OR: Nonresident Pass-Through Entity Owner’s Source Income Not Determined

Recently, the Oregon Tax Court addressed how a nonresident individual’s Oregon source income derived from investments in several pass-through entities should be determined.

Podcast Transcript

Recently, the Oregon Tax Court addressed how a nonresident individual’s Oregon source income derived from investments in several pass-through entities should be determined. The taxpayer, an Oregon nonresident, was a 50 percent (or less than 50 percent) owner of several pass-through entities that were presumed to be unitary in nature. Some of these entities did business in Oregon and others did not. The taxpayer reported and apportioned income to Oregon based on his distributive share of income from the pass-through entities operating, in whole or in part, in Oregon. Income from pass-through entities not doing business Oregon was excluded.   The Department audited the taxpayer and determined that the taxpayer’s income should be apportioned after considering and combining the income and factors of all the unitary pass-through entities, including those that had no Oregon resident partners or Oregon source income. The taxpayer protested and the matter went to the tax court. Before the court, the taxpayer argued that apportionment should be done at the individual pass-through entity level.  Using this method, the income or loss of each pass-through entity doing business in Oregon would be apportioned separately and results would be added together and reported on the taxpayer’s Oregon nonresident income tax return. In contrast, the Department of Revenue argued that the distributive share of income or loss from each pass-through entity in which the taxpayer was an owner should be aggregated, even those not doing business in Oregon.  After that, an apportionment factor would be computed. The numerator of the factor would include the aggregate of the taxpayer’s share of Oregon sales and the denominator would include the taxpayer’s aggregate share of total everywhere sales. That apportionment percentage would then be applied to the taxpayer’s total income or loss from the pass-through entities- including income from pass-through entities not doing business in Oregon.  The Department’s proposed method resulted in the taxpayer owing a greater amount of Oregon tax.

The tax court noted at the beginning of its 51-page opinion that, unlike in the corporate context, there was no explicit statutory basis for the Department’s combined reporting position as applied to the income derived from pass-through entities. The Department primarily argued that Oregon’s combined reporting rules for corporations and UDITPA allowed it to require combined reporting in the pass-through entity context. However, the court rejected this position. In sum, the history of Oregon’s current combined reporting scheme evidenced that it had never been established by Oregon courts that (1) a combined report could be required for entities other than corporations  and (2) UPITPA contained statutory authority requiring combined reporting (other than in the alternative apportionment context). Furthermore, the legislative history behind the adoption of Oregon’s current laws established that the legislature had intentionally adopted specific provisions to mandate combined reporting for corporations.  Furthermore, after a thorough review of Oregon’s statutes addressing taxation of pass-through entities and their owners, the court concluded that the Department’s actions in the instant case were inconsistent with the entity- level calculations required under the law.  Notably, the court illustrated that under this approach there could be instances where the aggregation of all distributive share income could result in a taxpayer having a greater Oregon distributive share than its federal distributive share. This would conflict with statutory language that the part of the federal distributive share taxed by Oregon would be, at most, the entire federal distributive share.  The court also noted that because a pass-through entity with no Oregon source income would not file an Oregon return, there would be no opportunity for such partnership to make the Oregon required modifications to the partnership’s income. If the legislature intended combination of pass-through entities it would have likely provided some mechanism whereby out-of-state pass throughs could make such modifications.  Finally, the court observed that the outcome for a nonresident owner electing to be included in a composite return would be materially different than the outcome of a taxpayer that did not so elect.  Had the taxpayer at issue joined in composite returns, its tax liability in Oregon would have been the same as what was reported on the original return.  Please contact Rob Passmore at 503-820-6844 with questions on Cook v. Dep’t of Revenue. 

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