Larry's Tax Law

More than 25 years ago, effective January 1, 1997, Treasury issued what have been called the “Check-the-Box” regulations (the “Regulations”).¹  The Regulations ended decades of battles between taxpayers and the IRS over entity classification.  Further, the Regulations simplified entity classification and brought much needed certainty to most entity classification decisions.

Under the Regulations, a business entity with more than one owner is either classified for federal tax purposes as a corporation or a partnership.²  Likewise, a business entity with only one owner is either classified as a corporation or is disregarded for federal income tax purposes as being separate and apart from its owner.³ 

If a business entity is disregarded, its activities are generally treated for federal tax purposes as the activities of its owner.  There are five notable exceptions to that rule. 

Background

Early in the pandemic, I reported on the widespread newly created remote workforces resulting from stay-at-home orders issued by the governors of most states.  In many cases, neither the employer nor the workers were prepared to take this journey.

Fears were rampant among employers that workplace productivity would diminish, quality of work would be impacted, technology would not support remote workers, culture would be compromised, employee recruiting and retention would be harmed, and customer goodwill would be tarnished.  On top of that, many employers worried that employee fatigue (mental and physical) would accompany the new workforce model.

Preliminary Results

Now that we are over two years into the pandemic, employers and employees alike are surprised to find that their fears, for the most part, were misplaced.  In most cases, it is reported that the remote workforce model is working quite well.    

• • Employees generally like the remote workforce model;
  • In a large number of cases, employees desire to remain remote post-pandemic;
  • The lack of commuting to and from work reduces employee disruption, stress  and household expenses (commuting costs, daycare, meals and clothes), and allows more time for family and leisure activities;
  • Workplace politics are diminished;
  • It creates flexibility as to where employees may live, resulting in housing costs reductions in some cases; and
  • Employee absenteeism is diminished.

As I previously reported, the Washington state capital gains tax has had a turbulent ride, commencing with a rough ride through the legislative process where it almost hit disastrous terrain on at least six (6) occasions.  Then, it was hit with a lawsuit to strike it down as unconstitutional before Governor Inslee could even sign the legislation into law.  Days later, it was sideswiped with a second lawsuit to end its short life.

As I reported on March 2, 2022, the new tax regime took a near lethal blow when Douglas County Superior Court Judge Brian C. Huber struck down the newly enacted Washington state capital gains tax as unconstitutional. 

Judge Huber concluded:

ESSB 5096 violates the uniformity and limitation requirements of article VII, sections 1 and 2 of the Washington State Constitution. It violates the uniformity requirement by imposing a 7% tax on an individual's long-term capital gains exceeding $250,000 but imposing zero tax on capital gains below that $250,000 threshold. It violates the limitation requirement because the 7% tax exceeds the 1% maximum annual property tax rate of 1%.

As suspected by many local commentators, the state would not let the tax regime die without a fight.  It is now seeking a higher court review of Judge Huber’s ruling, hoping to bring life back into the tax.

On March 25, 2022, Attorney General Robert W. Ferguson filed a notice of appeal.  Instead of appealing to the Washington Court of Appeals (the normal course of review), Mr. Ferguson filed a petition requesting the Washington State Supreme Court hear the case. 

As previously reported on May 7, June 17 and November 4 of last year, two lawsuits were filed in Douglas County Superior Court in Washington, seeking a declaration that the state’s new capital gains tax is unconstitutional.  The court consolidated the cases.  The parties filed cross motions for summary judgment, along with legal briefs in support of their positions.  The lawyers for the State of Washington asked for a judgment that the tax regime meets constitutional muster.  On the other hand, the lawyers for the taxpayers that initiated the case sought a judgment that the tax regime is unconstitutional.

The Oregon Legislature, in House Bill 3373, created the Office of the Taxpayer Advocate within the Oregon Department of Revenue.  The new law became effective on September 25, 2021.  According to the Oregon Department of Revenue website, the office is open and “here to help.”

The mission of the Office of the Taxpayer Advocate is threefold:

1. To assist taxpayers in obtaining “easily understandable” information about tax matters, department policies and procedures, including audits, collections and appeals;
2. To answer questions of taxpayers or their tax professionals about preparing and filing returns; and
3. To assist taxpayers and their tax professionals in locating documents filed with the department or payments made to the department.

On November 19, 2021, HR 5376, the 2,476-page bill, commonly known as the Build Back Better Act, was passed by the U.S. House of Representatives by a vote of 220-213.

The House’s vote on HR 5376 was held after the Congressional Budget Office released its cost estimates for the proposed legislation. It estimates HR 5376 will cost almost $1.7 trillion and add $367 billion to the federal deficit over 10 years. 

HR 5376 started out with robust changes to our tax laws, including large increases in the corporate, individual, trust and estate income tax rates, significant increases in the capital gains tax rates, taxation of unrealized gains of the ultra-wealthy, a huge reduction in the unified credit, a tax surcharge on high income individuals, trusts and estates, expansion of the application of the net investment income tax, elimination of gift and death transfer discounts, and additional limitations on the application of the qualified business income deduction. 

