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Flaw in Oregon’s formula for taxing part-year residents?

Posted: Sun Mar 10, 2019 6:33 pm
by SarahS
Hoping someone savvy with taxes can help clarify if my analysis is correct here. The outcome of this will impact whether I decide to do a Roth conversion this year.

Oregon says that only income earned as a resident of Oregon (or Oregon-sourced income earned as a non-resident) is subject to Oregon state income tax. Presumably, this means that a certain amount of Oregon income is taxed the same way (i.e., at the same % rate) regardless of whether you have additional income in another state. However, in looking at how they structure the calculation approach to determine state income tax on their Form OR-40-P (part-year resident), it would seem this is not the case. Specifically, it seems that a given amount of Oregon income will be taxed at a higher effective rate if there is additional non-Oregon income. And the more non-Oregon income there is, the higher the effective tax rate on the Oregon income.

If this is true, then I would not do the conversion this year. I was an Oregon resident in Jan and Feb, and a Florida resident (no state income tax) starting March 1 thru the rest of the year. So the vast majority of my federal income will not be for Oregon. By delaying the conversion until now, my goal was to avoid any state income taxes on it, but alas I feel the formula they use will indirectly result in some of it being taxed by the state (in the form of my actual Oregon income being taxed at a higher effective rate).

Basically, the formula used on OR-40-P is to determine what ones Oregon tax would be based on a two-step process: 1. First, determine what the Oregon tax would be based one’s federal income for the year, and then 2. apply a % to that total tax that reflects how much of that income was earned in Oregon. The flaw, it seems, is that this will result in those who have very little income in Oregon and a lot in another state effectively suffering the consequence of their non-linear (progressive) tax code and effectively pay a higher rate for the Oregon income. It seems like the approach instead should be to simply determined one’s Oregon income and then calculate state income tax on that amount.

Here is an illustrative simplified example with some hypothetical numbers.

Let’s say Oregon’s progressive tax code was:

-For income below $20,000 the tax rate is 5%.
-For income above $20,000 the tax rate is 10%.

Let’s consider two individuals- Person A and Person B. Person A earned $20,000 while in Oregon and $20,000 while in Florida. Person B earned $20,000 entirely in Oregon. So both earned the same amount of income in Oregon, and an equitable formula would result in both paying the same amount in state taxes. But here is what Form OR-40-P would result in.

Person A:
Step 1. Oregon tax on total (federal) income = $3,000
Step 2. % of income earned in Oregon = 50%
Oregon tax = $3,000 x 50% = $1,500
Effective Oregon tax rate = $1,500/$20,000 = 7.5%

Person B:
Oregon tax on income = $1,000
Effective Oregon tax rate = $1,000/$20,000= 5%

So, despite having the same amount of Oregon income ($20,000), the person who has additional income outside of Oregon pays more tax on the same income earned in Oregon.

Am I missing something? Is this the intent? Sure doesn’t seem fair.

Thank you

Re: Flaw in Oregon’s formula for taxing part-year residents

Posted: Sun Mar 10, 2019 6:37 pm
by ralph124cf
It seems as if you have discovered the problem, and also the solution to the problem. Don't do the ROTH conversion till nest year.

Ralph

Re: Flaw in Oregon’s formula for taxing part-year residents

Posted: Sun Mar 10, 2019 6:40 pm
by SarahS
Ralph, yes I would delay the conversion to next year if this is the case, but unfortunately this flaw will also subject my regular wages to a higher tax rate. I’m surprised the shenanigan would exist and that someone wouldn’t have flagged its inequity long ago.

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Sun Mar 10, 2019 7:07 pm
by quantAndHold
First question is why would Oregon care about he feelings of someone who has moved out of their state?

Regardless, I’ve never been an Oregon resident so I don’t know how their taxes work, but of the states where I have been a resident that have a progressive tax code, they all tax the amount you earn in that state, but use all of your earnings for the year to determine the tax rate.

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Sun Mar 10, 2019 7:11 pm
by SarahS
Quantandhold

If the point of your first comment is that they do this intentionally to squeeze a little more tax out if someone, but don’t care b/c that someone is leaving, then presumably they would care that this will also ding those entering the state in the middle of a year. Nothing says “hello and welcome” like an inflated tax bill.

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Sun Mar 10, 2019 7:15 pm
by Dale_G
It is not a "flaw", it is by intention. Every time I was a part year resident, I had the same experience.

