Carrie Sowders, CPA, Aldrich Partner, and Dan Eller, Schwabe Shareholder, pointed out that while tax conversations over the past year mostly revolved around what’s happening at the federal level, local taxes passed back in 2020 are now hitting home and may catch some by surprise. They highlighted the key federal and local tax issues and regulatory roadblocks that are top of mind for clients.
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Federal Taxes for Individuals
President Biden’s Build Back Better (BBB) tax plan went through many transformations before going nowhere by the end of 2021. We’re still waiting to see where it will land. The proposed capital gains tax increase in the plan last year (that would become effective /retroactive to an earlier date) drove more behavior than any other item in the bill. People were worried about whether it was time for a liquidity event and wanted to beat that date. Many were watching where tax rates would land and considered selling their business to get ahead.
Ultimately, the capital gains rate changes discussed last year went back and forth and were no longer in BBB at the end of 2021. Instead, Congress had proposed a surtax on high-income taxpayers.
For individuals, the new surtax would establish an incremental tax increase of 5% on income above $10 million and an 8% tax on income over $25 million. Had the surtax been enacted, large transactions such as the sale of a business would have seen a tax increase even absent a capital gains rate increase.
The administration outlined revised proposed changes in the “Green Book” released in late March 2022, which includes a revisited provision to increase capital gains rates on taxpayers with income over $1 million ($500,000 for married filing separately). In lieu of the surtax discussed last year, it includes an outline for a new wealth-based tax on individuals with over $100 million in wealth.
The state and local tax (SALT) deduction may also change. The itemized deduction for state taxes is currently limited to $10K of your state and local income and property taxes. Congress discussed last year going from $10K to $80K for a few years (2021-2030). A potential issue is how that may interplay with the alternative minimum tax (AMT) and what, if anything, would be done to the AMT as a result. In the meantime, Oregon has a new 2022 pass-through entity tax workaround that may benefit owners of LLCs, S corporations, and partnerships.
Also relevant to business owners is the provision in BBB about the net investment income tax (NIIT) that applies to passive type income with a 3.8% tax (interest, dividends). If this goes through, everyone with S corps will be having a conversation since it would expand the NIIT to this income without considering the owner’s activity level.
There was also talk about raising electric vehicle (EV) credits with income limits. For now, the historical credits still apply. Oregon currently has a rebate program to incentivize more EVs on the road. Please note that not all EVs qualify for the credit and/or rebate program.
Federal Taxes for Businesses
Proposals are floating to change the corporate tax rate and create a 15% minimum tax on book income for those with over $1 billion in profits. With more talk about the global economy, the more productive nations are joining arms and looking at a minimum tax to make sure corporations pay their fair share.
The March 2022 Green Book contains a revised minimum tax proposal and a proposal to increase the corporate tax rate to 28% from 21%.
BBB also proposed a 1% excise tax on stock buybacks, which led to a flurry of public companies undertaking buybacks, although this provision is no longer likely.
“Many of these taxes are additives, not replacements, and continue to compound. We have seen over the last couple of years that the incremental tax changes add up or stack, and it gets to be a lot.” – Dan Eller.
Eligible businesses can receive research and development (R&D) credits to encourage innovation and development of IP in the U.S., which has been around for a long time. However, starting in 2022 through 2026, the government now requires the capitalization and amortization of R&D expenditures. This change stems from the 2017 tax law changes under the last administration.
“This means that, suddenly, the R&D credit isn’t quite as beneficial up front, especially compared to other nations. But there is a provision in BBB to address this.” – Carrie Sowders.
The infrastructure bill signed into law last year had a few tax-related items, including a provision requiring digital asset reporting just like a cash transaction. This comes on the heels of Tesla announcing last year that they would take digital assets and cryptocurrency as payment for their products. We expect more bills to explore the crypto space because it could be another source of revenue for the government.
Oregon Tax Updates
Oregon passed significant tax increases over the past year and a half that are now becoming effective.
“All of 2021, we were so focused on federal tax, the capital gains rate, Build Back Better, and all the while the state and local taxes changed.”
– Dan Eller
A welcome surprise is the 17.34% tax kicker coming back this year as a credit for Oregonians.
“Generally, that would be considered a good refund. But the bad news is that there are a lot of other new Oregon taxes coming into play which will most likely cancel out the kicker.”
– Carrie Sowders
Oregon has enacted a pass-through rate change. Historically, individuals with pass-through income taxed in Oregon are eligible for a lower rate, going from 9.9% to 7.5% on the vast majority of income. That’s going to change now. Oregon is looking at taxable income of the business (not shareholder or partner), and individuals will get to the full 9.9% once the business’s taxable income reaches $5 million. In essence, the pass-through rate will start evaporating for any largely profitable businesses.
