By Joe Haberzetle, JD, LLM
Come 2018, many not-for-profit organizations with unrelated business income (UBI) could either be smiling or groaning over the shift in their Oregon tax bills.
Oregon recently followed the direction of many other states in attempting to collect more tax revenue from out-of-state businesses. The shift will come into effect through changes in how sales of services and intangibles are sourced to the state. The changes to Oregon’s apportionment rules are effective on January 1, 2018.
Not-for-profits with employees in Oregon may see a significant decrease in their tax bill if they provide taxable services to customers located outside of Oregon. Meanwhile, Washington-based service providers with Oregon customers should expect the opposite.
What is Apportionment?
Oregon’s excise tax changes concern how certain taxpayers, including not-for-profit organizations with UBI, must determine their taxable income in Oregon.
Generally, UBI must be divided between the states wherein an organization does business. Tax is then calculated on the portion of UBI attributable to each state. The method of determining the UBI attributable to each state is known as apportionment.
For example, here is a simplified illustration of UBI apportionment: A not-for-profit organization has $1,000 of UBI, $600 of which is sourced to Washington and $400 of which is sourced to Oregon. Oregon may only impose its excise tax on $400. The apportionment method imposed by the states determines how much of the organization’s income is sourced to each.
States have broad discretion to formulate an apportionment method, as long as they do not impose different rules on in-state and out-of-state businesses. Each state with an income tax may have a different formula for apportioning UBI. Oregon’s apportionment formula governs how the organization’s income is sourced in the above example.
Historically, most states used a three-factor apportionment formula that considered a business’ payroll, property, and sales in the state, compared to outside of the state. Under a three-factor formula, not-for-profits would generally have a higher UBI tax bill in states where they had offices and employees.
However, more than 20 states have switched to a one-factor formula that only considers a business’ gross receipts within and outside of the state. Oregon made this switch in 2005, but in doing so, its sourcing rules continued to source in-state sales of services based on where services were performed.
Under Oregon’s current rules, sales of services are deemed to be made in Oregon if the services are performed in Oregon. Customer location is irrelevant. If services are performed both in Oregon and in another state, the sale is considered to be made in Oregon if a greater portion of the related costs (e.g. payroll) are incurred in Oregon.
As a result of Oregon’s current sourcing rules, not-for-profit organizations do not pay Oregon excise tax on UBI if they hire employees who perform services exclusively outside of the state–even if their customers are located in Oregon.
Under Oregon’s new sourcing rules, beginning in 2018, sales of services will be deemed to be made in Oregon if the services are delivered in Oregon. Typically, services are delivered in a state if the customer is in the state. Therefore, the focus of sourcing sales of services changes from employee location to customer location.
The new rules could dramatically increase or decrease the Oregon UBI tax paid. Not-for-profits located outside Oregon that perform services for Oregon customers will likely pay more tax to the state. Not-for-profits located in Oregon with customers in many states will likely pay less tax.
Is Your Nonprofit Organization Affected by the New Apportionment Rules?
Since Oregon generally follows the federal rules for income tax exemptions, with few exceptions, organizations exempt from federal income tax are also exempt from Oregon excise taxes.
However, if your organization has UBI, it may also have an Oregon filing requirement. If it does, 2017 is a great time to plan for the changes ahead.
Other states are likely to follow the trend of switching to a one-factor sales formula and sourcing sales based on customer location. Washington made this switch for purposes of the B&O tax in 2010 and California followed for its income tax in 2013.
Whether or not your organization files an Oregon excise tax return, if it has UBI from sales of services to customers in many states, it’s important to periodically review state apportionment methods. This will allow you to make sure the organization is taking full advantage of opportunities to minimize state tax liabilities.
Have questions about this article? Contact Clark Nuber for more information.
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