Oregon Changes Tax Structure for Most Businesses

“Pass-through entities” (partnerships, LLCs, and S corps) are business forms that state recognize that still have some privileges under the law like ability to sue and limited liability. One reason why corporate income tax collections appear to have declined over time is because businesses that once would have been “C-corporations” are now taking these other forms. They’re still paying taxes, just through the individual code and not the corporate code.

States with high individual income taxes can thus harm precisely those businesses that employ a lot of people and conduct a lot of economic activity. Oregon, for example, has one of the nation’s highest income tax rates (9.9 percent on income over $125,000). Some people cried foul, saying it was lower than the corporate rate of 7.6 percent (which you really can't, since corporate income is taxed twice, once at the corporate level and again at the shareholder level; pass-throughs only pay tax once, at the individual level).

Consequently, in their recent special legislative session, Oregon policymakers approved a new tax structure for certain pass-through entities. Previously, these pass-through entities would pay individual income tax on their earnings (four tax brackets, ranging from 5 percent to 9.9 percent). The new structure expands this to six brackets, but greatly changes when the thresholds kick in for businesses with less than several million in earnings (see table). Oregon also hiked taxes on corporations, kicking in the top rate at just $1 million instead of $10 million.

The budget law allows the changes to be pared back if the revenue loss exceeds the expected $200 million by more than 25 percent.

Driven by rhetoric about cutting taxes for small businesses but in reality just adding more complexity and non-neutrality to the tax code, these changes make Oregon the third state to adopt a special income tax system for pass-through businesses. Kansas offers a complete exclusion for all pass-through business income, resulting in a non-neutral situation where income from corporate profits is taxed twice, wage income is taxed once, and most small business is not taxed at all. Ohio has enacted a 50 percent exclusion for the first $250,000 of pass-through income, adding complexity to an already non-neutral carveout. Oregon’s is more transparently an effort to tax corporations while reducing tax burdens for some (but not all) pass-through entities.