An elective state and local workaround (SALT) will begin in 2022 and last through 2023. Pass-through entities can elect to pay the owners’ taxes at the entity level. To qualify, the entities must be wholly owned by individuals. The rates on the workaround are 9% for the first $250K and 9.9% after that. While great in theory because the company pays it, deducts it, and works around the SALT cap, it may not work out well in reality. If your whole financial life is your business, it doesn’t consider your itemized deductions or any other factors, just the business income, making it less valuable since you will constantly be overpaying and getting a refund from the state for the overpayment. There are also some potential issues surrounding S corporation owners being taxed at different rates that haven’t been resolved.
In 2020, while we were focused on the pandemic, new taxes passed. One of them was the Oregon Metro tax of 1% for singles with income over $125,000 or married couples making more than $200,000. Also, if you’re a business in the tri-county area with gross receipts above $5 million, you get that 1% tax on your entire income, not just on the income above $5 million. If you’re paying the Metro tax on your business and it passes through you personally, you won’t be double-taxed due to an allowable subtraction of that income.
Funds raised from this tax will fund new initiatives to combat houselessness in the metro area. But, again, while 1% on its face doesn’t seem like a significant increase, it’s a 1% income tax that kicks in on top of everything else.
“An additional 1% tax is like a 10% increase in the income tax rate. At the federal level, such tax changes have always been hotly contested.” – Dan Eller
If your business is in Multnomah County, you are also subject to a City of Portland/Multnomah County business tax separate and distinct from the Metro tax. However, there are some favorable rules regarding splitting your income for manufacturers that could minimize the company’s tax burden.
The other major tax passed was the Multnomah Preschool for All tax, applicable only to individuals. It’s an income tax of 1.5% (for single income greater than $125,000 or married income greater than $200,000) and 3% (for single income greater than $250,000 or married income greater than $400,000). The 3% tax will rise to 3.8% in 2026. Owners of pass-through entities residing in Multnomah County will be subject to Multnomah taxes on all pass-through income not previously taxed and at the entity level.
In summary, two new 2021 taxes could add up to almost 5% more in taxes for those above certain income levels. And whether or not there’s a SALT deduction increase, it’s likely a lot of that will be entirely borne by the taxpayer with no offset.
“It makes people living in Multnomah County some of the highest taxed in the country, if not the highest taxed. And this is an expensive place to do business.” – Carrie Sowders
“In the past year, I’ve had more conversations about tax residency with clients than the last ten years combined. What’s different is that people are now planning for it within Oregon, not just those from other states like California. People within Oregon want to be residents of other counties in Oregon for tax purposes, so it’s been interesting doing tax planning within the state.” – Dan Eller
These taxes were implemented in 2020 for applicability in 2021 and are income-based. Because income taxes are typically handled and withheld by employers, many may be surprised once they see how this all plays out, and a lot of them will have to write a check once they file their taxes.
“Business owners should note that the obligation to withhold and remit this for your employees (based on income) needs to start now, and businesses are subject to estimated tax requirements starting this year as well.” – Carrie Sowders
There isn’t much to report on the Oregon Corporate Activity Tax (CAT). About a dozen CAT bills were introduced in the 2021 session but never went anywhere. Regulatory activity by the department of revenue has continued but slowed.
“I was at a recent revenue advisors meeting for the state, and they were projecting that the CAT revenue to the state was higher than they thought it would be.” – Dan Eller
Much of the discussion surrounded what to do with fiscal year taxpayers and a calendar year CAT. If you are a fiscal non-calendar year taxpayer, you have your books and records established for that fiscal period. This was one of the only changes in last year’s legislation with a mandatory shift of all fiscal year taxpayers to file on a fiscal year with a required short year return to make the switch.
“For a lot of manufacturers and distributors, the CAT didn’t end up being as painful as they thought it would be based on early rules.” – Carrie Sowders
“The Department of Revenue is starting its enforcement activity, and CAT audits are coming. This audit activity will become regular over the next several years, so you’ll have to make some decisions on how you want to proceed.” – Dan Eller
Washington Tax Updates
Washington’s most significant tax highlight is a 7% capital gains tax, effective January 1, 2022. Income taxes are prohibited in Washington, but this will be an excise tax with some exemptions. It’s going through the court system now, and we should know more soon, but it will likely go to the Supreme Court of Washington.
Managing Your Tax Liability with Aldrich
As more changes and updates unfurl, we know it can be tough to stay ahead of the curve. Our advisors are here to help guide you through any tax policy changes that may come into effect. If you have questions about how your finances or want to explore strategies to increase your tax efficiency, contact your Aldrich Advisor.
Meet the Expert
Carrie Sowders, CPA
Aldrich CPAs + Advisors LLP
Carrie leads our Manufacturing group at Aldrich and specializes in serving large and middle market companies, primarily in the consumer and industrial products sectors. Carrie has exclusively practiced in tax since beginning her career in 1998. Prior to joining Aldrich in 2009, Carrie spent a decade with Deloitte and oversaw the tax function of a... Read more Carrie Sowders, CPA
- Certified Public Accountant
- Manufacturing tax
- Consumer business
- Multinational corporate issues
- Tax accounting and methods