United States: Ohio Enacts Municipal Income Tax Reform

Concluding a process that spanned several years, Ohio Governor John Kasich signed legislation on December 19th reforming Ohio's municipal income tax system, which is required to be adopted by all municipalities levying an income tax on and after January 1, 2016.1 The legislation provides for a uniform tax base and other definitions, adopts a uniform five-year net operating loss (NOL) carryforward for both corporations and individuals to be phased in over a six-year period, and limits the ability of municipalities and tax administrators to adopt conflicting rules.

Background

Ohio is one of the few states that has historically allowed each of its municipalities to define its own tax base, subject to minimal restrictions.2 With over 600 local jurisdictions, varying tax ordinances, regulations, and rates have resulted in costly and burdensome compliance for taxpayers, especially for businesses whose employees live and work in different Ohio cities. The new law is intended to advance uniformity by clearly limiting the options available to each municipal legislative authority to impose and administer the municipal income tax.

Corporate and Pass-Through Entity Income Tax Uniformity Provisions

Generally, municipal taxable income, which is the amount on which a tax is based for corporations, is limited to income after adjustments (including a reduction for exemptions from income), apportionment and allocation, and a further reduction for any available pre-2017 carryforward NOLs.3 The legislation adopts uniform definitions required to be used by municipalities in determining municipal taxable income, as well as provisions addressing the taxation of pass-through entities, NOL treatment, the ability to file consolidated returns, apportionment sourcing rules and guidelines for requesting alternative apportionment.

Conformity to Internal Revenue Code (IRC) or Ohio Revised Code Title 57

The legislation explicitly states that a term used in the municipal income tax chapter that is not defined has the same meaning as when used in a comparable context in the IRC or Title 57 of the Ohio Revised Code unless a different meaning is clearly required. If there are disparities in the definition contained in the IRC and Title 57 of the Ohio Revised Code, the IRC definition controls.4

Treatment of Pass-Through-Entities

Pass-through entities5 continue to be subject to municipal income taxes at the entity level.6 However, municipalities may also elect to tax the pass-through entity income attributed to a resident individual owner.7 Municipalities may not tax non-resident pass-through investors on flow-through income.8 However, an exception to this treatment may apply to income from S corporations as the current exemption from taxation at the individual S corporation shareholder level is maintained.9 Unlike other pass-through entities, S corporation owners' flow-through income will not generally be subjected to tax in the resident municipality.10 Municipalities that voted in 2002 or 2004 to impose tax on resident owners at the shareholder level may continue to do so.11

NOL Uniformity

The legislation adopts a mandatory and uniform five-year carryforward period for NOLs first incurred in taxable years beginning on and after January 1, 2017. As a result, NOL carryforwards may first be used on calendar returns due in April 2019 for the 2018 taxable year.12 The NOL carryforward provision is phased in over a five-year period, with a flat 50 percent per year limit beginning in taxable year 2018.13 Full use of NOL carryforwards will begin in taxable year 2023.14 Pre-2017 NOL carrforward deductions that are available must be utilized before a taxpayer may deduct any NOL amounts newly authorized under this legislation.15

Consolidated Returns

A taxpayer may elect to file a consolidated return based on its federal consolidated group.16 The election is binding for five years.17 Under certain circumstances, a municipal tax commissioner can require that a taxpayer file a consolidated return.18 Prior law allowed taxpayers an election to file a consolidated return, but it was not clear whether an elected consolidation was based on the entire federal consolidated group or was in effect a nexus consolidation of affiliated members. Municipalities had varying positions on this matter. A taxpayer that made an election or had an agreement with a municipality prior to January 1, 2016 to file a consolidated or nexus combined return may continue to file under its current methodology.19

