Oregon Decouples From the QSBS Regime: How a State Tax Policy Change Could Fund Your Year Abroad

As discussed in a prior alert, Oregon enacted a tax bill that, in part, decouples from the beneficial federal tax regime for sales of qualified small business stock (QSBS). As a result, Oregonians selling QSBS will have to pay Oregon tax on the gain (up to 13.9 percent), while nonresidents from most other states would not pay any state tax on the gain from the sale of the same stock.

At first blush, this appears to be yet another policy choice by Oregon that encourages residents to abandon their Oregon domicile and move to another state before the sale. However, a unique provision in the Oregon definition of “resident” may provide an attractive alternative: live abroad for a year in your dream location, with this incredible experience more than paid for with the Oregon taxes no longer owed. A different method also exists for those who cannot (or prefer not) to live abroad for a year. This alert discusses both options.

Before launching into the special rule, we summarize the general rules that determine when an individual is subject to Oregon tax. This generally depends on residency, with nonresidents only subject to Oregon tax on Oregon-source income (e.g., wages from working in Oregon or gain from the sale of Oregon real property); while residents are taxed on worldwide income (just like U.S. taxation of U.S. persons). Oregon generally does not tax nonresidents on gain from the sale of stock of a C corporation (with an exception for when a nonresident takes affirmative steps to cause the stock to have an Oregon situs). An individual generally is treated as an Oregon resident under either of two tests: (1) day count (has a permanent place of abode in Oregon and is present in Oregon on more than 200 days in the tax year) and (2) domicile (treats Oregon as their true home where they expect to return after any time away). This alert primarily concerns taxpayers domiciled in Oregon—specifically, a situation where someone can be domiciled in Oregon, with Oregon tax law treating them as a nonresident.

QSBS Regime and Impact of Oregon Decoupling

At a high level, the QSBS regime encourages creation of, and investment into, startup C corporations by excluding some or all of the gain from a future sale of the stock. Subject to holding period requirements, taxpayers can exclude 50 percent to 100 percent of the first $15 million for stock acquired after July 4, 2025, and the first $10 million for stock after September 27, 2010, and on or before July 4, 2025. The exclusion rules are more complicated for stock acquired after August 10, 1993, and on or before September 27, 2010. The $15 million/$10 million exclusion amounts may be greater, depending on the taxpayer’s tax basis in the stock.

For purposes of this alert, we focus on an Oregonian selling QSBS in 2026 or 2027 who has a five-year holding period in the QSBS at the time of sale and a gain of $10 million. For this Oregonian, the QSBS regime allows for exclusion of all of the $10 million of gain from federal taxable income. The Oregonian also would have excluded all of the gain from Oregon taxable income if the sale occurred before 2026. However, because the sale occurs in 2026 or 2027, the Oregonian must include the gain in Oregon taxable income, subject to Oregon tax at a top rate of 9.9 percent ($990,000 in Oregon tax). If this Oregonian lives within the Metro taxing district, add another 1 percent tax ($100,000) for the Supportive Housing Services tax (discussed in this alert). If the Oregonian also lives in Multnomah County, add another 3 percent tax ($300,000) for the Preschool for All tax (discussed in this alert). Accordingly, the Oregonian could face $1.39 million of Oregon tax.

$1.39 million of tax savings is enough to make anyone question whether to continue living in Portland, Oregon. At the same time, changing one’s domicile is a cumbersome process, and goes far beyond simply renting a place in a new state and changing one’s driver’s license and voter registration. A detailed discussion of the requirements for changing domicile is beyond the scope of this article but here we explained domicile changes for purposes of Washington state law and the standards are similar. A good way to think of it is to use the unofficial “tears” test: changing domicile is a big deal and generally means the person will no longer regularly see the close friends they have; if there are no tears when the person leaves Oregon, domicile did not change.

Unique Oregon Rule for Treating a Person Domiciled in Oregon as a Nonresident

Importantly, Oregon has a unique provision in the definition of “resident” that allows an individual to remain domiciled in Oregon, while being treated as a nonresident for tax purposes. One of the authors of this alert previously published an article about this provision in the Spring 2011 Oregon State Bar Tax Section Newsletter. The special rule ties the definition of nonresident to a limited federal tax benefit provided by IRC § 911 for U.S. taxpayers living abroad.

