NW Tax Wire Tax Breaks for Oregon Partnerships, LLCs, and S - PDF document

miller nash llp | Winter 2014 brought to you by the tax law practice team NW Tax Wire ™ Tax Breaks for Oregon Partnerships, LLCs, and S Corporations cluded in the calculation of the reduced will apply to all eligible income for that rates. Note that regardless of whether tax year. The reduced rates are applied income from a particular activity is on the net amount of all eligible non- by William S. Manne subject to the Internal Revenue Code passive income, after applying eligible bill.manne@millernash.com Section 469 passive-loss rules, there nonpassive losses. The reduced rates 503.205.2584 is an additional, potentially different apply to nonresidents’ income earned In a special legislative session Oregon requirement that the taxpayer in Oregon, and to part-year residents’ that adjourned on October 2, 2013, “materially participat[e] in the day-to- Oregon income, by first applying the the Oregon legislature passed House day operations of the trade or business.” reduced rates to all nonpassive income, Bill 3601, which provides for reduced It is not clear from the statute how and then multiplying by the ratio of the personal income tax rates on non- the Oregon “material participation” taxpayer’s nonpassive Oregon income passive, flow-through income from requirement differs, if at all, from the to all nonpassive income. S corporations, partnerships, and lim- federal “active participation” test under The decision whether to elect ited liability companies that are taxed Section 469. out will require careful analysis of as partnerships. This is income ordi- Eligibility for the reduced rates a taxpayer’s situation each tax year. narily listed on Schedule E of the indi- also requires that the entity employ at Why would a taxpayer not elect to take vidual’s federal form 1040. Beginning least one person who is not an owner, advantage of the lower rates? It appears January 1, 2015, individual taxpayers member, or limited partner of the that if the election is made, itemized de- subject to Oregon personal income tax partnership or S corporation, and that ductions such as mortgage interest and will be taxed at preferential rates of at least 1,200 hours of work in Oregon (continued on page 5) 7 to 9 percent (versus the top marginal be performed during the tax year by rate of 9.9 percent) on the first $5 mil- the employee(s). Only hours worked inside this issue lion of nonpassive income each year, in a week in which a worker works at depending on the level of income. To 2 More Flexibility for Reverse least 30 hours may be counted toward Exchanges be eligible, a taxpayer must materially that requirement. The statute appears participate in the entity and there must 3 Is Oregon Charitable to require employed personnel (versus to Charities? Recent be at least one nonowner employee. independent contractors). Developments From the To determine what income is Oregon Tax Court The reduced rates will be automati- eligible for reduced rates, the statute cally applied each year, but taxpayers 4 Export Tax Incentive: The refers to Internal Revenue Code Section DISC Touches Down in can choose to elect out (to have regular 469, which is used to establish federal Oregon rates apply), if that is more advanta- income tax limitations on passive-activ- geous. The election can be made in any ity losses and credits. If flow-through year, is irrevocable, and is made on the income or losses are subject to the taxpayer’s original Oregon income tax limitations of Section 469, then that form. Once made, the election to accept income or loss is not eligible to be in- the reduced rates or apply regular rates www.millernash.com

More Flexibility for Reverse Exchanges A typical reverse exchange can be the Sheldon Leonard Partnership will illustrated as follows. Our taxpayer, complete the exchange and acquire Leonard, finds an apartment complex the apartment complex as replacement by Jeneé Hilliard that he’d like to buy as investment property. So each QEAA acknowledges jenee.hilliard@millernash.com 503.205.2505 property, and he also wants to sell his that there are QEAAs outstanding current investment duplex without with two other parties, and each QEAA When the real estate market is hot, paying tax. Leonard can sign a QEAA provides that any of the three parties it can be a great time to sell real prop- and have an EAT buy the apartment can give notice to the EAT of the intent erty. And because people don’t want to complex for him, and then Leonard can to acquire the apartment complex, and pay tax unless they have to, it can be list his duplex for sale. If the duplex sells upon doing so, the other two parties will attractive to complete a 1031 exchange within 180 days after the apartment have no right to acquire the apartment with the proceeds from the sale. But a complex is purchased, he can complete complex. Leonard signs 45-day designa- hot real estate market can be a difficult the exchange and have the apartment tions for all three taxpayers, and each time to buy real estate, and if a taxpayer complex serve as replacement prop- designation lists the three duplexes sells real estate, it doesn’t necessarily erty for his duplex. But if Leonard has owned by that taxpayer as the relin- mean that acceptable replacement prop- multiple duplexes, owns them through quished property. This results in nine erty can be found within the timelines various partnerships, and is willing duplexes’ being designated as potential required by Section 1031. Private Letter to sell any of the duplexes as part of a relinquished properties to pair with the Ruling 201416006, issued earlier this 1031 exchange, it increases Leonard’s apartment complex. The IRS ruled that year, provides a little additional flex- chances of completing a 1031 exchange each of the three QEAAs was a separate ibility for taxpayers with multiple real if he can use whichever duplex sells QEAA meeting the requirements of estate holdings who complete a reverse first as the relinquished property in an Revenue Procedure 2000-37 and that 1031 exchange. exchange with the apartment complex. each taxpayer was allowed to complete a Private Letter Ruling 201416006 has separate 45-day designation. This struc- Reverse exchanges are typically opened the door to allow more flexibility ture provides flexibility for a taxpayer accomplished by complying with the in designating relinquished property in with multiple potential relinquished “parking” rules in Revenue Procedure reverse exchanges. properties held in various forms of 2000-37. In a typical reverse exchange, ownership by increasing the number of a taxpayer will enter into a qualified The facts of Private Letter Ruling potential relinquished properties that exchange accommodation agreement 201416006 can be illustrated as follows. can be designated for a single replace- (referred to as a “QEAA”) with an Leonard owns three duplexes and also ment property. exchange accommodation titleholder owns 51 percent of the Howard Leonard (referred to as an “EAT”; this role is Partnership and 51 percent of the Shel- There are, of course, a few limita- typically played by a single-member don Leonard Partnership. Each of the tions with this ruling. First, private limited liability company formed by partnerships also owns three duplexes. letter rulings provide tax advisors the 1031 accommodator). This approach Leonard finds the apartment complex with guidance about how the Internal can be used to ensure that the taxpayer and wants it to serve as replacement Revenue Service might view an issue, isn’t under any time pressure to find property for whichever of the nine but they can be relied on only by the and purchase replacement property, but duplexes sells first. Leonard has an taxpayer who requested the ruling and replaces that risk with the fact that the EAT acquire the apartment complex as cannot be used or cited as precedent. exchange will fail if the taxpayer cannot potential replacement property. He then Second, the taxpayer who requested find someone to buy his or her relin- enters into three QEAAs with the EAT. the ruling asserted that each taxpayer quished property within the 180-day One QEAA is with Leonard personally, had a bona fide intent to acquire the period. This structure also requires that one QEAA is with the Howard Leonard replacement property under the terms the taxpayer have the cash and financ- Partnership, and the final QEAA is of the QEAA. In its ruling, the IRS ing available to acquire the replacement with the Sheldon Leonard Partnership. specifically stated that it was relying property before the relinquished prop- When the EAT acquires the apartment on this representation in making its erty is sold; for many taxpayers, this is a complex, it is not clear whether Leonard, ruling. Ultimately only one taxpayer can difficult hurdle to overcome. the Howard Leonard Partnership, or (continued on page 5) 2 | miller nash llp | NW Tax Wire