Oregon court upholds pass-through deduction addback law


Nisha Mathew
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Jamie C. Yesnowitz 
Washington, DC
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Chuck Jones 
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Lori Stolly
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On March 21, 2019, the Oregon Tax Court held that legislation enacted in 2018 that requires a personal income tax addback of the federal pass-through entity deduction was not a “bill for raising revenue” for purposes of the Oregon Constitution’s Origination or Supermajority Clauses.1 Thus, the legislation was valid even though it did not originate in the state’s House of Representatives or receive approval by three-fifths of the legislature. The Court held that the legislation brought money into the state’s treasury, but lacked the essential feature of a bill levying a tax because it merely changed the base of the personal income tax.

Background Major federal tax reform legislation, commonly referred to as the Tax Cuts and Jobs Act (TCJA), was enacted in late 2017.2 Under Internal Revenue Code (IRC) Sec. 199A(a), the TCJA created a 20% deduction from taxable income for a non-corporate taxpayer with “qualified business income” from a domestic business operated as a sole proprietorship or through a partnership or S corporation.3 In 2018, Oregon enacted legislation, S.B. 1528, which requires taxpayers to add back this pass-through deduction to their federal taxable income.4 Two state senators, Brian Boquist and Herman Baertschiger, filed a complaint in the Oregon Tax Court seeking a declaratory judgment that S.B. 1528 was not valid because it was a bill for raising revenue that violated the Origination and Supermajority Clauses of the Oregon Constitution. Because the senators argued that they may be eligible for the IRC Sec. 199A(a) deduction as owners of businesses that could generate qualified business income, the Oregon Department of Revenue agreed that the senators had standing to bring this action as Oregon taxpayers. There was no dispute that the contested legislation originated in the House and did not receive three-fifths approval in the House or the Senate.

Oregon Constitution’s origination and supermajority clauses Two provisions in the Oregon Constitution place restrictions on the enactment of legislation for raising revenue. The Origination Clause was adopted as part of the original Oregon Constitution and provides in relevant part that “[b]ills may originate in either house, but may be amended, or rejected in the other; except that bills for raising revenue shall originate in the House of Representatives.”5 The Supermajority Clause was adopted in 1996 and provides that “three-fifths of all members elected to each House shall be necessary to pass bills for raising revenue.”6 Therefore, the Oregon Tax Court needed to determine whether the legislation was a bill raising revenue.

In doing so, the Oregon Tax Court looked to three basic considerations identified by the Oregon Supreme Court when interpreting a provision of the Oregon Constitution: (i) the provision’s specific wording; (ii) the surrounding case law; and (iii) the historical circumstances that led to its creation.7 In Bobo v. Kulongoski, the Oregon Supreme Court first applied this analysis to the phrase “bills for raising revenue” and established a two-part test.8 First, the Court considers whether the bill collects or brings money into the treasury. If the bill does not collect money for the state, the bill is not considered to raise revenue and so the constitutional restrictions on such a bill do not apply. If money is collected for the state, the Court considers “whether the bill possesses the essential features of a bill levying a tax.” In Bobo, the Court examined a bill originating in the Senate that retroactively transferred certain Medicaid funds out of the general state fund and reduced the amount of money returned to taxpayers as part of the “kicker” refund.9 The Court held that this legislation was not a bill for raising revenue because it did not collect or bring money into the treasury, and so the Court never analyzed whether such bill possessed the features of a levied tax.
In City of Seattle v. Department of Revenue, the Oregon Supreme Court applied both parts of the Bobo analysis.10 The City of Seattle case concerned a bill originating in the Senate that repealed a property tax exemption for out-of-state public entities. After concluding that the legislation collects or brings money into the treasury, the Court held that the bill did not possess the “essential features of a bill levying a tax” because it “collaterally provide[d] for assessment or regulation of levied taxes.”11 The Court did not consider the bill’s primary purpose because the bill merely affected the tax base.
S.B. 1528 was not a bill for raising revenue After applying the analysis used in Bobo and City of Seattle, the Oregon Tax Court concluded that the enactment of S.B. 1528 did not violate the Origination or Supermajority Clauses because it was not a bill for raising revenue. The Court determined that while the bill collects or brings money into the treasury, it does not possess the essential features of a bill levying a tax. In reaching its decision, the Court noted the trend among federal and state courts of narrowly interpreting terms such as “bills for raising revenue” and limiting their application “to bills to directly levy taxes in the strict sense of the word.” Also, the Court noted that with few exceptions, “courts generally also have upheld bills that change the tax base as not constituting bills for raising revenue.”
In considering the bill, the Court was required to determine whether the legislature intended to collect or bring money into the treasury through the bill by examining the text, context and legislative history. Examples of bills that satisfy this test include bills that: (i) impose a new tax; (ii) increase an existing tax; or (iii) eliminate an exemption. If the bill brings money into the treasury, the bill must also possess the essential features of a bill levying a tax. The Court explained that this question must be construed narrowly and that no Oregon court has provided a positive definition of “essential features of a bill levying a tax.” However, case law in the state clearly excludes bills that: (i) impose fees for governmental services; (ii) primarily regulate behavior or regulations outside the area of taxation by imposing fines or penalties; or (iii) regulate a tax or tax base.
S.B. 1528 collects or brings money into state treasury After a detailed examination of the text, context and legislative history, the Court concluded that S.B. 1528 collects or brings money into the treasury. The bill requires a taxpayer to add an amount to federal taxable income that the taxpayer otherwise could deduct. This addition increases taxable income and the amount of tax due. The Court rejected the Department’s argument that S.B. 1528 does not bring money into the treasury but merely preserves the status quo. Under the Department’s argument, the quick enactment of S.B. 1528 prevented IRC Sec. 199A(a) from affecting Oregon taxpayers. The Department’s interpretation of raising revenue apparently required that: (i) the bill increase revenue in comparison to a benchmark amount; and (ii) the benchmark amount be set at the amount of revenue generated by the Oregon personal income tax law without regard to S.B. 1528 and IRC Sec. 199A(a). In rejecting this argument, the Court explained that the dictionary definition cited by the Oregon Supreme Court in Bobo does not mention an increase in revenue relative to another point in time or set of circumstances. Also, for a bill that increases revenue, nothing in Bobo or City of Seattle supported the Department’s benchmark argument. In applying City of Seattle, the Court determined that S.B. 1528 raises revenue because Oregon would automatically adopt the IRC Sec. 199A(a) deduction in the absence of S.B. 1528.
S.B. 1528 does not have essential features of a bill levying a tax While the taxpayers were successful in proving that the bill raised revenue, they were unable to show that the bill had all of the essential features of a bill levying a tax. The Court came to this conclusion on the grounds that S.B. 1528 is a tax base bill. Similar to the bill at issue in City of Seattle, S.B. 1528 regulates an existing tax. Rather than imposing a tax, S.B. 1528 modifies the Oregon personal income tax base by creating an addition that modifies federal taxable income. In rejecting the taxpayers’ argument that S.B. 1528 imposes a tax, the Court explained that S.B. 1528 is a clear example of a modification that adds back the amount of a single deduction. This modification constitutes a change to the tax base that is within the framework of Bobo as applied in City of Seattle. The Court acknowledged the taxpayers’ argument that S.B. 1528 was projected to raise more than $1 billion over a six-year period, but the Oregon Supreme Court has explained that the revenue effect of a bill has no bearing on whether it is a bill for raising revenue.

