Last week, the Oregon legislature passed HB 3601 as part of the “grand bargain” that, among other provisions, changes individual and corporate tax law in Oregon.
The law included some tax breaks as well as tax increases. It raises revenue with increased tax rates for C corporations with taxable income over $1M, and by curtailing some exemptions and deductions for individual taxpayers; but it also lowers the tax rates applicable to income from some pass-through entities with activity in Oregon. This has been touted as “rate reduction for small businesses,” but only some owners of some companies will see the Oregon tax rate on their pass-through business income decrease, beginning in tax years starting on or after January 1, 2015.
Pass-through Income Rate Reduction
The lower tax rates can be used by some owners of entities that are taxed as an S corporation or partnership. This excludes sole proprietorships! Some single-member LLCs and unincorporated businesses may find it advantageous to find their way to S corporation status before these rates go into effect. But before you start changing your entity structure, note these two requirements, both of which must be met in order to qualify for the reduced rates:
- The income must be non-passive to the owner under federal law to qualify, which means the owner must “materially participate” in the business – this usually means working for the business at least 500 hours during the year. This also will exclude rental income from the lower rate, unless it is earned by a materially participating rental real estate professional. Passive investors in Oregon partnerships and S corporations will not see any reduction in their tax rates.
- The business must employ (as a W-2 employee) at least one non-owner in Oregon on a substantially full-time basis (at least 30 hours per week) for at least 1,200 hours during the tax year. Weeks in which employees worked less than 30 hours are simply not counted for this test; to reach the 1,200 hours, the entity must have at least one non-owner employee who logged at least 1,200 hours during weeks in which that employee worked at least 30 hours.
If your pass-through income meets these requirements, here are the applicable tax rates:
|Amount of pass-through income||Applicable tax rate|
|Less than $250,000||7%|
|$500,000 – $1,000,000||7.6%|
|$1,000,000 – $2,500,000||8%|
|$2,500,000 – $5,000,000||9%|
|More than $5,000,000||9.9%|
|Outside of this provision, Oregon’s individual tax rates currently reach 9% at Oregon taxable income of $50,000, and 9.9% at taxable over $250,000|
The new rates don’t come into effect until the 2015 tax year, so you still have plenty of time to ponder and plan.
Corporate Income Tax Rate Increase
One of the ways the law pays for the rate reduction on qualifying pass-through income is by establishing a permanent 7.6% tax rate for corporate taxable income in excess of $1M. This looks like a rate increase, since existing law would have put the tax rate on C corporation net income of less than $10M at 6.6% for 2013 – but actually C corporations in Oregon have been paying tax at 7.6% (or higher) on taxable income over $250,000 since 2009, when some temporary tax rate increases were enacted. Those higher rates had expired for many corporations in 2013 (back to 6.6% for up to $10M in C corporation in income), but are now retroactively reinstated at 7.6% at $1M in C corporation and above.
Reductions in Individual Exemptions and Deductions
The biggest change for individuals was to Oregon’s treatment of medical expenses for people age 62 and older. We previously reported on some limits on the Oregon medical deduction passed earlier this year; however, HB 3601 changed how the deduction works, and curtailed it a great deal more.
Starting with 2013 tax years, the deduction is now an Oregon subtraction; it is capped at $1,800 per qualifying person and $3,600 per joint return; the $1,800 phases out based on income, reaching $0 at $200,000 of adjusted gross income (joint returns)/$100,000 (single/separate returns); and the age to qualify for the subtraction is gradually raised from 62 over the next several years, reaching 66 for 2020 tax years and beyond.
In addition to the medical deduction limitations, the following changes to individual tax law were also made:
- The individual exemption (currently $183 per person) can no longer be taken by joint filers with $200,000 or more of AGI, and single/separate filers with $100,000 in AGI.
- The earned income credit allowed in Oregon is now 8% of the federal earned income credit allowed (previously 6%).