IRC § 911 has long provided a system pursuant to which U.S. taxpayers living abroad could exclude from income a capped amount of foreign-earned income. In 1999, Oregon revised the definition of “resident” so that an Oregonian who qualifies for the benefits of IRC § 911 is treated as a nonresident of Oregon. These Oregonians are nonresidents, even if they remain domiciled in Oregon while living abroad. This provides a more generous tax benefit than the federal one because it generally provides an uncapped exclusion for all income not sourced to Oregon, including gain from the sale of stock, instead of a capped exclusion limited to foreign earned income.

The rules for being a “qualified individual” for purposes of the federal foreign earned income exclusion are complicated. For an Oregonian who retains their Oregon domicile, the key will be to be present in one or more foreign countries for 330 or more days during any consecutive 12-month period—beginning before the sale of the QSBS. There also are issues related to ensuring that the Oregonian has a “tax home,” as defined in IRC § 911(d)(3), outside the United States before the sale of the QSBS. Nonetheless, it generally should be possible to be a nonresident for Oregon tax purposes, despite retaining an Oregon domicile, as illustrated in Example 4 of OAR 150-316-0027(2)(a):

John arrives in England on April 24, 1998, at noon. He remains in Europe until 2 p.m. on March 21, 1999, when he returns to the United States. John is present in a foreign country for 330 full days during at least two twelve-month periods: April 25, 1998, through April 24, 1999 & March 21, 1998, through March 20, 1999. John qualifies for foreign nonresident treatment from April 25, 1998, through March 20, 1999.

An Incredible Life Experience Funded With Oregon Tax Savings

Living abroad for a year can be a complicated and expensive process, especially for people with school-age children. At the same time, it offers an amazing opportunity that few can experience. Further, a QSBS exit with $10 million of gain presents a great time for someone to consider this life-changing event. For Oregonians, the Oregon legislature made this decision easier. Oregonians can avoid the hassles of changing domicile and still use the Oregon tax savings to pay for this adventure (expensive though it may be, someone should be able to live abroad for a year for less than the $990,000 to $1.39 million of Oregon and local taxes owed if the Oregonian does nothing). We note that this technique also generally should work for sales of stock that are not QSBS (or gain from the sale of QSBS in excess of the exclusion cap).

Alternative to Living Abroad: IRC § 1045 Rollover

While living abroad for a year may provide the most memorable Oregon tax savings strategy, Oregon tax law also provides another alternative. Oregon limited its decoupling from the federal QSBS regime to the gain exclusion provisions of IRC § 1202. Although people generally focus on gain exclusion, the federal QSBS regime also includes the IRC § 1045 rollover provisions for QSBS.

Generally, taxpayers can defer gain from the sale of QSBS by purchasing new QSBS of an amount equal to the gain within 60 days from the sale. This rollover is similar to an IRC § 1031 exchange for real property, but simpler. In particular, there is no need to involve an intermediary and the selling shareholder can have the proceeds from the sale deposited into their own account. At the same time, an IRC § 1045 rollover has a much shorter window for purchasing the new property than an IRC § 1031 exchange: 60 days, rather than 180 days.

Taxpayers generally have used an IRC § 1045 rollover for gain in excess of the QSBS exclusion cap or where the taxpayer did not have a long enough holding period to maximize the exclusion benefit. Regardless, an Oregonian (under either the day count test or the domicile test) seeking to defer Oregon taxation of gain excluded for federal tax purposes generally should be able to rollover all of the gain from the sale of the QSBS to new QSBS. The federal gain exclusion benefits generally should apply to gain from the sale of the new QSBS in the same manner as the sold QSBS. With respect to Oregon tax, parking the sale proceeds in the new QSBS generally should provide the Oregonian time to take the planning steps necessary (e.g., change domicile or live abroad) to prevent Oregon taxation of the gain from the sale of the new QSBS.

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