NW Tax Wire Worker Classification Continues to Be in the Spotlight - - PDF document

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miller nash llp | Winter 2011

NW Tax Wire

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inside this issue

2 iTax: (re)Expanding the Paradigm for State Tax Professionals 3 Tax Hawks: What Constitutes “Charitable” for Purposes

• f Oregon’s Property Tax

Exemption? 5 OCTA One Year Later

Worker Classification Continues to Be in the Spotlight

September saw a flurry of activity from the Internal Revenue Service (the “IRS”) and Department of Labor (the “DOL”) regarding worker classification. While it is no secret that worker clas- sification is an area of focus for the IRS and DOL, September’s activity in this area highlights the complexity and risk related to worker relationships. IRS / DOL Memorandum of Under- standing On September 19, 2011, the IRS and DOL entered into a Memorandum

• f Understanding (the “MOU”) on

enhanced information-sharing and

• ther collaboration to “help reduce

the incidence of misclassification of employees as independent contractors, help reduce the tax gap, and improve compliance with federal labor laws.” Per the MOU, the DOL will share certain wage-and-hour investigation data with the IRS so that the IRS can determine employment tax compliance. The IRS may also share DOL information with authorized state and municipal taxing agencies, and will also provide annual data to the DOL regarding trends in worker misclassification. In addition, the DOL announced that it has signed or will be signing memorandums of understanding with the following states: Connecticut, Hawaii, Illinois, Maryland, Massachu- setts, Minnesota, Missouri, Montana, New York, Utah, and Washington. IRS Voluntary Classification Settle- ment Program Just a day after signing the MOU, the IRS issued Announcement 2011-64 regarding a new Voluntary Classifica- tion Settlement Program (the “VCSP”) to allow employers to voluntarily reclas- sify workers as employees in order to

• btain a degree of employment tax and

audit relief. Previously, the IRS offered limited relief for worker reclassification under Section 3509 (providing for reduced tax rates for employers meeting certain criteria), or through the Classification Settlement Program for employers under IRS audit. The VCSP allows employers that are not currently under examination by the IRS to voluntarily apply to the IRS to reclassify workers as employees for future tax periods in order to obtain a reduction in past employment taxes for misclassified employees, as well as audit relief.

by Ryan R. Nisle

ryan.nisle@millernash.com 503.205.2521

by Merril A. Keane

merril.keane@millernash.com 503.205.2556

Oregon Property Tax Appeals Deadline Approaches

It’s that time of year again (and we don’t mean the holiday season). For most taxpayers, the deadline to appeal your Oregon property tax is December 31 (this year, January 2, 2012, since the 31st falls on a Saturday). In the current economic environment, the real market value of many pieces of real property has dropped below the property’s “maximum assessed value.” The tax rolls may not reflect the true value of the property. In that case, it may make sense to appeal the value to the local Board of Property Tax Appeals. Please contact Valerie Sasaki or Ryan Nisle at 503.224.5858 for additional information.

2 | miller nash llp | NW Tax Wire

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iTax: (re)Expanding the Paradigm for State Tax Professionals

“. . . we all need to remember to look beyond the U.S. territorial borders when evaluating tax filings.”

There are only so many hours in a given day. Thus, experienced state tax professionals tend to focus their energy

• n staying on top of developments in

the 11,000+ domestic state and local taxing jurisdictions that fall within our job descriptions. The California Court

• f Appeal’s opinion in Apple, Inc. v.

Franchise Tax Board has caused some of us to rethink that paradigm. Apple, Inc. involved the California tax treatment of repatriated dividends that Apple’s sub- sidiaries paid to it in 1989. The specific question was what method Apple should use to account for the divi- dends’ source. The Franchise Tax Board (the “FTB”) argued that Apple should be required to use a last-in-first-

