Oregon Tax Court Holds Non-Resident Corporate Partners Of Law Firm Are Legitimate Taxable Corporate Entities

On August 6, the Oregon Tax Court held that non-resident professional service corporations serving as partners of a multistate law firm were legitimate "taxable corporate entities."1 Finding that the corporations were not sham corporations primarily created to avoid the payment of Oregon income tax, the Court found that there were a number of legitimate business reasons for the business model. Because the out-of-state partners were recognized as legitimate corporations, they could not be required to pay state income tax on their partnership income sourced to Oregon.

Background

The taxpayer, Stoel Rives, was a multistate law firm that was formed as a partnership owned by out-of-state corporate partners. Individual lawyers were the principals and shareholders in these professional service corporations. For the 1995 tax year, the Oregon Department of Revenue sought to impose assessments of Oregon income tax upon individuals as partners of the law firm instead of recognizing the partners as corporate entities. As individuals, the partners would be required to pay Oregon state income tax on their share of the partnership income sourced to Oregon.

Stoel Rives disputed the assessments, asserting that the out-of-state partners were taxable corporate entities and not the related individuals. The individuals had legally formed professional service corporations in their respective jurisdictions and according to Stoel Rives, these corporations, and not the individuals, became the partners of the law firm. The Magistrate Division of the Oregon Tax Court agreed with Stoel Rives and granted its motion for summary judgment. In response, the Department appealed the matter to the Regular Division of the Oregon Tax Court. The parties subsequently filed motions for summary judgment and stipulated to an extensive set of facts. The issue before the Court was whether the out-of-state partners were, in fact, taxable corporate entities.

Legitimate Business Model

The Court began its analysis by asserting that the two-part test espoused by the U.S. Supreme Court in Moline Properties2 was appropriate to this case. The Moline test determined whether a corporation was a viable taxable entity versus a shareholder who created a "sham" corporation. Under Moline, courts consider whether: (i) the corporation was created for business purposes; and (ii) the corporation actually conducted business activity in a corporate form.

The Court summarily concluded that the corporations...