United States:
Oregon Adopts Tax Deduction Workaround For Oregon Income Taxes Attributable To Partnership And S Corporation Income
16 August 2021
Lane Powell
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Under recently enacted Oregon legislation, certain partnerships
and S corporations may elect to pay an “alternative business
income tax” at the entity level. Or Laws 2021, ch 589 (SB
727). If they do so, these entities may provide an opportunity for
their individual partners and shareholders to effectively deduct,
on their federal income returns, Oregon income taxes attributable
to partnership and S corporation income, notwithstanding the
$10,000 federal individual income tax limit on the deduction of
state and local taxes (the SALT-deduction limit). The law is
generally effective for tax years beginning on or after
January 1, 2022, and before January 1,
2024.
Although individuals may deduct a maximum of $10,000 of state
and local taxes on their federal income tax returns, this
limitation does not apply to entities. By permitting eligible
partnerships and S corporations to move the incidence of state
income tax on partnership and S corporation income to the entity
level from the individual partner/shareholder level, the new
legislation is designed to take advantage of this difference in
federal income tax treatment.
Eligible Entities
Partnerships and S corporations, comprised
solely (i) of individuals or
(ii) pass-through entities which are owned entirely by
individuals, may make the election to pay the alternative tax.
Tax Rate
The tax is imposed on the aggregate sum of the members’
shares of distributive proceeds from the entity for that tax year.
The tax is imposed at a rate of nine percent (9%) on the first
$250,000 of aggregate member distributive proceeds and at a rate of
nine and nine-tenths percent (9.9%) on aggregate member
distributive proceeds in excess of $250,000.
How the Election Works
Partners and S corporation shareholders (collectively referred
to as members) generally report their distributive shares of
partnership or S corporation income and pay federal and state
income tax on that income on their individual tax returns. As a
result, the state and local taxes paid on that income is subject,
together with all other state and local taxes the members pay, to
the $10,000 federal SALT deduction limit. However, in computing a
member’s distributive share of entity income for federal
income tax purposes, a partnership or S corporation may deduct tax
imposed and paid at the entity level.
The Internal Revenue Service (IRS) has stated that it intends to
issue proposed regulations, which will provide that state and local
income tax payments made by partnerships and S corporations, to
satisfy state or local income tax liability imposed directly on the
entity, are not subject to the SALT-deduction limit and may be
deducted in computing members’ distributive shares of entity
income. IRS Notice 2020-75.
Thus, if an entity makes the election to pay Oregon entity-level
tax, that tax would be deducted in computing the members’
distributive shares of entity income on their federal
Schedule K-1s.
In computing Oregon taxable income reported on their
members’ Oregon Schedule K-1s, the entities
are required to add back the Oregon alternative tax that had been
deducted for federal income tax purposes. However, each member
would be entitled to an Oregon income tax credit
equal to the member’s pro-rata share of the Oregon
alternative tax paid by the entity.
Key Limitations and Open Issues
- The Election May Not Benefit All Members: Due
to the methodology used to compute the entity-level tax and the
member tax credit, and differences in the individual members’
own tax situations, the election may not result in a reduction in
members’ overall tax burdens. Under certain circumstances, it
could increase their tax. - Disregarded Entities: The SALT-deduction
workaround does not apply to an entity, which is disregarded for
income tax purposes as separate from its owner. An example is an
LLC with a single member, where the LLC has not elected to be taxed
as a corporation. - Grantor Trust Member: It is unclear if a
partnership or an S corporation with a member that is a grantor
trust can elect to use the workaround. Because federal and Oregon
tax law treat the grantor of a grantor trust as owning the assets
of the trust, the grantor, and not the grantor trust, likely would
be treated as the member for purposes of Oregon’s workaround.
We hope that the Oregon Department of Revenue will provide guidance
on this issue. - Non-Grantor Trust Member: Given the narrow
scope of entities that would qualify to make the election, it does
not appear that a partnership or an S corporation with a
non-grantor trust as a member would be eligible. The Department may
provide guidance on this issue. - Corporate or Tax-Exempt Member: A partnership
or an S corporation with a member that is a C corporation or a
tax-exempt entity cannot elect to use the workaround. - No IRS Ruling: The Oregon workaround statute
was just enacted. The IRS has not ruled on whether the statute
complies with the requirements of IRS Notice 2020-75.
Repeal Before 2024
In the event Congress repeals the federal SALT-deduction limit,
the Oregon workaround is repealed for any tax year to which the
federal SALT-deduction limit is not applicable.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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