Kulick v. Department of Revenue

• Decision Date: 18 February 1981
• Citation: 624 P.2d 93,290 Or. 507
• Parties: Leonard KULICK, Sidney Kulick, Howard Shirvan and Stanley Shirvan, Appellants, v. DEPARTMENT OF REVENUE, State of Oregon, Respondent. TC 1195 to TC 1198; SC 26841. . *
• Court: Oregon Supreme Court

Page 93

624 P.2d 93

290 Or. 507

Leonard KULICK, Sidney Kulick, Howard Shirvan and Stanley Shirvan, Appellants, v. DEPARTMENT OF REVENUE, State of Oregon, Respondent.

TC 1195 to TC 1198; SC 26841.

Supreme Court of Oregon, In Banc. ^*

Argued and Submitted Oct. 6, 1980.

Decided Feb. 18, 1981.

Eli Uncyk, New York City, argued the cause for appellants. On the brief were Bodie, Minturn, Van Voorhees, Larson & Dixon, Prineville, and Simon, Sussman, Uncyk, Forseter & Borenkind, New York City.

Ira W. Jones, Sr. Asst. Atty. Gen., Salem, argued the cause for respondent. With him on the brief was James M. Brown, Atty. Gen.

LINDE, Justice.

Taxpayers, residents of New Jersey and shareholders in an Oregon corporation, appeal from a decision of the Oregon Tax Court that affirmed assessments against them of personal income taxes on their shares of both the distributed and the undistributed income of the corporation. The issue is whether such an exertion of the state's taxing power over nonresident individuals exceeds the state's reach and seeks to take their property without due process of law, contrary to the 14th amendment. We conclude that Oregon may validly levy the tax and therefore affirm.

The Oregon Tax Court stated the case as follows:

"The defendant assessed Oregon personal income taxes, interest and penalties on each plaintiff's pro rata share of the distributed and undistributed taxable income of Timber Investors, Inc., an Oregon corporation, for the tax years 1973, 1974 and 1975. By agreement of the parties, the four cases were consolidated for purposes of briefing and oral argument.

"During the years in question, the four plaintiffs were equal shareholders in Timber Investors, Inc., an Oregon corporation which had elected, through its shareholders, to be taxed under the Subchapter S provisions of the federal Internal Revenue Code of 1954. During the years in question, none of the plaintiffs (all of whom are residents of New Jersey) filed Oregon personal income tax returns.

"The defendant's Orders Nos. I 77-23, I 77-24, I 77-25, and I 77-26, denying the plaintiffs' petitions for abatement of the taxes, interest and penalties, were issued on July 28, 1977. Plaintiffs appealed to this court pursuant to ORS 314.460 (1975 Replacement Part)."

Kulick et al. v. Dept. of Rev., 7 OTR 471, 472 (1978). ¹

The federal Subchapter S provisions to which the tax court referred permit a qualified "small business corporation" and its shareholders to elect personal taxation of the shareholders in lieu of the corporate income tax. 26 U.S.C.A. §§ 1371-1378. ² Under Oregon's tax laws, once a corporation and its shareholders have chosen federal Subchapter S tax treatment, the distributed and undistributed taxable income of the corporation "derived from or connected with sources in this state" likewise is taxed as income of the individual shareholders rather than corporate income, notwithstanding the fact that the shareholder or his own property is not employed in business, trade, or an occupation in Oregon. ³

Taxpayers concede that even as nonresidents, they could constitutionally be reached by an Oregon tax on income derived from their own business or occupational activities in the state. This was settled in Shaffer v. Carter, 252 U.S. 37, 40 S.Ct. 221, 64 L.Ed. 445 (1920), which sustained an Oklahoma income tax levied against an Illinois resident's income from an oil and gas business in Oklahoma. They point out, however, that not they but only the corporation, Timber Investors, Inc., did business in Oregon. Conceding further that Oregon could tax the income they derived from this Oregon business while still in the hands of the corporation, as Wisconsin did by "privilege" or withholding taxes sustained in Wisconsin v. J. C. Penney Co., 311 U.S. 435, 61 S.Ct. 246, 85 L.Ed.2d 267 (1940), and International H. Co. v. Wisconsin Dept. of Taxn., 322 U.S. 435, 64 S.Ct. 1060, 88 L.Ed. 1373 (1944), plaintiffs argue that Oregon's law has not availed itself of these or other devices, ⁴ and that the mere fact that the corporation's income accrues to their benefit or is distributed to them does not give the state a sufficient tie in order to tax nonresident shareholders.

