Oregon Poised to Sunset Federal SALT Workaround

In 2021, Oregon lawmakers enacted a workaround to the federal state and local tax (SALT) deduction limitation, allowing individual taxpayers with an ownership interest in a pass-through entity to write off their state taxes. The workaround mechanism enables taxpayers to pay a special tax on their business income with a corresponding state tax credit offsetting traditional taxes and claiming a federal deduction as an ordinary business expense. Taxpayers utilized the program far more than lawmakers and administrators anticipated at its inception. Now, however, Oregon may become the first state to allow the program to quietly expire.

State and Local Tax Workarounds

Under the Tax Cuts & Jobs Act of 2017, Congress limited the deductibility of SALT to $10,000 regardless of filing status. In a high-tax state, like Oregon, the policy strictly limits the amount of city, county, regional, and state income taxes higher-income taxpayers can write off from their federal taxes. For many, the policy results in a substantial tax increase depending on their home state.

Immediately following the federal law's enactment, states began exploring policy workarounds to maintain SALT deductibility, primarily to avoid the political backlash against the high taxes and sustain competitiveness. Initially, states explored a tax credit mechanism allowing taxpayers to make charitable contributions to government programs and services, but the Internal Revenue Service (IRS) disallowed those workarounds. (Note: Oregon lawmakers also plan to eliminate the Oregon Opportunity Grant Tax Credit, which previously existed as the state's credit workaround.)

Since late 2018, states began utilizing another SALT workaround mechanism where the state imposed an optional tax on the income derived from pass-through entities, such as s-corporations and partnerships, and provided a corresponding tax credit for the owner's personal income tax return. For revenue purposes, the tax and credit mechanism did not materially affect state revenues but maintained the deductibility for federal tax purposes. Unlike the charitable credit, the IRS blessed these business entity tax workarounds in November 2020.

As of the date of this post, 38 states and the District of Columbia allow taxpayers to use the elective tax workaround.

Oregon's Pass-Through Entity Elective Tax

During the 2021 session, Oregon lawmakers enacted SB 727, establishing the alternative business income tax workaround utilized by most states. The tax and credit program, known as the pass-through entity elective (PTE-E) tax, allows eligible pass-through businesses to pay an elective tax of 9 percent on their first $250,000 in distributive earnings and 9.9 percent for amounts in excess. After paying the elective tax, the business owner can claim a dollar-for-dollar credit against the tax they otherwise would pay and receive full deductibility on their federal taxes.

Since the federal tax laws and regulations governing the SALT deductions were evolving and the change occurred during the eleventh hour of President Trump's administration, the legislature set the program to run for two years, expiring for tax years beginning on or after January 1, 2024. Sen. Brian Boquist (I-Dallas), who carried the bill on the floor, said the expiration would allow the 2023 legislature to check the pulse of the federal deduction and, if needed, extend it moving forward.

Legislature Stalled on PTE-E Extension

Early into the 2023 session, the Senate Finance & Revenue Committee held a public hearing on  SB 158, a measure seeking to amend and extend the PTE-E until 2026, guaranteeing that residents could continue to utilize the mechanism. The amendments to the program expand the benefits to trusts with an ownership interest in a pass-through entity and change some of the accounting mechanics to address complexities inadvertently created by the 2021 legislation.

In testimony, the Oregon Department of Revenue said including trusts in the tax credit program would increase the administrative difficulty in tracing and verifying taxpayer information. In non-legislative parlance, tax programs cost money to run, and, if the policy is going to expand a program in a way that makes it more complicated, it may increase needed expenditures to meet the legislature's directive.

Although the enabling legislation did not require a trip to the legislature's budget-writing Ways & Means Committee, the Senate Finance & Revenue Committee was instructed to send the bill to the budget committee for an appropriation. This is a highly unusual step for a tax program measure to take in the legislative process. Usually, if a tax program incurs an administrative cost, it is paid using general funds or receives a special appropriation through the legislature's program change bill, one of the final bills to emerge from the budget process.

Since referring the measure to the Ways & Means Committee on April 3, SB 158 has not received further attention from the legislature. If lawmakers adjourn the session without moving the bill with an appropriation, the PTE-E will sunset on January 1, 2024, gifting a surprise federal tax increase for unknowing taxpayers.

If you or your accountants are interested in maintaining the PTE-E through the lifespan of the SALT limitation, you can find your state representative and senator through the Oregon legislature's "Find My Legislator" tool here.

Update: On Monday, June 19, the House Revenue Committee released amendments replacing the contents of HB 2083, a placeholder study bill, with a proposal to extend the PTE-E without the program changes proposed in SB 158. The committee will consider the amendment and, if there is support, advance the bill out of committee, bypassing the appropriations process because the bill would not increase the state's administrative costs.