Welcomed Ohio Municipal Income Tax Reform To Be Implemented For 2016 Tax Year

Updating our previous post, Gov. Kasich signed H.B. 5, the Ohio Municipal Income Tax Reform Bill, into law on December 19, 2014. The Bill requires Ohio municipalities imposing an income tax to update their ordinances to comply with certain uniformity provisions contained in Chapter 718 of the Ohio Revised Code for the 2016 tax year. This Bill is a significant achievement, as it reflects years of work to streamline Ohio’s complex and often inefficient municipal income tax system.

However, not all are pleased with the General Assembly’s efforts to create a more business-friendly municipal income tax system as municipal leaders have voiced concerned with revenue loss to Ohio cities and villages. H.B. 5’s opponents believe this reform is an invasion on the Ohio Constitution’s Home Rule, granting municipalities certain authority to govern itself to the extent not in conflict with Ohio law.

The following discusses some of the more significant changes provided for in the Bill.

Income Tax Base

H.B. 5 specifies certain types of income municipalities must tax and those which municipalities may not tax. Resident individuals will be taxed on: (1) compensation, including qualifying wages, salaries, and commissions; (2) net profits, including distributive share income from a pass-through entity (less net operating loss carryforward); and (3) lottery, gaming, prizes, and similar winnings. Nonresident individuals will be taxed on: (1) compensation for work performed in the municipality; (2) net profit apportioned or allocated to the municipality, but excluding distributive share income from a pass-through entity; and (3) lottery, gaming, prizes, and similar winnings. Notwithstanding, certain exempt income is not subject to municipal income tax, including social security benefits, retirement benefits, unemployment compensation, pensions, disability benefits, compensation for personal injury or property damage, and alimony and child support, among others. Although exempting pensions and several other retirement benefits, municipalities may tax nonqualified deferred compensation, including supplement executive retirement plan income, and income from stock options.

Business entities, including pass-through entities but not disregarded entities, will be taxed on their net profit apportioned or allocated to the municipality. Net profits of a pass-through entity is calculated as if the entity were taxed as a C corporation for federal income tax purposes, except guaranteed payments and other similar amounts paid to a partner, shareholder, member, etc. may not be deducted. Income is apportioned based upon an equal-weighted property, payroll and sales ratio. However, pursuant to a unique throwback rule, sales are sourced to the location from where the property is shipped (i.e., origin-based sourcing), unless the taxpayer is regularly engaged in business at the place where the property is delivered. H.B. 5 also implements a uniform provision for when taxpayers may request and use an alternative apportionment method.

In essence, for small businesses, their individual owners will file and pay tax where they reside, while the entity will pay tax in municipalities where it does business on its apportioned income.

S Corporation Exception

Notwithstanding the above, municipalities which voted to tax S corporations at the shareholder level during certain previous local elections are permitted to continue to do so. Of the approximately 600 municipalities in the state, there are approximately 119 municipalities to which this exception applies.

Mandatory Net Operating Loss Carryforward

Municipalities must allow taxpayers an NOL carryforward for five years for NOLs incurred in 2017 or thereafter. However, for the first five years of this rule (2018 to 2022), the NOL deduction and carryforward are limited to 50% of the amount otherwise allowed.

NOLs incurred before 2017 and deductible under a pre-2017 ordinance are still permitted under the terms provided for in the pre-2017 ordinance.

Casual Entrant Rule

Individuals working in a municipality for no more than 20 days in a year are not subject to tax, with the Bill providing a uniform definition of what constitutes a “day.” This increases the current threshold of 12 days. Employers must begin withholding municipal income tax on the 21st day the employee works in that municipality, but are not required to retroactively withhold tax on wages earned for the first 20 days. Moreover, this rule applies to compensation earned by a sole proprietor reported on Schedule C if the sole proprietor does not have a base of operation in the municipality where he/she worked temporarily.

This rule does not apply to professional athletes, entertainers, or public figures.

Administration and Appeals

One particularly frustrating aspect of Ohio municipal income tax for accountants and tax return preparers is the wide range of different administrative procedures and policies amongst the municipalities. A significant benefit from H.B. 5 will be the added efficiency resulting from significant steps to simplify administration of municipal income taxes.

The Bill prescribes a uniform three-year statute of limitations for assessments and refund claims, and a uniform interest rate equal to the federal short-term rate plus 5%, applicable to both underpayments and refunds. Estimated tax payments may only be required if the estimated tax is at least $200. Further, a tax administrator’s assessment must be served upon taxpayers via certified mail or personal service, and be clearly identified as an assessment. If these requirements are not met, the 60-day period to appeal the assessment to a local board of tax review will generally not begin to run.

The Bill also imposes a Taxpayer Bill of Rights mirroring the rights protected under Ohio law. Additionally, innocent spouse relief and an offer in compromise program is implemented which are similar to existing Ohio and federal programs.

Lastly, although centralized filing was not implemented, the Ohio Department of Taxation is required to develop a method allowing businesses to file annual net profit returns electronically through the Ohio Business Gateway or other method, with the Department forwarding the returns to the appropriate tax administrator.

H.B. 5 enacted many additional changes to the Ohio Revised Code that are beyond the scope of this post. If you have any questions regarding H.B. 5 and how it may affect you or your business Ohio municipal income tax obligations, please contact Steve Dimengo, Rich Fry, or Casey Davis.

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