Dale

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Sun Mar 10, 2019 7:17 pm
by SarahS
Dale_G wrote:
Sun Mar 10, 2019 7:15 pm
It is not a "flaw", it is by intention. Every time I was a part year resident, I had the same experience.

Dale
Ok, good to know we’re all getting screwed. Glad I learned this now. I will leave a little surprise for Oregon the next time I’m there 😉

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Sun Mar 10, 2019 7:21 pm
by trueblueky
SarahS wrote:
Sun Mar 10, 2019 6:33 pm
Hoping someone savvy with taxes can help clarify if my analysis is correct here. The outcome of this will impact whether I decide to do a Roth conversion this year.

Oregon says that only income earned as a resident of Oregon (or Oregon-sourced income earned as a non-resident) is subject to Oregon state income tax. Presumably, this means that a certain amount of Oregon income is taxed the same way (i.e., at the same % rate) regardless of whether you have additional income in another state. However, in looking at how they structure the calculation approach to determine state income tax on their Form OR-40-P (part-year resident), it would seem this is not the case. Specifically, it seems that a given amount of Oregon income will be taxed at a higher effective rate if there is additional non-Oregon income. And the more non-Oregon income there is, the higher the effective tax rate on the Oregon income.

If this is true, then I would not do the conversion this year. I was an Oregon resident in Jan and Feb, and a Florida resident (no state income tax) starting March 1 thru the rest of the year. So the vast majority of my federal income will not be for Oregon. By delaying the conversion until now, my goal was to avoid any state income taxes on it, but alas I feel the formula they use will indirectly result in some of it being taxed by the state (in the form of my actual Oregon income being taxed at a higher effective rate).

Basically, the formula used on OR-40-P is to determine what ones Oregon tax would be based on a two-step process: 1. First, determine what the Oregon tax would be based one’s federal income for the year, and then 2. apply a % to that total tax that reflects how much of that income was earned in Oregon. The flaw, it seems, is that this will result in those who have very little income in Oregon and a lot in another state effectively suffering the consequence of their non-linear (progressive) tax code and effectively pay a higher rate for the Oregon income. It seems like the approach instead should be to simply determined one’s Oregon income and then calculate state income tax on that amount.

Here is an illustrative simplified example with some hypothetical numbers.

Let’s say Oregon’s progressive tax code was:

-For income below $20,000 the tax rate is 5%.
-For income above $20,000 the tax rate is 10%.

Let’s consider two individuals- Person A and Person B. Person A earned $20,000 while in Oregon and $20,000 while in Florida. Person B earned $20,000 entirely in Oregon. So both earned the same amount of income in Oregon, and an equitable formula would result in both paying the same amount in state taxes. But here is what Form OR-40-P would result in.

Person A:
Step 1. Oregon tax on total (federal) income = $3,000
Step 2. % of income earned in Oregon = 50%
Oregon tax = $3,000 x 50% = $1,500
Effective Oregon tax rate = $1,500/$20,000 = 7.5%

Person B:
Oregon tax on income = $1,000
Effective Oregon tax rate = $1,000/$20,000= 5%

So, despite having the same amount of Oregon income ($20,000), the person who has additional income outside of Oregon pays more tax on the same income earned in Oregon.

Am I missing something? Is this the intent? Sure doesn’t seem fair.

Thank you
Imagine taxpayer spends half the year in each of two states with identical tax rates and policies.

Person A pays $1500 to Oregon and $1500 to state X.
Person B pays $1000 to Oregon and $1000 to state X.

Meanwhile, Person C, who lives in Oregon (or state X) all year, pays $3000. Seems fair to have A and B pay the same.

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Sun Mar 10, 2019 9:09 pm
by boomer_techie
SarahS wrote:
Sun Mar 10, 2019 6:33 pm
-For income below $20,000 the tax rate is 5%.
-For income above $20,000 the tax rate is 10%.

Let’s consider two individuals- Person A and Person B. Person A earned $20,000 while in Oregon and $20,000 while in Florida. Person B earned $20,000 entirely in Oregon.
Person A is a higher earner than Person B ($40K vs $20K), so in a progressive tax system, Person A should pay more tax to Oregon.

