United States

Ohio Supreme Court rules on supplemental executive retirement plans

INSIGHT ARTICLE  | 

Recently, the Supreme Court of Ohio (the Court) issued a decision in MacDonald v. Cleveland Income Tax Bd. of Rev., Slip Opinion No. 2017-Ohio-7798, upholding a ruling of the Ohio Board of Tax Appeals (BTA) that income from a supplemental executive retirement plan (SERP) constitutes a pension based on the plan’s design and the definition of a pension. As a result, the SERP income was not subject to Cleveland income tax.

Upon retirement, the taxpayer, William MacDonald III, was entitled to receive SERP benefits offered during his employment as an executive with National City Corporation. The SERP is considered a nonqualified deferred compensation plan under federal law. Also, In this case, the benefits were an unfunded promise to pay him in the future in the form of an annuity over the course of his and his spouse’s lives. This is different than a 401(k) and other similar retirement plans that are funded by employers and follow special tax treatment.

While federal income tax is due as SERP payments are received by the taxpayer, the employer did not withhold city income tax under the assertion that the SERP was exempt under a Cleveland ordinance that excludes pension benefits from taxable income for municipal purposes rules. Upon review, the city included the present value of the SERP in the taxpayer’s income for the year and assessed a deficiency in taxes paid.

Ultimately the dispute rose to the Ohio Supreme Court which reviewed the Cleveland ordinance for the definition of a pension.  While the City defined the term “pension” in its rules and regulations, it was not defined in the Cleveland ordinance, which carries more weight than the regulations, prompting the Court to review the basic definition of a pension. Specifically, the Court stated that one dictionary defines pension as “a fixed sum paid regularly to a person…as a retirement benefit” and other definitions are similar. Consequently, the Court found the SERP met that definition and was to be considered a pension. Unsuccessfully, Cleveland raised several arguments that the pension exemption did not apply in the case, including that the SERP was compensation for services rendered; “pensions” were more narrowly defined in its local regulations; and the SERP fell within the definition of “qualifying wages” under Cleveland ordinance and state law. All arguments advanced by the city of Cleveland were eventually rejected.

While the Court’s decision specifically relates to the City of Cleveland income tax, the decision may have implications for taxpayers with SERP income in other local jurisdictions across the state. Now that the decade long litigation is resolved, taxpayers should stay tuned into whether Cleveland or other municipalities change any existing rules in light of the Court's decision. Further, taxpayers outside Ohio with similar deferred income should consider whether jurisdictions in which they pay taxes have similar rules that may exempt such income from tax in that jurisdiction or whether those jurisdictions revisit their rules going forward. 

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