To the cheer of most U.S. taxpayers, HR 5376, as passed by the House, is a dwarf, in terms of the tax provisions, compared to its original form.  As tax legislation, at least in its current state, it is much ado about nothing.  

However, U.S. taxpayers should not get too joyful about the legislation in its current form.  It will likely be substantially altered by the Senate, regaining many of its original provisions (with or without modification).  In fact, Skopos Labs reports that the bill, as passed by the House, has a 10 percent chance of being in enacted into law.

HR 5376, at its heart, provides funding, establishes new programs and otherwise modifies current provisions of the law aimed at enhancing a broad array of programs, including education, childcare, healthcare and the environmental protections.

While it may not be worth spending too much time focusing on HR 5376, as its tax provisions will be drastically altered by the Senate, it is worth briefly noting what is in the bill and what may be missing.

As previously reported on May 7 and June 17 of this year,  Washington state lawmakers enacted a new capital gains tax, set to go into effect on January 1, 2022, but two lawsuits were initiated to declare the tax unconstitutional.  To date, the court cases are continuing their way through the judicial process.

On November 2, 2021, as part of the statewide general elections process, Washington voters were not asked to vote on the new state capital gains tax; rather they were asked for their opinion on the tax.

The specific question posed, as written by the Office of the Attorney General, is as follows:

Last fall, the IRS announced, with respect to pass-through entities (LLCs or other entities taxed as partnerships or S corporations), that, if state law allows or requires the entity itself to pay state and local taxes (which normally pass through and are paid by the ultimate owners of the entity), the entity will not be subject to the $10,000 state and local taxes deductibility cap (the “SALT Cap”). 

On February 4, 2021, Senate Bill 727 (“SB 727”) was introduced in the Oregon Legislature.  SB 727 is Oregon’s response to the IRS announcement (see discussion below).

On June 17, 2021, after some amendments, SB 727 was passed by the Senate and referred to the House.  Nine days later, the House passed the legislation without changes.  On June 19, 2021, Oregon Governor Kate Brown signed SB 727 into law, effective September 25, 2021.  In general, it applies to tax years beginning on or after January 1, 2022.  Interestingly, SB 727 sunsets at the end of 2023.

In relevant part, SB 727 allows pass-through entities to make an annual election to pay Oregon state and local taxes at the entity level.  For pass-through entities that make the election, their owners will potentially be able to deduct more than $10,000 of Oregon state and local taxes on the federal income tax return.  However, it gets even better—SB 727 includes a refundable credit feature that may result in further tax savings for some owners of pass-through entities.

As song writer and musician Bob Dylan said in his hit song, “The Times They Are A-Changin'”:

Come gather’ round people
Wherever you roam
And admit that the waters
Around you have grown
And accept it that soon
You’ll be drenched to the bone
If your time to you is worth savin’
Then you better start swimmin’ or you’ll sink like a stone
For the times they are a-changin’

The federal tax laws are certainly about to change. With the need to raise revenue as a top priority for the Biden Administration, everyone is expecting dramatic changes to the Internal Revenue Code.

Prologue

Kyle N. Richard recently joined Foster Garvey.  Kyle’s practice is primarily focused on assisting our municipal clients in bond and tax matters.  With his tax experience, however, he assists our tax practice group clients on broader federal, state and local tax matters.  We are excited to have Kyle join our tax team, adding to our already robust bench strength.

The article below was authored by Kyle.  Expect to see more of Kyle’s contributions to Larry’s Tax Law in the future.

Larry

On September 30, 2021, the Washington State Supreme Court upheld the constitutionality of the additional 1.2 percent business and occupation (B&O) tax imposed by the 2019 Substitute House Bill 2167 (“SHB 2167”) on “specified financial institutions”—financial institutions with annual net income of more than $1 billion.  SHB 2167 increases the tax rate for these institutions from 1.5 percent (the rate generally applicable to financial institutions) to 2.7 percent.

The tax was codified in Section 82.04.29004 Revised Code of Washington (“RCW”).  Like other B&O taxes in Washington, the amount of tax due is measured by the amount of the specified financial institution’s gross revenues attributed to Washington State, which is generally based on an apportionment formula (contained in RCW 82.04.460-.462).  The effect of this apportionment regime is that a certain percentage of a financial institution’s total gross income for the year is treated as earned in Washington and taxed under Washington law.

The Washington Bankers Association and American Bankers Association (taxpayers) commenced a lawsuit, arguing that the tax violated the U.S. Constitution’s Dormant Commerce Clause (“DCC”).  At trial, the court concluded that the taxpayers had standing to challenge the tax under the Uniform Declaratory Judgments Act (“UDJA”) and held that the additional graduated tax rate discriminated against out-of-state businesses, in violation of the DCC.  The trial court denied reconsideration of its decision.  The Washington Department of Revenue then appealed directly to the Washington State Supreme Court.