Adopting the CAT
Oregon's Corporate Activity Tax was voted into law last fall and became applicable on Jan. 1, 2020. However, the revenue department is still figuring out the rules for the CAT.
In short, businesses with taxable commercial activity in Oregon in excess of $1 million will have to pay a tax at a rate of 0.57%, plus a flat tax (a filing fee) of $250.
There are multiple exceptions, but nothing a capable team of Big Eight accountants cannot handle. The problem is for small and medium businesses, collecting the tax, and choosing how to pass on the expense is complicated. Perhaps prohibitively so.
Accountant Harriet Strothers is a partner Delap LLP. She gives presentations on the CAT three times a week. For 15 years, Strothers was a tax director at a Fortune 500 home builder. On Jan 26, she faced a room of homebuilders at the Oregon Homebuilders Association in Lake Oswego.
Strothers explained that the law is unlikely to be struck down in court because of three other bills that were passed to protect it, and she couldn't see anyone gathering 150,000 signatures by July 2, 2020.
"So, I believe we're stuck with it," said Strothers, setting the tone for the talk.
The formula looks simple. Businesses take their Oregon commercial activity (working gross receipts), then deduct a whole host of exclusions, and then deduct 35% of apportioning cost inputs or labor costs. Then subtract $1 million to get the tax base, then multiply that by 0.57 and add $250, which is the "minimum tax" or filing fee.
If the tax base is zero, there's no tax to pay.
Oregon commercial activity is all income from all sources, except investment income as long as you're not in the business of investing.
For family businesses, Strothers said she thinks they will go by what they used in Internal Revenue Code Section 318, which is lineal. Grandparents, parents, children and spouses are all considered one person. Siblings without the benefit of a parent in the ownership are not considered one person under Section 318.
This definition is important for a lot of construction firms, which are family businesses.
She warned homebuilders that "when you're calculating your cost of goods sold, it includes labor applicable and cost of goods sold."
Jeff Bettinelli (see sidebar), a builder in the audience, asked, "If I have a garage door company and they supply the garage door and the labor to put it on, do we need to have them separated for the labor component?"
Strothers said she has a request into the Department of Revenue to provide an example of whether or not they can use a ratio.
"If you're a sub, I urge you to use a reasonable ratio. Don't pump up the labor to help your general (contractor), because the Department of Revenue will hold you responsible after the fact when they get their full audit regime together."
Someone else asked about engineering and architecture because they are a service.
"Well, they're a subcontractor. You can ask them to separate their labor."
She gave a single-family contractor deduction example. If they have $10 million in annual Oregon commercial activity and $70 million everywhere else in commercial activity, when all is said and done they will pay $38,283 in CAT.
Another audience member asked, "Does the subcontractor's labor also include burden and overhead costs?" Strothers said she didn't know, and it was a good question for the department of revenue.
A certain ratio
Many were worried about subs picking a ratio of goods to labor.
Strothers said an absolute ratio would not work because it is different for each trade, and within each trade, it's different for each business. "But it looks like they will allow you to pick a ratio that is reflected from your prior-year tax return. So, if you sell garage doors, if you spend 40% on labor and 60% on materials, you can do that."
Businesses will want to pass through the tax to their customers, but Strothers warned that it's not a sales tax.
"You can pass it through to your customer in the form of increased prices, in the form of a note on an invoice, but you have to be really careful. It's not a sales tax. It's your tax, not your customers' tax."
She added that tacking on 0.57% is also illegal because it is overstating the effective rate.
"We recommend you calculate it based on 2019. You get a ratio. The highest I have seen at this 0.39. Can you call it a surcharge? You can call it whatever you want."
AN ACCOUNTANT TURNED BUILDERS HAS CAT CONCERNS
Jeff Bettinelli used to be a Big Eight accounting firm manager. Fifteen years ago, he became a homebuilder, founding Black Diamond Homes. He buys empty lots, purchases home plans, hires subs to build the homes on spec, and sells them to families through a realtor. They mostly go for $500,000 to $750,000, but he does have a $2 million house in McMinnville.
"I think for a home builder, this is not a fair tax because when we buy the land, we're immediately paying this 0.57% tax on it. And then the home is just a high-dollar item with a low profit margin. Say the profit margin is 15%. This tax of basically one half of 1%, so that's taking a big chunk out of the profit."
He added that sometimes his profit margin goes below 10% on a new house and that the tax is going to be too complex for a lot of small businesses to figure out.
"If you want to try to exclude all these costs, small builders (are) not even going to understand it. If you have a big national company, they've got the accounting staff to calculate all the costs. And all the small subcontractors that supply materials and labor, they're not going to want to give us the first set of labor versus materials ratio."
For example, if Black Diamond is charged $1,000 for a garage door, Bettinelli is sure his supplier is not going to want to reveal the materials and labor cost ratio, in case Bettinelli shops elsewhere.
Even as an accountant, Bettinelli sees tracking all the costs to comply with the law as extremely complicated. He thinks less financially literate people are just going to guess, or go with the cost of goods sold, times 35%, and miss out on deductions.
Bettinelli says he will have to calculate if it's worth his time to add a different code in his accounting software for each purchase, for tax purposes.
"The garage door guy will have to do the same thing. He's just in a different industry."
The million-dollar exclusion should exempt some small businesses and subs, but for Bettinelli, "If you sell more than three houses a year, then you're subject."
"Say you sell a million-dollar house. The CAT is $5,700 without any deductions. You calculate deductions, and it might be $4,000. Is that worth that? $1,700 dollars? Yes."
Reporter, The Business Tribune
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