After closely examining the enactment history of the Supermajority Clause, the Tax Court concluded that the voters intended to require a supermajority for bills that increase tax rates or impose new taxes, not modifications to the tax base. Also, the Court determined that the voters intended for the “bills for raising revenue” terminology to be interpreted identically for both the Origination and Supermajority Clauses. The Court was not persuaded that voters intended to treat a base-broadening bill as one for raising revenue. The taxpayers also argued that the Court should consider the legislature’s longstanding and contemporaneous interpretation of the Origination and Supermajority Clauses to determine whether S.B. 1528 is a bill for raising revenue. In rejecting the use of the doctrine of contemporaneous construction, the Court noted that its application was not appropriate because the legislature has not passed any legislation to implement or interpret the Origination Clause during the 162 years following its adoption. Because the Supermajority Clause originated with the legislature, the Court determined the legislative history was “contemporaneous” and more persuasive than later legislative interpretations.

Commentary This decision provides a detailed analysis of the factors that must be considered in determining whether legislation is a “bill for raising revenue” that is subject to the Oregon Constitution’s Origination and Supermajority Clauses. The Tax Court agreed with the taxpayers that S.B. 1528 satisfied the first part of the Bobo analysis because the bill collects or brings money into the treasury. However, for the second and more complex test, the Court held that S.B. 1528 did not have the essential features of a bill levying a tax because it merely modified the tax base by requiring the addback of the federal pass-through entity deduction. The fact that the legislation is projected to provide substantial revenue to Oregon did not persuade the Court that S.B. 1528 was a “bill for raising revenue.” This decision has received a fair amount of attention given the potential consequences and the identity of the taxpayers that challenged the law, but state Sen. Brian Boquist does not plan to file an appeal.12

S.B. 1528 was enacted during Oregon’s main 2018 legislative session. During a special session held later in 2018, Oregon enacted additional legislation directed at income from pass-through entities.13 The legislation expands the availability of an elective reduced personal income tax rate for certain pass-through income received by taxpayers who are doing business as sole proprietors.

This decision may have an effect on future Oregon tax legislation. During the past few years, the Oregon legislature has considered enacting a new gross receipts tax. Based on the Court’s analysis, the enactment of a new tax apparently would require the approval of a three-fifths supermajority of the legislature. Legislation enacting an entirely new tax presumably would have all of the “essential features of a bill levying a tax.” Also, this decision could be used to support an argument that future IRC conformity bills will not require supermajority approval by the legislature.

1 Boquist v. Department of Revenue, Oregon Tax Court, No. TC 5332, March 21, 2019, (unpublished).
2 P.L. 115-97. For a discussion of the TCJA, see GT Alert: Tax Reform Law Transforming Business and Tax Planning.
3 IRC § 199A(a). 
4 Ch. 108 (S.B. 1528), § 10, Laws 2018. 
5 OR. CONST. art. IV, § 18 (emphasis added by Oregon Tax Court).
6 OR. CONST. art. IV, § 25(2) (emphasis added by Oregon Tax Court).
7 Priest v. Pearce, 840 P.2d 65 (Or. 1992).
8 107 P.3d 18 (Or. 2005).
9 The “kicker” is a tax credit or refund that is available when there is a state revenue surplus. OR. REV. STAT. § 291.349. 
10 357 P.3d 979 (Or. 2015). 
11 Id. 
12 Hillary Borrud, Republican Lawmaker Loses in Lawsuit Over Oregon Democrats’ 2018 Tax Law, THE OREGONIAN/OREGONLIve, March 29, 2019. Senator Herman Baertschiger has not indicated whether he plans to pursue an appeal.
13 Ch. 1 (H.B. 4301), Laws 2018, 1st Special Session.

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