During a brief special legislative session, Oregon enacted a variety of changes to its corporate and personal income tax statutes.1 The legislation increases the corporate income tax rate on income between $1 million and $10 million, and changes the taxation of interest charge domestic international sales corporations (IC-DISCs). Furthermore, the legislation amends personal income tax provisions by allowing taxpayers to receive a lower tax rate for nonpassive income received from partnerships and S corporations. The legislation also eliminates the personal exemption for certain taxpayers, increases the earned income tax credit and amends the deduction for medical expenses of seniors not covered by insurance. Finally, the legislation increases the tax on cigarettes.

Corporate Income Tax

Tax Rate Increase

Historically, corporations doing business in Oregon have been subject to a 6.6 percent corporation excise (income) tax rate on the first $10 million of taxable income, and a 7.6 percent tax rate on additional amounts.2 For tax years beginning on or after January 1, 2013, the legislation provides that the 6.6 percent rate only applies to the first $1 million of taxable income and the 7.6 percent rate applies to all taxable income over $1 million.3

Interest Charge Domestic International Sales Corporations

Federal law permits qualifying corporations that receive most of their gross receipts from qualified exports to elect favorable income tax treatment as an IC-DISC.4 Under existing Oregon law, an IC-DISC generally is taxed in the same manner as other corporations without regard to the federal IC-DISC provisions.5 The IC-DISC provisions in Oregon law are amended to "mirror the federal treatment by creating a deduction for commission payments made to an IC-DISC and a subtraction for dividends received from an ICDISC."6 Specifically, for tax years beginning on or after January 1, 2013, a 2.5 percent tax is imposed on commissions received by an IC-DISC and a deduction is allowed for commission payments to an IC-DISC that is formed on or before January 1, 2014.7 Also, an IC-DISC formed on or before January 1, 2014 is exempt from the corporate minimum tax.8 For purposes of personal income tax, taxpayers may subtract from federal taxable income the amount of any dividend received from an IC-DISC.9 These amendments are designed to offer favorable tax treatment to taxpayers that derive most of their receipts from qualified exports.

Personal Income Tax

The legislation enacts a new statute that allows taxpayers to make an election to receive a lower personal income tax rate on nonpassive income from a partnership or S corporation. Also, provisions concerning the personal exemption, earned income tax credit and deduction for medical expenses not covered by insurance are amended.

Lower Tax Rate for Nonpassive Income from Pass-Through Entities

For tax years beginning on or after January 1, 2015, qualifying taxpayers may make an irrevocable annual election on an original return to receive preferential personal income tax rates of 7 percent to 9.9 percent for nonpassive income10 attributable to a partnership or S corporation.11 If the election is not made, the personal income tax rates range from 5 percent (for very small amounts of income) to 9.9 percent.12 If a taxpayer that meets the requirements listed below has nonpassive income attributable to any partnership or S corporation after a reduction for nonpassive losses,13 the qualifying portion of the income is taxed at the following rates:

  • For the first $250,000 of taxable income, the tax rate is 7 percent;
  • For taxable income exceeding $250,000 but not exceeding $500,000, the tax rate is 7.2 percent;
  • For taxable income exceeding $500,000 but not exceeding $1 million, the tax rate is 7.6 percent;
  • For taxable income exceeding $1 million but not exceeding $2.5 million, the tax rate is 8 percent;
  • For taxable income exceeding $2.5 million but not exceeding $5 million, the tax rate is 9 percent; and
  • For taxable income exceeding $5 million, the tax rate is 9.9 percent.14

The lower tax rates apply to nonpassive income attributable to a partnership or S corporation only if:

  • The taxpayer materially participates in the day-to-day operations of the business;
  • The partnership or S corporation employs at least one person who is not an owner, member or limited partner of the partnership or S corporation; and
  • At least 1,200 aggregate hours of work in Oregon are performed during the tax year by employees of the pass-through entity who are not owners, members or limited partners of the pass-through entity.15

Note that a non-resident may not join in the filing of a composite return made by the pass-through entity, and may only apply the reduced tax rates to income earned in Oregon.16 Also, the statute provides a formula for part-year residents to use in computing the amount of income that is taxed at the lower rates.17

Personal Exemption and Earned Income Credits

For tax years beginning on or after January 1, 2013, a taxpayer may not claim a personal exemption credit if the taxpayer's federal adjusted gross income exceeds $200,000 for joint return filers, a surviving spouse or a head of household.18 Similarly, the credit may not be claimed by individual filers or married individuals filing separately whose income exceeds $100,000. Prior to amendment, taxpayers reduced their indexed personal exemption credit if their income was greater than certain amounts ranging from $117,300 to $234,600 depending upon their filing status.19

For tax years beginning on or after January 1, 2014, the earned income credit is increased to 8 percent (previously, 6 percent) of the federal earned income credit.20

Subtraction for Medical Care Not Covered by Insurance

For tax years beginning on or after January 1, 2013, the legislation allows individuals who meet certain age requirements to subtract from federal taxable income the amount paid for medical care that is not compensated for by insurance.21 As amended, the minimum age to be eligible for this subtraction is 62 for the 2013 tax year and gradually increases to 66 for tax years beginning on or after January 1, 2020.22

The subtraction is limited to $3,600 for a joint return and $1,800 for an individual return.23 However, the subtraction is further limited or eliminated for middle-income and upper-income taxpayers.24 Previously, taxpayers were allowed an itemized deduction for the amount paid for medical care and not compensated for by insurance up to 7.5 percent of federal adjusted gross income.25 The minimum age requirement was 62.