An alternate way of looking at their algorithm: Person A earned half their income in Oregon, therefore, their Oregon tax bracket inflection point should be half of $20,000, i.e. $10,000. Essentially, because they weren't in the state the whole year, they only get a pro rata share of the $20,000 bracket. Oregon apparently does this by share of income. Other states might do this by time in the state.

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Sun Mar 10, 2019 10:59 pm
by leeks
Dale_G wrote:
Sun Mar 10, 2019 7:15 pm
It is not a "flaw", it is by intention.
+1

You may not like it, but this is a deliberate policy.

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Mon Mar 11, 2019 12:30 am
by Nestegg_User
...so make sure you make your purchases in OR before you move... to take advantage of the no sales tax :)

If a significantly higher amount is earned out of state then your tax drag will be decreased... if only 10k of 100k is earned there, then your FL tax is 0 and you will only pay 1/10 th of the number for OR (hmmm, let's see... line 7 less fed tax ( up to 6650) less 4435 standard deduction (although in your case since you're still employed it's probably higher since they deduct SS paid and some reduction from treasuries (315) and foreign tax(311) on form ASC.... so figure 4014 + 9%(excess over 50 k) initial tax of (less 2x201 for personal exemption) ... with one tenth, you're talking less than $800 then....) which I then wouldn't be complaining too much about for that case...

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Mon Mar 11, 2019 12:46 am
by Nestegg_User
SarahS wrote:
Sun Mar 10, 2019 7:11 pm
Quantandhold

If the point of your first comment is that they do this intentionally to squeeze a little more tax out if someone, but don’t care b/c that someone is leaving, then presumably they would care that this will also ding those entering the state in the middle of a year. Nothing says “hello and welcome” like an inflated tax bill.
got a bit of that the first year... but it was minimal since it was only interest / cap gains for a month... versus salary for the rest of year earned elsewhere ( plus interest/cap gains the rest of year).... mostly a blip since the other was also a taxing state

but it's nice not paying sales tax on a new vehicle!
and not having personal property taxes!
...and even had lower property tax in OR ( very location dependent)

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Mon Mar 11, 2019 1:10 am
by SevenBridgesRoad
Nestegg_User wrote:
Mon Mar 11, 2019 12:46 am
SarahS wrote:
Sun Mar 10, 2019 7:11 pm
Quantandhold

If the point of your first comment is that they do this intentionally to squeeze a little more tax out if someone, but don’t care b/c that someone is leaving, then presumably they would care that this will also ding those entering the state in the middle of a year. Nothing says “hello and welcome” like an inflated tax bill.
got a bit of that the first year... but it was minimal since it was only interest / cap gains for a month... versus salary for the rest of year earned elsewhere ( plus interest/cap gains the rest of year).... mostly a blip since the other was also a taxing state

but it's nice not paying sales tax on a new vehicle!
and not having personal property taxes!
...and even had lower property tax in OR ( very location dependent)
And it's really super nice sitting in the car while someone pumps our gasoline.

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Mon Mar 11, 2019 1:19 am
by Nestegg_User
.... if you can make it out to a station after two and a half feet of snow (with additional afterwords!!). (glad I had a snowblower!... and a 4x4! ... not to mention, retired!... but we had ours cleared ( over 600 ft) before most, in case we wanted to go somewhere)

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Mon Mar 11, 2019 8:34 am
by Katietsu
I think the current way is the fairer way.

To use your example of person A and person B:

Person A makes $20,000 a month. Therefore, they have an annual income of $240,000. They live in Oregon for one month.

Person B makes $20,000 per year and lives in Oregon for the full year.

The point of a progressive tax system, is that higher earners should pay a higher per cent of their income in taxes. Therefore, shouldn’t Person A be subject to a higher tax rate?

There are states that do not consider income earned elsewhere for part year residents, but instead annualize the income. In other words, a person living in that state for two months would multiply their income by 6 in order to determine their effective tax rate.

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Mon Mar 11, 2019 11:18 pm
by grabiner
Most states handle part-year resident taxes this way.

Suppose you earn $50K in state X, then move to state Y and earn $50K there. With proration, you pay half the tax on $100K to each state, which is the average of what you would have paid if you had been a full-year resident of either state.

There are a few states which don't prorate. When I moved to NJ in November 2010, I got a tax break, because NJ has a progressive tax and doesn't prorate. I paid a low NJ tax on the income I earned in NJ that year, even though I had a high income for the year.