• ut (“LIFO”) proration of income. This

would treat dividends as having come first from the current year’s earnings and then from the sequential most recent prior year’s earnings. Apple argued that the dividends should be subject to preferential ordering rules and be deemed to be paid first out of income that was taxed in prior years, thus reducing Apple’s income subject to California tax. As many of our readers know, the state of California has declined to adopt federal taxable income—or the Internal Revenue Code—as the basis of its corporate tax regime. California also al- lows taxpayers to adopt a “water’s edge” combined report. This includes only the income and attributes of domestic entities and a portion of the income of certain controlled foreign subsidiaries (“CFCs”). Subpart F income is incor- porated into the ratio that California uses to determine what part of a CFC’s income is subject to inclusion in the California tax base. Through its tax year ending on September 30, 1988, Apple filed all its worldwide entities on the same Califor- nia combined report. Apple first made a water’s-edge election on its California corporation excise tax return for the tax year ending September 30, 1989. This included only the income of its unitary domestic entities and partial income of its CFCs. Apple received and repatri- ated substantial foreign CFC dividends in 1989. It took the position that the dividends were paid from CFC retained earnings accrued over the period that Apple had filed on a worldwide basis with California, and that Apple thus had paid California tax on the earnings. Apple argued that California Tax and Revenue Code Section 25106 allowed it to transfer dividends without tax consequences. The FTB argued that the dividends were paid out of excluded income and should be deductible instead under Tax and Revenue Code Section 24402, which provides that a recipient corpora- tion may deduct from its gross income dividends that were declared from income already included in the Califor- nia corporate franchise tax base of the payor corporation. The Court of Appeal held that the FTB’s application of the LIFO ordering rules was appropriate because “it deters abuse by preventing a corporation from declaring what year’s earnings are be- ing distributed. To allow preferential

• rdering of dividends between tax years

would allow potentially indefinite tax avoidance by ignoring consideration

• f earnings attributable to untaxed

excluded income until all included income had been exhausted.”

So what?

Many of the companies that we work with do not have an organizational chart and intercompany dividend ac- counting as complicated on a national/ international basis as that of Apple,

• Inc. But the Apple decision (and the

resulting hubbub in the state and local continuing education world) is a good reminder that we all need to remember to look beyond the U.S. territorial borders when evaluating tax filings. Here are a few quick snapshots

• f how we have seen these

issues come up in the Pacific Northwest: Idaho Unlike California, Idaho is not ex- plicitly disconnected from the Internal Revenue Code. The Idaho Corporate Income Tax Return starts with fed- eral taxable income after net operating

• losses. Idaho, however, allows corpo-

rate taxpayers to make a water’s-edge

• election. This means that the activity of

unitary group members outside of the United States is disregarded for Idaho tax purposes. The income of foreign affiliates may be excluded if a taxpayer elects a water’s-edge status. Similarly, the denominator of a corporate taxpay- er’s property, payroll, and sales factors must include only the domestic factor information. Taxpayers that elect to not make a water’s-edge election are considered worldwide filers. These taxpayers may

by Valerie H. Sasaki

valerie.sasaki@millernash.com 503.205.2510

| 3

Tax Hawks: What Constitutes “Charitable” for Purposes of Oregon’s Property Tax Exemption?

In Oregon, just because an organi- zation has 501(c)(3) income-tax-exempt status does not necessarily mean that the organization will qualify for a property tax exemption. In fact, all real property and personal property is subject to property tax unless a specific exemption applies. Fortunately, many charities are exempt from property taxes under ORS 307.130, which grants an exemption for property owned by “benevolent, charitable and scientific institutions” if the property is “actu- ally and exclusively occupied or used in the literary, benevolent, charitable

• r scientific work carried on by such

institutions.” Any organization seek- ing a property tax exemption under ORS 307.130, however, must file an application and will have the burden of proving that the exemption is appropri-

• ate. Additionally, an organization that

has been granted a property tax exemp- tion could lose that exemption (or part

• f the exemption) if the county assessor

believes that the exemption is no longer valid. County assessors most commonly challenge a charitable organization’s claim to a property tax exemption by arguing that the property is not exclusively used in the charitable work

• f the organization (e.g., a shed rented

to a neighbor) or that the organization is not “charitable.” In September 2011, the Magistrate Division of the Oregon Tax Court addressed the issue whether an organization can be charitable if it charges admission fees to the public and does not have a policy allowing free

