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:
|Oregon Sales||Minimum Tax|
|$500,000 to $1 million||$500|
|$1 million to $2 million||$1,000|
|$2 million to $3 million||$1,500|
|$3 million to $5 million||$2,000|
|$5 million to $7 million||$4,000|
|$7 million to $10 million||$7,500|
|$10 million to $25 million||$15,000|
|$25 million to $50 million||$30,000|
|$50 million to $75 million||$50,000|
|$75 million to $100 million||$75,000|
|$100 million or more||$100,000|
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 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.
In general, the Oregon income tax laws are based on the federal income tax laws. In other words, Oregon is generally tied to the Internal Revenue Code for purposes of income taxation. As a consequence, we generally look to the federal definition of taxable income as a precursor for purposes of determining Oregon taxable income.
What does this mean to taxpayers in the trade or business of selling recreational or medical marijuana in Oregon?
Currently, it appears these taxpayers are stuck with the federal tax laws. Consequently, unless the Oregon legislature statutorily disconnects from IRC § 280E, for Oregon income tax purposes, all deductions relating to the trade or business of selling medical or recreational marijuana will be disallowed.
I suspect the result of IRC § 280E and its impact on Oregon income taxation will be that many taxpayers in this industry will go to lengthy efforts to capitalize expenses and add them to the cost of goods sold. Caution is advised. The taxing authorities will likely closely scrutinize this issue.
In addition to income taxes, retail marijuana sales in Oregon are subject to a sales tax. This is a tax that is paid by the customer, and collected and paid over to the taxing authorities by the retailer. Interestingly, the sales tax regime has been strenuously resisted by Oregon taxpayers for decades. The Oregon Legislature, however, passed HB 2041, introducing a state sales tax of 17% (with the possible add-on of up to 3% by local governments) on the retail sales of marijuana. Governor Kate Brown signed the bill into law on October 5, 2015. As a consequence, taking into consideration both income taxes and sales taxes, the marijuana industry and its customers may become a big contributor to the state’s tax revenues. I am not sure I could have ever predicted the current state of affairs.
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.
The Timely Filing Requirement Imposed by Oregon DOR in Order for Taxpayers to be Able to use the "Prior Year Tax Safe Harbor" Stricken by the Oregon Tax Court
On September 13, 2013, in Finley v. Oregon Department of Revenue, the Oregon Tax Court granted taxpayer’s Motion for Summary Judgment, and held Oregon Administrative Rule 150-316.587(8)-(A) is invalid to the extent it requires taxpayers to have timely filed their prior year’s Oregon income tax return to be eligible for the “Prior Year Tax Safe Harbor.”
I represented the taxpayer in this matter. The facts were straightforward. The tax years at issue were 2008 and 2009. The taxpayer was a resident of Oregon during these years.
For tax year 2008, the taxpayer paid his taxes in a timely manner. Unfortunately, he filed his Oregon individual income tax return late.
For tax year 2009, the taxpayer had a substantial increase in his income due to a capital gain-generating transaction. To avoid an estimated tax payment penalty, on December 31, 2009, thinking he qualified for the “Prior Year Tax Safe Harbor,” he made an Oregon estimated tax payment of 100% of his 2008 Oregon income tax liability. Then, he timely filed his 2009 Oregon income tax return, and he paid the additional taxes shown due on the return. Thereafter, the Oregon Department of Revenue sent the taxpayer a nice letter, thanking him for his generous tax payment, but requesting he pay an additional large sum, representing an estimated tax (late payment) penalty. Not being able to resolve the matter with the Department, we filed a complaint in the Oregon Tax Court. The case was ultimately heard by Judge Henry Breithaupt in the Regular Division of the Oregon Tax Court.
Looks Like Oregon Tax Laws are Changing Again
House Bill 3601 A (“HB 3601”) passed the Oregon House of Representatives and the Oregon Senate on October 2, 2013, during a special session. Governor Kitzhaber signed the bill into law on October 8, 2013. The new law is effective January 1, 2014. This is good news for some Oregon taxpayers and bad news for others.
The most significant impact of HB 3601 is found in six provisions, namely:
I. Corporate Excise Tax Rates. The corporate excise tax rates are increased. Effective for tax years beginning in 2013 or later, a 6.6% tax rate applies to the first $1,000,000 of taxable income and a tax rate of 7.6% applies to any excess taxable income. Under current law, the 6.6% tax rate applies to the first $10,000,000 of taxable income and the 7.6% tax rate applies to any excess taxable income. This change in current law represents a substantial increase in tax for many corporate taxpayers.
II. IC-DISCs. Except as expressly provided by Oregon law, DISCs are taxed in Oregon like corporations. ORS 317.635(1). HB 3601 exempts existing Interest Charge DISCs (i.e., IC-DISCs formed on or before the effective date of the act) from the Oregon corporate minimum tax under ORS 317.090. HB 3601 also causes any commissions received by DISCs to be taxed at 2.5%, and allows a deduction for commission payments made to existing DISCs.
III. Dividends Received from DISCs. HB 3601 allows a personal income taxpayer to subtract from income any dividend received from a DISC formed under IRC § 992.
IV. Personal Exemption Phase-Out. HB 3601 denies personal income taxpayers from claiming the personal exemption credit(s) (current $90 per exemption) if federal adjusted gross income is $100,000 or more for a single taxpayer and $200,000 or more for a married filing joint taxpayer.
V. Senior Health Care Costs. HB 3601 provides a small deduction for “senior” health care expenses not compensated by insurance. The bill, however, adds a phase-out for taxpayers with federal adjusted gross income over certain thresholds. Likewise, the definition of a “senior” starts out at age 62 for the 2013 tax year and increases each year thereafter by one year until tax year 2020.
VI. Reduced Tax Rates for Applicable Non-passive Income. For tax years beginning in 2015 or later, applicable non-passive income attributable to certain partnerships and S corporations will be taxed as follows:
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,” Oregon Association of Tax ConsultantsBeaverton, OR, To be rescheduled
- To be rescheduled