Plaintiffs seek support for this view in what they perceive to be stricter standards for the extraterritorial exercise of state power in United States Supreme Court decisions concerning the jurisdiction of state courts, most recently Rush v. Savchuk, 444 U.S. 320, 100 S.Ct. 571, 62 L.Ed.2d 516 (1980); World-Wide Volkswagen Corp. v. Woodson, 444 U.S. 286, 100 S.Ct. 580, 62 L.Ed.2d 490 (1980); and Kulko v. California Superior Court, 436 U.S. 84, 98 S.Ct. 1690, 56 L.Ed.2d 132 (1978). The Department of Revenue, on the other hand, places continued reliance on the previously cited decisions sustaining the Wisconsin dividend taxes. The department also contends that by virtue of their own choice of Subchapter S taxation the shareholders have placed themselves in sufficient "contact" with Oregon to support the state's power to tax them on the corporation's income derived from this state. The tax court followed its earlier decision in O'Neil v. Dep't of Rev., 6 OTR 467 (1976), which sustained the tax on nonresident shareholders under the Supreme Court's J. C. Penney Co. and Harvester Co. precedents, supra, adding the observation that the Court's willingness to disregard form for substance meanwhile had been demonstrated when Spector Motor Service v. O'Connor, 340 U.S. 602, 71 S.Ct. 508, 95 L.Ed. 573 (1951) was overruled in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 97 S.Ct. 1076, 51 L.Ed.2d 326 (1977).

It must be recognized that the laws sustained in the J. C. Penney Co. and Harvester Co. decisions can be distinguished insofar as they asserted the state's power to collect the tax from the corporation rather than the shareholders. It should be recognized also that the bounds within which the federal Constitution confines the reach of the state's taxing power have long been a body of law in search of a theory. The problem of territorial limits on taxation, as on other legislation or on adjudication, antedate and exist independently of the 14th amendment and its due process clause. See Tharalson v. State Dept. of Rev., 281 Or. 9, 17-21, 573 P.2d 298 (1978). Since analysis of the problem has been placed under that protean rubric, the question of theory is how much survives of the original concern with territoriality as such and how much now concerns due process in the sense of fairness and considerations of economic reality.

In answer, Wisconsin v. J. C. Penney Co., supra, often is quoted for what it said as much as for what it held. Justice Frankfurter wrote for the Court:

"A state is free to pursue its own fiscal policies, unembarrassed by the Constitution, if by the practical operation of a tax the state has exerted its power in relation to opportunities which it has given, to protection which it has afforded, to benefits which it has conferred by the fact of being an orderly civilized society.

"Constitutional provisions are often so glossed over with commentary that imperceptibly we tend to construe the commentary rather than the text. We cannot, however, be too often reminded that the limits on the otherwise autonomous powers of the states are those in the Constitution and not verbal weapons imported into it. 'Taxable event,' 'jurisdiction to tax,' 'business situs,' 'extraterritoriality,' are all compendious ways of implying the impotence of state power because state power has nothing on which to operate. These tags are not instruments of adjudication but statements of result in applying the sole constitutional test for a case like the present one. That test is whether property was taken without due process of law, or, if paraphrase we must, whether the taxing power exerted by the state bears fiscal relation to protection, opportunities and benefits given by the state. The simple but controlling question is whether the state has given anything for which it can ask return...."

311 U.S. at 444, 61 S.Ct. at 250. ⁵ The Supreme Court of Louisiana, in a case somewhat analogous to ours, quoted these paragraphs to sustain that state's taxation of a gain imputed to a nonresident when he received a distribution of Louisiana assets of a Delaware corporation headquartered in Indiana. Johnson v. Collector of Revenue, 246 La. 540, 165 So.2d 466, 477 (1964). The court rejected the argument that the undoubted "protection, opportunities and benefits" afforded those assets in Louisiana were extended to their corporate owner rather than to the stockholder who upon liquidation became the beneficiary of their gain in value.

It may be that due process requires some minimal "nexus" or connection of the taxpayer with the taxing state over and above the economic connection of the taxable income itself. If neither the individual nor the legal entity through which his income is earned has this requisite nexus with the taxing state, neither might be taxed. In recent times the required nexus has been discussed mostly in the context of a nondomiciliary state's taxes on portions of a corporation's income from interstate commerce, where it is intertwined with concern about undue burdens on that commerce. See, e. g., Exxon Corp. v. Wisconsin Dept. of Revenue, --- U.S. ----, 100 S.Ct. 2109, 65 L.Ed.2d 66 (1980); Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 436-442, 100 S.Ct. 1223, 63 L.Ed.2d 510 (1980); National Bellas Hess, Inc. v. Department of Revenue, 386 U.S. 753, 87 S.Ct. 1389, 18 L.Ed.2d 505 (1967). This court found a lessee's use of railroad cars within Oregon a sufficient nexus to tax a portion of the rental income received by the lessor corporation. Amer. Refrig. Transit Co. v. Tax Com., 238 Or. 340, 395 P.2d 127 (1964). Compare Hamilton Corp. v. Tax Com., 253 Or. 602, 609-610, 457 P.2d 486 (1969).

This case differs insofar as no issue of interstate commerce is...