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Tue Mar 12, 2019 1:46 pm
by talzara
SarahS wrote:
Sun Mar 10, 2019 6:33 pm
So, despite having the same amount of Oregon income ($20,000), the person who has additional income outside of Oregon pays more tax on the same income earned in Oregon.
The US Supreme Court has ruled that state taxes must be internally consistent. If you earned income in two states that have identical tax laws, the total taxes must be no higher than if you earned income in only one of the states.

Oregon's tax system is internally consistent. If you earned $20,000 in Oregon and $20,000 in another state with the same tax laws, then your taxes are calculated on $40,000 of income and then allocated 50/50. The total taxes are the same as if you'd earned $40,000 in Oregon alone.
grabiner wrote:
Mon Mar 11, 2019 11:18 pm
There are a few states which don't prorate. When I moved to NJ in November 2010, I got a tax break, because NJ has a progressive tax and doesn't prorate. I paid a low NJ tax on the income I earned in NJ that year, even though I had a high income for the year.
New Jersey's tax system is also internally consistent. If you earned $20,000 in New Jersey and $20,000 in another state with the same tax laws, then your total taxes are less than if you'd earned $40,000 in New Jersey alone. It is unconstitutional to have higher taxes, but it is constitutional to have lower taxes.
Katietsu wrote:
Mon Mar 11, 2019 8:34 am
There are states that do not consider income earned elsewhere for part year residents, but instead annualize the income. In other words, a person living in that state for two months would multiply their income by 6 in order to determine their effective tax rate.
Which states annualize the income? If there are tax brackets, annualizing could fail the internal consistency test. This wouldn't be a problem for flat taxes.

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Tue Mar 12, 2019 5:06 pm
by megabad
SarahS wrote:
Sun Mar 10, 2019 6:33 pm
Am I missing something? Is this the intent? Sure doesn’t seem fair.
Agree with other posters. This seems consistent with most states that I have lived in with state income tax. Since taxes are not intended to be fair (inherently in the US), I can't answer your questions. Since most state income taxes are only very slightly progressive at the lower end of the scale it has an almost negligible impact on anyone above the poverty line (all other variables created equal). This is much "fairer" in my opinion than say, charging residents from another state that work in your state 1 day income taxes (which we just recently had posts on). I don't think this would be high on my list of fairness complaints in life (and I have many).

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Wed Mar 13, 2019 7:21 am
by Katietsu
talzara wrote:
Tue Mar 12, 2019 1:46 pm
Katietsu wrote:
Mon Mar 11, 2019 8:34 am
There are states that do not consider income earned elsewhere for part year residents, but instead annualize the income. In other words, a person living in that state for two months would multiply their income by 6 in order to determine their effective tax rate.
Which states annualize the income? If there are tax brackets, annualizing could fail the internal consistency test. This wouldn't be a problem for flat taxes.

Thank you for your informative post. And, now that you jogged my memory, I do believe the time I ran into annualizing was for a flat tax rate.

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Wed Mar 13, 2019 8:55 am
by Spedward
I have to file a good many non-resident state returns in different states. Travel a good bit for work. There are a significant number of states that do this. They effectively pull in investment income, etc and tax it in the non-resident state based on some formula. State apportionment - it sucks. And nothing you can do about it - I have tried.

Re: Flaw in Oregon’s formula for taxing part-year residents?

Posted: Wed Mar 13, 2019 8:34 pm
by grabiner
Spedward wrote:
Wed Mar 13, 2019 8:55 am
I have to file a good many non-resident state returns in different states. Travel a good bit for work. There are a significant number of states that do this. They effectively pull in investment income, etc and tax it in the non-resident state based on some formula. State apportionment - it sucks. And nothing you can do about it - I have tried.
I don't think any state actually taxes non-resident investment income (unless it has a source in the state, such as a rental property). What the state does is to use the investment income, and other income, to determine your tax rate. In most states, if your income is $100K, and $20K was earned in the state, your state tax is 20% of the state tax on $100K. It doesn't matter whether the other $80K was salary earned outside of the state, or investment income which is sourced to your home state.

The net effect is that you pay tax at the higher of the non-resident state rate or the home state rate. In the situation above, your home state will give you a credit of the lower of the tax you paid to the other state, or 20% of the tax you paid to your home state. (The exact formula varies by state. MD, for example, allows a credit up to the difference between the tax on total income and in-state income, which is more than 20% of the total state tax in the example above because the MD tax is progressive.)