• r reduced-fee admissions based on a

person’s ability to pay. Cascade Raptor Center v. Lane County Assessor, No. TC- MD 101269B (Or Tax Ct Sept. 12, 2011). Cascade Raptor Center (the “Raptor Center”) is an Oregon nonprofit corpo- ration that is exempt from income tax under Section 501(c)(3) of the Internal Revenue Code. The Raptor Center rescues and rehabilitates sick, injured,

• r orphaned birds and specializes in

birds of prey, with the goal of return- ing the birds to the wild. The Raptor Center also uses nonreleasable birds as ambassadors in nature-education and community-outreach programs. At the Raptor Center headquarters, there is a visitor center, a gift shop, an education pavilion, a clinic, bird enclosures, and a few other buildings. Most of the bird enclosures display nonreleasable birds to the visitors of the center. Addition- ally, the Raptor Center provides on-site and off-site educational programs. To qualify for a property tax ex- emption, the charitable organization’s primary or sole purpose must be for the direct good or benefit of the pub- lic, it must operate in a manner that furthers its charitable purpose, and its activities must have “an element of gift and giving.” OAR 150-307.130-(A) (3)(d). In Cascade Raptor Center, the county assessor argued that the Raptor Center’s operations did not include any element of gift and giving because the Raptor Center charged admission fees, regardless of whether a person was able to pay the fees. But, OAR 150 307.130 (A) (3)(d)(C) specifically provides that the fact that an organization charges fees does not, in and of itself, mean that the

• rganization is not charitable.

In Cascade Raptor Center, the court found that even though the Raptor Center charged admission fees and did not have a policy to reduce or eliminate the admission fees based on a person’s ability to pay, the Raptor Center’s activi- ties did involve an element of gift and

• giving. In arriving at this conclusion,

the court evaluated the extent to which volunteers assisted the Raptor Center in its operations, the extent to which it received donations, and the extent to which it provided services at a price lower than its cost to operate the Raptor

• Center. The court found it favorable that

the Raptor Center employed only three staff members and had over 100 vol- unteers who volunteered over 20,000 hours per year because the volunteer time was significant and it allowed the volunteers, their guests, and the public to receive a beneficial experience. The court also found it favorable that dona- tions and grants to the Raptor Center made up about 71 percent of the Rap- tor Center’s total revenue and that the strong support of the public through donations of time and money showed that the public believed the organiza- tion to be charitable. Finally, the court found it favorable that the admission fees covered only 13 percent of the Rap- tor Center’s annual expenses, which

by Jeneé Hilliard

jenee.hilliard@millernash.com 503.205.2505

by William C. Fisher

will.fisher@millernash.com 503.205.2525

(continued on page 4)

NW Tax Wire | miller nash llp | 4 iTax . . . | Continued from page 2 this factor is a taxpayer’s Oregon sales, and the denominator is defined as “total sales of the taxpayer everywhere during the tax period.” This means that the receipts of certain unitary foreign entities, which may be excludable for federal purposes, may create factor dilution for Oregon purposes. Washington For periods before June 1, 2010, taxpayers that reported gross receipts under the “Service and Other” cat- egory in Washington, as well as other specified Washington taxpayers, were allowed to utilize a modified cost-of- performance model to source receipts. Washington is typically considered a specific-allocation state, so taxpayers

• ften don’t consider the costs from their

include the income of certain unitary subsidiaries that are excluded from the federal consolidated return, as well as their factor presence in foreign jurisdic- tions. As one may imagine, the question whether to make an Idaho water’s-edge election is very fact-specific and re- quires specific analysis for each corpo- rate taxpayer with a material presence

• utside the United States.

Oregon Oregon connects to federal taxable income before net-operating-loss sub-

• tractions. Thus, the base income subject

to apportionment is the taxpayer’s do- mestic and includable foreign income. Oregon, however, is a 100 percent sales factor jurisdiction. The numerator of foreign activities in this calculation. In my first year of law school, one

• f my professors opined, “The law is a

seamless web.” The financial affairs of taxpayers are similarly seamless. The California Court of Appeal’s decision in Apple, Inc. reminds us of this truism. The increasing complexity of tax and revenue systems has led to specializa- tion of in-house tax professionals and