Apportionment

The use of a three-factor formula including property, payroll, and sales is still generally required.20 With respect to the calculation of the sales factor, gross receipts are typically sourced to the location where the sale was made or performed.21 Gross receipts from the sale of tangible personal property are sitused to the municipality in which the sale originated if the taxpayer is not actively soliciting sales through its own employees at the destination location.22 This throwback rule is more restrictive than those typically seen in other states. There was an attempt to eliminate or adjust the throwback sale rules as part of the uniformity effort but this attempt was unsuccessful. Gross receipts from the sale of services are sourced to the municipality to the extent that such services are performed in the municipality.23

In addition, a taxpayer may request, or a tax administrator may require, the use of an alternative apportionment method if the statutory apportionment formula does not fairly represent the extent of a taxpayer's activities within the municipality.24

Residency Determinations and Withholding

The new law clarifies the method used to determine residency and generally allows employers to delay municipal income tax withholding for nonresidents of a municipality until they have spent a minimum of 20 days in a calendar year working in that location. Specifically, the new law sets forth a presumption that an individual is domiciled in a municipality for all or part of a taxable year if the individual was domiciled in that municipality on the last day of the prior year, or the tax administrator reasonably determines that the individual is domiciled in such municipality.25 The individual may rebut the presumption of domicile by proving (by a preponderance of the evidence) that the individual was not domiciled in the municipality.26 The new law sets forth 25 specific factors that can be used along with other "relevant" information to determine municipal residency.27 Previously, residency could be determined based on different municipal ordinances which were generally based on a common law residency test.

An employer will be required to withhold tax for the municipality in which the employee principally works.28 In addition, the "casual entrant" rule is modified to extend the threshold for withholding of payroll tax to 20 days during a calendar year for most employees working in a municipality. Previously, the threshold was 12 days.29 The new law also defines "day" for purposes of the rule so that an employee may only be considered to work in one municipality on any calendar day.30 Note that the "casual entrant" rule is in regard to employee withholding only and does not apply to business taxpayers conducting business in a municipality. A business with less than 20 days of activity in a municipality could still be subject to a municipality's tax.

Administration and Other Reforms

The law standardizes due dates, penalty and interest imposition, and other administrative procedures. The bill creates uniform due dates for income tax returns (i.e. on or before the 15th day of the fourth month of a taxpayer's year-end)31 and withholding remittance,32 as well as audit procedures33 for all municipalities. The bill also synthesizes the applicable statute of limitations, and the amounts of penalties and interest that municipalities must impose for failure to pay taxes on time or file returns.34

The legislation also provides for various other tax reforms including:

  • An increase in the minimum amount due to require the filing of estimated taxes from $100 to $200 annually;35
  • An exemption from the municipal income tax withholding requirements for employees working in multiple locations for small employers (taxpayers with annual total revenues of less than $500,000);36 and
  • A requirement for most municipalities to publish contact information for a tax matters person (the tax administrator or employee of the tax administrator).37

Commentary

The intended goal of the enacted legislation is to provide a uniform method of determining tax liability in each of Ohio's municipalities and to reduce costs of compliance. Ohio's complex system of municipal taxation has often been criticized as being anti-competitive from an economic development standpoint and has contributed to the state's ranking of 39th on the 2014 Tax Foundation's Business Tax Climate Index.38

Enactment of the law caps a multi-year process during which Ohio's municipalities strongly objected to various provisions citing concerns regarding lost revenue. Specifically, the cities voiced concern with the new rules requiring a five-year NOL carryforward and allowing employees to spend up to 20 days in a municipality without any resultant income tax liability. As a compromise, the final legislation acknowledged a potential devastating revenue loss by two cities and allowed for an exception from the withholding rule for employees working at certain petroleum refineries located in those jurisdictions.39

The law changes were supported by the Ohio Society of CPAs, as well as the Ohio Chamber of Commerce, which were both members of the Ohio Municipal Tax Reform Coalition.40 It will be interesting to see whether the municipal income tax changes result in the anticipated enhanced business climate and lead to new investments and jobs. In any case, the new rules should make complying with Ohio's municipal income tax system somewhat simpler and more predictable.

Footnotes

1 Sub. H.B. 5, Laws 2014. H.B. 5 was originally introduced Jan. 30, 2013. The legislation was previously introduced in 2012 as H.B. 601.

