Earlier this year, the Idaho Supreme Court, in Noell Industries, Inc. v. Idaho State Tax Comm’n, --- P.3d ---- (2020), ruled that gain from the sale of membership interests in a limited liability company that had business operations in Idaho by a taxpayer domiciled outside of Idaho was not business income. As a result, the gain was not taxable in Idaho.
The court, in a 3-2 decision, upheld the district court’s reversal of the Idaho Tax Commission’s determination to tax the income. The sharks were circling the taxpayer, ready to attack, but the majority of the justices on the Idaho Supreme Court intervened, saving the taxpayer from a savage death (or at least a boatload of taxes).
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). 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:
- Measure 97 contained a corporate alternative tax based on Oregon gross receipts – a tax that has no relationship to profits.
- 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.
- 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.
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:
$500,000 to $1 million
$1 million to $2 million
$2 million to $3 million
$3 million to $5 million
$5 million to $7 million
$7 million to $10 million
$10 million to $25 million
$25 million to $50 million
$50 million to $75 million
$75 million to $100 million
$100 million or more
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 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.”
The goodwill of a business can never be exchanged for the goodwill of another business. Goodwill is not like kind property. Treasury Regulation 1.1031(a)-2(c)(2) makes that crystal clear, providing:
The goodwill or going concern value of a business is not of a like kind to the goodwill or going concern value of another business.
I was recently interviewed by Ama Sarfo, a reporter for Law360 (a national legal publication of LexisNexis). I discussed some of the audit risks Subchapter S corporations and their shareholders face these days. Below is an excerpt of the Article.
Audit Risk: It's estimated that the U.S. has a $450 billion gap between taxes that are owed to the government and taxes that are actually paid on time. This staggering number, despite significant budgetary constraints, has put taxpayer compliance back in the forefront for the IRS. In the 1990s, the Service was forced to move its focus from the audit function to information and technology as its systems were terribly out of date. Taxpayers need to be on their game because the IRS is back in the audit business, and noncompliance penalties are stronger than they've ever been before.
Larry J. Brant
Larry J. Brant is a Shareholder and the Chair of the Tax & Benefits practice group at 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
- "Entity Classification – The Check-The-Box Regulations Revisited," New York University Advanced Conference on Subchapter SNew York, NY, 7.21.22
- "Entity Classification – The Check-The-Box Regulations Revisited," New York University 81st Institute on Federal TaxationNew York, NY, 10.23.22-10.28.22
- "The Intersection of Code Section 1031 and Opportunity Zones," 2022 OSCPA Northwest Federal Tax Conference10.24.22
- "Entity Classification – The Check-The-Box Regulations Revisited," New York University 81st Institute on Federal TaxationSan Diego, CA, 11.13.22-11.18.22