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April 2018

Why the Governor’s action prevents further tax abuse

by Juan Carlos Ordóñez

A new report confirms the wisdom behind Governor Brown’s recent announcement that she will sign Senate Bill 1528 — legislation ensuring Oregon does not replicate the new, misguided federal tax break for business owners. The Trump tax scheme “invites rampant gaming” of the tax system, according to a report by the Center on Budget and Policy Priorities (CBPP). A prime opportunity for abuse, the report goes on to explain, is the tax break that Oregon has now chosen not to duplicate.

The tax break at issue is a new tax deduction for owners of “pass-through” businesses. Such businesses — S-corporations, partnerships, LLCs, and sole proprietorships — do not pay corporate taxes on their profits. Instead, the profits are passed through to the owners, who report the profits on their personal income taxes. The new federal tax law created a 20 percent tax deduction for pass-through income, removing one-fifth of their income from taxation.

The complexity of this new tax deduction has left many accountants and taxpayers scratching their heads. Factors that can determine how much a business owner can deduct include the amount of pass-through income, the type of business activity, how much the business pays its workers, and how much property the business owns.

This much is clear, though: At a time when our economy is extremely out of balance, this tax break steers the bulk of the benefits to the most well off. Business income, after all, is concentrated at the top of the income ladder.

The new federal tax deduction is also ripe for abuse. As the CBPP notes:

The deduction effectively means that certain pass-through income will face a lower tax rate than wages and salaries, creating an incentive for high-income individuals to reclassify their salaries as pass-through income. While the new law includes complex “guardrails” intended to prevent such abuse, they are poorly designed. Tax experts have suggested, for example, that while highly paid doctors are not eligible for the pass-through-income deduction, a group of doctors could create a real estate pass-through company — which would be eligible for the deduction — and have the company own the medical practice’s building and charge extremely high rent, so that a significant portion of the doctors’ income would then accrue to that company and receive the deduction.

Those most likely to abuse this new provision are those who have the means to hire clever tax lawyers and accountants.

We recommend reading the full report by the CBPP, which explores in depth the flaws of the Trump tax scheme, including how the federal pass-through business deduction invites abuse.

Because Oregon automatically connects to the federal definition of taxable income, Oregon would have replicated the federal tax deduction on pass-through income, had Oregon lawmakers not acted. The Oregon legislature rightly rejected the tax break by passing Senate Bill 1528. Last week, Governor Brown announced she will sign the bill.

It’s important to note that Oregon already provides its own homegrown tax break to certain owners of pass-through businesses. This tax break charges a lower tax rate on the profits of millionaire business owners than the tax rate that teachers and firefighters pay. Unfortunately, this tax break remains on the books, despite its patent unfairness to working families.

Oregonians can take some comfort in knowing that our state leaders chose not to add another tax break for pass-through businesses to Oregon's tax code — even though the misguided federal tax deduction will haunt our nation’s tax system for years to come.

 

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