2 OHIO REV. CODE ANN. §§ 715.013; 718.01.

3 OHIO REV. CODE ANN. § 718.01(A)(1)(a).

4 OHIO REV. CODE ANN. § 718.01.

5 The term "pass-through entity" is defined to include partnerships and limited liability companies not treated as an association taxable as a C corporation for federal income tax purposes, as well as S corporations and other entities that are afforded pass-through entity treatment for federal income tax purposes. OHIO REV. CODE ANN. § 718.01(N).

6 See OHIO REV. CODE ANN. § 718.01(L). The term "person" is defined broadly to include practically all business entities, including pass-through entities. OHIO REV. CODE ANN. § 718.01(M).

7 OHIO REV. CODE ANN. § 718.01(B)(1)(a).

8 OHIO REV. CODE ANN. § 718.01(B)(2).

9 OHIO REV. CODE ANN. § 718.01(C)(14).

10 OHIO REV. CODE ANN. § 718.01(C)(14)(a).

11 OHIO REV. CODE ANN. § 718.01(C)(14)(b), (c). 119 municipalities enacted this provision in 2002 or 2004.

12 OHIO REV. CODE ANN. § 718.01(E)(8)(c)(i). Approximately two-thirds of Ohio's municipalities that impose an income tax currently allow some carryforward of NOLs.

13 Id.

14 OHIO REV. CODE ANN. § 718.01(E)(8)(c)(ii).

15 OHIO REV. CODE ANN. § 718.01(E)(8)(d).

16 OHIO REV. CODE ANN. § 718.06(B)(1).

17 Id.

18 OHIO REV. CODE ANN. § 718.06(C). Specifically, these circumstances include instances "where the tax administrator determines, by a preponderance of the evidence, that intercompany transactions have not been conducted at arm's length and that there has been a distortive shifting of income or expenses...."

19 OHIO REV. CODE ANN. § 718.06(H).

20 OHIO REV. CODE ANN. § 718.02(A).

21 OHIO REV. CODE ANN. § 718.02(A)(3).

22 OHIO REV. CODE ANN. § 718.02(D)(1).

23 OHIO REV. CODE ANN. § 718.02(D)(2).

24 OHIO REV. CODE ANN. § 718.02(B)(1).

25 OHIO REV. CODE ANN. § 718.012(A)(1).

26 OHIO REV. CODE ANN. § 718.012(A)(2).

27 OHIO REV. CODE ANN. § 718.012(B). Relevant factors include the location of the individual's financial institutions, issuers of credit cards, and address of driver's license.

28 OHIO REV. CODE ANN. § 718.011(B)(1)(a).

29 OHIO REV. CODE ANN. § 718.011(B)(1). The term "day" was undefined, which led to confusion regarding how to determine when an employee had spent the requisite amount of time in the jurisdiction to require income tax withholding.

30 OHIO REV. CODE ANN. § 718.012(B)(2). Specifically, an employee working in multiple locations during a single day is considered to have worked in a municipal corporation if the employee spends "more time in that municipal corporation than in any other municipal corporation on that day."

31 OHIO REV. CODE ANN. § 718.05(G)(1), referencing the time period contained in OHIO REV. CODE ANN. § 5747.08.

32 OHIO REV. CODE ANN. § 718.03(B)(1).

33 OHIO REV. CODE ANN. § 718.36.

34 OHIO REV. CODE ANN. § 718.12.

35 OHIO REV. CODE ANN. § 718.08(B)(1).

36 OHIO REV. CODE ANN. §§ 718.011(E); 718.01(TT).

37 OHIO REV. CODE ANN. §§ 718.39; 718.01(U)(2), (3).

38 See Ohio's Tax Foundation Business Climate Tax Index rank at http://taxfoundation.org/state-tax-climate/ohio.

39 OHIO REV. CODE ANN. § 718.011(G).

40 See the Ohio Municipal Tax Reform Coalition's Web site at http://munitaxreform.org.

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