• consultants. While it may not be real-

istic for the state tax manager to stay abreast of all the developments in inter- national taxation, effective communica- tion within a company’s tax department and with tax consultants can result in significant state tax savings and a lower effective tax rate. meant that the admission fees were less than the actual cost to run the Raptor

• Center. The finding of the court that

the Raptor Center’s operations had an element of gift and giving led the court to determine that the Raptor Center was “charitable” and that it was entitled to a property tax exemption. Although Oregon law does not disqualify an organization from being a “charity” for purposes of a property tax exemption solely because the orga- nization charges fees without a policy reducing or eliminating the fees for the poor or indigent, this can be a factor that draws additional scrutiny from county tax assessors. In Cascade Raptor Center, although the Raptor Center was ultimately found to be charitable, it likely could have avoided the cost and time

• f

litiga- tion by having a written policy to allow low-income people to have free or reduced- cost access to the facility (although this is not re- quired by law), especially since the Raptor Center appears to have granted free and reduced-cost access to the facility upon request. As a result of the recession, finances are tight across the state of Oregon, and it is to be expected that county tax as- sessors will be more aggressive in disal- lowing property tax exemptions (either upon application or after an exemption has been granted, if the assessor be- lieves that the exemption is no longer warranted). At the end of the day, each

• rganization will bear the burden of

proof that it is entitled to a property tax exemption if the tax assessor disagrees. Cascade Raptor Center serves as a re- minder to nonprofit corporations to be vigilant in monitoring the use of their property to ensure that the property is used “exclusively” for their charitable work and that, if required, they can sup- port their claim that their organizations are “charitable.” Tax Hawks . . . | Continued from page 3

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Attorneys in Miller Nash’s tax practice represent clients ranging from national companies to indi- viduals and closely held businesses. We add value by helping our clients plan their business and investment activities to attain their business objectives while minimizing their local, state, and fed- eral taxes. Our tax attorneys deal with the Internal Revenue Service, the Oregon Department of Revenue, and the Washington Department of Revenue, as well as many local governments, and are actively involved with local, state, federal, and international tax issues. Additionally, Miller Nash represents national, regional, and local companies in administrative hearings and in state and fed- eral courts in tax disputes with revenue authorities. Miller Nash tax attorneys are recognized leaders in their fi eld, from having served (or serving) on the executive committee of the Oregon State Bar’s Tax Section (three as its chair) and from being regular speakers at a variety of industry and professional seminars. Our tax attorneys work behind the scenes on legislative and regulatory matters and represent clients through all stages of appeals and in tax court. W W W . M I L L E R N A S H . C O M learn more about our tax team at

Practice Leader: William S. Manne

bill.manne@millernash.com

5 | miller nash llp | NW Tax Wire Before last year’s holiday season, we discussed a gift that the Oregon Court of Appeals gave small businesses in its decision Oregon Cable Telecom- munications Association v. Department

• f Revenue (Oct. 6, 2010). In that case,

the court decided that the Oregon Department of Revenue (the “DOR”) violated rulemaking procedures found in ORS 183.335(1). Specifically, the DOR failed to adequately describe the economic impact of OAR 150-308.515(1) (b) on small businesses. After reviewing the context and legislative history of ORS 183.335, the court explained that, at minimum, the statement dis- cussing a rule’s effect on small business1 must include “an approximate calculation of the total (even if nonspecific) small busi- nesses subject to the proposed rule.”2 The administrative rule at issue stated that “several” cable and Internet compa- nies would be assessed in the 2009 tax year, which failed the standard applied by the court. The court emphasized that these rulemaking procedures had been established by the legislature so that agencies would inform themselves of the potential economic effect on small businesses while the rule was being drafted, and not after the fact. Over one year has passed since the Oregon Cable case was decided. A review of the DOR’s recently adopted and amended rules reveals compliance with the “approximate calculation”

• requirement. Yet a couple of concerns

still persist regarding the protection

• f small businesses in the DOR’s rule-

making practices. First, although the DOR now pro- vides numerical estimates, where ap- propriate, when discussing the effect of a proposed rule on small businesses, the DOR still does not sufficiently include small businesses in the development of such rules. When describing a rule’s economic impact on small businesses, an agency must provide a “description