Cigarette Tax Increase

For the distribution of cigarettes occurring in 2014 or 2015, an additional tax of 13 cents is imposed on each pack of cigarettes.26 This amount is increased to 14 cents per pack of cigarettes distributed in 2016 and 2017 and to 15 cents per pack of cigarettes distributed in 2018 and thereafter.

Commentary

Oregon Governor John Kitzhaber called for the legislative special session to increase funding for education, mental health and senior services and to "provide targeted tax relief for small business owners and working families."27 Because this legislation increased the corporate income tax rate, a three-fifths majority was required for approval. As explained by the legislature's revenue impact statement, the preferential personal income tax rate for nonpassive income from partnerships and S corporations is intended to encourage small business growth and investment.28 Also, the subtraction of dividends received by an ICDISC is designed to encourage businesses based in Oregon to conduct export activity. The increase of the earned income tax credit is intended to assist low-income households and encourage them to participate in the labor force. Thus, even though the corporate income tax rate was increased on taxable income between $1 million and $10 million and will impact relatively small businesses, some of the other provisions are designed to offset this tax increase under certain conditions.

Footnotes

1 Ch. 5 (H.B. 3601), 2013 Special Session, Laws 2013. Note that this legislation is not officially enacted until either (i) it is affirmatively approved by the state's voter referendum process or (ii) the expiration of the 90-day period following the end of the legislative session if the voters have not filed a timely petition. OR. CONST. art. IV, § 1(3). The 2013 Special Session adjourned on October 3, 2013.

2 Prior OR. REV. STAT. § 317.061(1), (2).

3 OR. REV. STAT. § 317.061(1), (2).

4 See IRC §§ 991-997. The IC-DISC structure takes advantage of the lower tax rate on dividends.

5 OR. REV. STAT. § 317.635(1).

6 Oregon Legislative Staff Measure Summary for H.B. 3601, Oct. 1, 2013.

7 OR. REV. STAT. § 317.283(2).

8 OR. REV. STAT. § 317.635(2). The corporate minimum tax is imposed by OR. REV. STAT. § 317.090.

9 H.B. 3601, § 6(b).

10 "Nonpassive income" means income other than income from passive activity as determined under IRC Section 469, but does not include wages, interest, dividends or capital gains. H.B. 3601, § 11(1)(a). Note that the only addition or subtraction allowed in the calculation of nonpassive income for which the taxpayer uses the reduced tax rates is the depreciation adjustment directly related to the partnership or S Corporation. H.B. 3601, § 11(4).

11 H.B. 3601, § 11. Presumably, this election also would be available to limited liability companies (LLCs) that are taxed as partnerships or S corporations. The legislative summary provides "[n]onpassive income earned from S-corporations, partnerships, and LLCs that file tax returns as either type of entity may, at [the] taxpayer's election, be subject to preferential rates . . .." Oregon Legislative Staff Measure Summary for H.B. 3601, Oct. 1, 2013. However, this election would not be available to a disregarded single member LLC because it cannot be taxed as a partnership or S corporation.

12 OR. REV. STAT. § 316.037. In general, Oregon imposes the following personal income tax rates: (i) for the first $2,000 of taxable income, the tax rate is 5 percent; (ii) for taxable income over $2,000 but not over $5,000, the tax rate is 7 percent; (iii) for taxable income over $5,000 but not over $125,000, the tax rate is 9 percent; and (iv) for taxable income over $125,000, the tax rate is 9.9 percent.

13 "Nonpassive loss" means loss other than loss from passive activity as determined under IRC Section 469. H.B. 3601, § 11(1)(b).

14 H.B. 3601, § 11(2). For tax years beginning on or after January 1, 2019, these rates may be adjusted by the legislature after comparing the actual revenue loss resulting from the reduced tax rates to the projected revenue loss. However, the adjusted rates may not exceed 9.9 percent of taxable income or be reduced to less than 7 percent. H.B. 3601, §§ 11(3), 13.

15 H.B. 3601, § 11(6).

16 H.B. 3601, § 11(5), (7).

17 Id.

18 OR. REV. STAT. § 316.085(5).

19 Prior OR. REV. STAT. § 316.085(5).

20 OR. REV. STAT. § 315.266(1).

21 H.B. 3601, § 4(1).

22 H.B. 3601, § 4(2).

23 H.B. 3601, § 4(1).

24 H.B. 3601, § 4(3), (4). The deduction may not exceed $1,400 per individual, if federal adjusted gross income is at least $50,000 but less than $100,000 (joint filer, head of household or surviving spouse) or at least $25,000 but less than $50,000 (individual filer or married individual filing separately). The deduction may not exceed $1,000 per individual if the federal adjusted gross income is at least $100,000 but less than $200,000 (joint filer, head of household or surviving spouse) or at least $50,000 but less than $100,000 (individual filer or married individual filing separately). No deduction is allowed if federal adjusted income exceeds $200,000 (joint filer, head of household or surviving spouse) or $100,000 (individual filer or married individual filing separately).

25 Prior OR. REV. STAT. § 316.695(1)(d)(B).

26 OR. REV. STAT. § 323.030(4).

27 Press Release, Office of Oregon Governor, Sep. 23, 2013.

28 Revenue Impact of Proposed Legislation, H.B. 3601-A, Oregon Legislative Revenue Office, Oct. 1, 2013.

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