing that there shall be subtracted from federal taxable income:
“Any federal deduction that the taxpayer would have been allowed for the production, processing or sale of marijuana items authorized under ORS 475B.010 to 475B.395 or 475B.395 or 475B.400 to 475B.525 but for section 280E of the Internal Revenue Code.”
SECTION 29 of House Bill 4014 provides that the amendments to ORS 316.680 by Section 28 apply to conduct occurring on or after July 1, 2015 but before January 1, 2016, and to tax years ending before January 1, 2016. The amendments to ORS 316.680 by section 28a apply to conduct occurring on or after January 1, 2016, and to tax years beginning on or after January 1, 2016.
Implications for the Oregon Cannabis Industry
What this means for the cannabis industry in Oregon is twofold:
- For Oregon personal income tax purposes only (for tax years beginning on or after July 1, 2015 but before January 1, 2016), the prohibition contained in Code Section 280E does not apply to the non-medical production, processing or sale of marijuana. In other words, a subtraction from Oregon personal income tax is permitted by folks in a recreational marijuana business for any federal deduction a taxpayer would have been allowed for expenses related to the production, processing or sale of marijuana had there been no prohibition under Code Section 280E.
- For Oregon personal income tax purposes only (for tax years beginning on or after January 1, 2016), the prohibition contained in Code Section 280E does not apply to the production, processing or sale of marijuana (medical and non-medical marijuana). In other words, on or after January 1 of this year a subtraction from Oregon personal income tax is permitted by folks in both a medical and recreational marijuana business for any federal deduction a taxpayer would have been allowed for expenses related to the production, processing or sale of marijuana had there been no prohibition under Code Section 280E.
Interestingly, House Bill 4014 does not appear to address the Oregon corporate excise or income tax regimes. Remember, Section 71 of Measure 91 clearly tells us that, after July 1, 2015, Code Section 280E does not apply to the computation of Oregon corporate taxable income.
Why did Oregon lawmakers feel the need to make it clear that Code Section 280E does not apply to the computation of Oregon individual taxable income in the case of both medical and recreational marijuana business activities (as of January 1, 2016), but did not do the same for the computation of Oregon corporate taxable income?
Oregon law clearly contemplates corporations and other entities will be used to operate marijuana related businesses. In fact, both Measure 91 and the Oregon regulations governing the local marijuana industry allow businesses to be organized as corporations (and other entities). The definition of "person" in Measure 91 includes corporations (Section 5(24)), and various parts of the regulations contemplate that marijuana licenses will be issued to corporations and other entities (e.g., OAR 845-025-1045(3).
Was this apparent omission intentional or simply as oversight by Oregon lawmakers? It certainly seems Measure 91 covers (for purposes of Code Section 280E) recreational and medical marijuana activities at both the Oregon corporate and individual income tax levels. Was House Bill 4014 necessary to clarify the elimination of the application of Code Section 280E for Oregon income tax purposes?
It will be interesting to see how the Oregon Department of Revenue interprets House Bill 4014 and Measure 91 in this regard. Time will tell.
One interesting observation about Measure 91 is that the clear language eliminating the application of Code Section 280E for Oregon individual and corporate taxation is not expressly limited to marijuana activities. Arguably, it eliminated the application of Code Section 280E for Oregon income tax purposes in all instances (including the sale or distribution of illegal drugs). It appears House Bill 4014 removes that interpretation of the law in the instance of the Oregon individual tax regime as it expressly limits the application to marijuana, but its silence as to the Oregon corporate tax regime leaves that interpretation alive. I hope this was not the legislature’s intent.
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 accordance with ORS 316.037, the Oregon income tax rates that would otherwise apply to individual taxpayers are 9 percent on taxable income over $5,000 (up to $125,000), and 9.9 percent on taxable income over $125,000. At first blush, the reduced tax rates offered under ORS 316.043 look desirable. An understanding of the statute, however, is needed before jumping in head first.
- Election. To qualify for this reduced rate structure, which is subject to adjustment as provided by ORS 316.044, taxpayers must make an election on their original return by checking Box 22c and completing and attaching Oregon Department of Revenue Schedule OR-PTE, OR-PTE-PY or OR-PTE-NR. The election cannot be made on an amended return. Does the original return have to be timely filed? The statute is silent. Caution is advised!
- Material Participation. The reduced rate structure is only available to taxpayers who materially participate in day-to-day operations of a partnership or an S corporation that constitutes a trade or business.
- Non-Passive Income Only. The reduced rate structure only applies to “non-passive” income that flows through to the taxpayer from the partnership or S corporation.
- One or More Non-Owner Employees. The S corporation or partnership must employ at least one non-owner and an aggregate of at least 1,200 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.
- Irrevocable. Per the statute, once made, the election is irrevocable—it cannot be amended or revoked. Does this mean that once an election is made, the taxpayer is required to use the reduced rate structure for all future tax years, or does it simply mean that the taxpayer cannot revoke the election for the particular tax year the election is made? Logic dictates that the election is made for each tax year, so the later should be true. The statute, however, does not provide a clear answer to this question. Caution is advised! The Oregon Department of Revenue has not yet written administrative rules to accompany ORS 316.043. I suspect, it will address this question in any rules it drafts.
- No Disregarded Entities. The owner of a disregarded entity (e.g., a single-member limited liability company or a sole proprietorship) is not eligible for the reduced tax rates.
- Limited Deductions. For purposes of computing the taxpayer’s income, which is subject to the regular income tax rates, the taxpayer is allowed to use all subtractions, deductions or additions otherwise allowable under the Oregon tax laws set forth in ORS Chapter 316. For purposes of computing the non-passive income to which the reduced tax rates apply, however, the taxpayer is only allowed to take into consideration depreciation deductions or adjustments directly related to the partnership or S corporation. Consequently, before making the election to use the reduced tax rates, an analysis of the impact of the limited use of subtractions, deductions and additions against the non-passive income needs to be undertaken.
- Composite Returns. A taxpayer who uses the reduced income tax rates may not join in the filing of a composite return under ORS 314.778.
Until the Oregon Department of Revenue drafts administrative rules to accompany ORS 316.043, the questions discussed above will remain unanswered. Consequently, caution is advised. Careful review and consideration is required before tax practitioners jump into an election under this alternative tax rate regime. Unfortunately, traps exist for the unwary.
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 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