• f the manner in which the agency

proposing the rule involved small busi- nesses in the development of the rule.”3 This provision supports the notion that rulemaking agencies should (1) under- stand the breadth of a proposed rule change as it relates to small businesses, and (2) reduce the effect on small busi- nesses when appropriate.4 Despite this encouragement from the legislature and the Oregon Court

• f Appeals, the DOR has not adequately

included small businesses while de- veloping its recent rules. For example, the DOR recently amended OAR 150- 314.280-(F) (which is estimated to af- fect roughly 300 small businesses) and OAR 150-317.710(5)(b) (which roughly 100 small businesses are subject to). Although small businesses were im- pacted, they were not included in the development of these amendments. In the Statement of Need and Fiscal Impact, the DOR states that small businesses were not included in the development of these amendments be- cause they “were not directly involved.” Excluding small businesses from participating in the rule-development process is contrary to the legislature’s intent, yet such exclusion continues to exist in DOR rulemaking. A second concern is that the DOR’s Fiscal and Economic Impact Statements (“FEISs”) do not comprehensively comply with ORS 183.335(2)(b)(E). In the Oregon Cable case, the court did not address the Oregon Cable Telecom- munications Association’s claim that the DOR violated rulemaking proce- dures by inadequately explaining the proposed rule’s fiscal and eco- nomic impacts. But the DOR continues to produce FEISs that violate ORS 183.335(2)(b)(E). For example, the FEIS discussing OAR 150-314.HB2071(A)5 iden- tifies corporations that will be subject to the rule but fails to estimate the economic impact on such corpora- tions. The Oregon Cable case was a significant step toward enforcing the requirement that state agencies con- sider a rule’s economic impact on small

• businesses. Still, additional safeguards

must be employed by the DOR in order for small businesses to be protected in the manner that our legislature intended.

by James M. Walker

james.walker@millernash.com 503.205.2353

OCTA One Year Later

1 This statement is required by ORS 183.335(2)(b)(E). 2 Oregon Cable Telecommunications v. Dept. of Rev., 237 Or App 628, 636, 240 P3d 1122 (2010) (interpreting ORS 183.336(1)(a)). 3 ORS 183.336(1)(d). 4 Oregon Cable, 237 Or App at 642. 5 This is an administrative rule that establishes an electronic filing mandate.

“Yet a couple of concerns still persist re- garding the protection of small businesses in the DOR’s rulemaking practices.”

NW Tax Wire™ is published by Miller Nash LLP. This newsletter should not be construed as legal opinion on any specific facts

• r circumstances. The articles are intended for general informational purposes only, and you are urged to consult a lawyer con-

cerning your own situation and any specific legal questions you may have. To be added to any of our newsletter or event mail- ing lists or to submit feedback, questions, address changes, and article ideas, contact Client Services at 503.205.2608 or at clientservices@millernash.com.

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Worker Classification . . . | Continued from page 1 Specifically, taxpayers that agree to prospectively treat a class of workers as employees (1) will pay only 10 percent

• f past employment tax liability for the

most recent tax year under reduced Section 3509 rates, (2) will not be liable for interest and penalties, and (3) will not be subject to employment tax audit with respect to the classification of the workers for prior years. The employer must also agree to extend the period of limitations on assessment of employ- ment taxes for three years for the first, second, and third calendar years after the employer reaches agreement with the IRS on worker reclassification. To be eligible for the VCSP, an em- ployer must have consistently treated workers as nonemployees, must have filed all required 1099s for the previous three years, and cannot be under audit by the IRS, the DOL, or any state gov- ernment entity concerning the classifi- cation of the workers. The IRS retains discretion as to whether to accept any application under the VCSP. It continues to be important for employers to review and assess their worker classification practices in

• rder to determine whether workers

are properly classified as employees

• r independent contractors. Given the

newness of the VCSP and the extent

• f potential liability involved, how-

ever, caution should be exercised when considering applying to the IRS for relief through the VCSP. Among other things, employers should consider the full ramifications of worker misclassifi- cation before applying to participate in the VCSP. For example, could there be employee benefits issues (e.g., perhaps former independent contractors should have been eligible to participate in the company’s 401(k) plan), wage-and-hour issues, or state tax liability?