Significant Ohio municipal tax reform enacted with H.B. 5
TAX ALERT |
On Dec. 19, 2014, Ohio Governor Kasich signed into law Substitute House Bill 5 (H.B. 5), enacting numerous changes to the state’s municipal tax laws, including significant modifications to the tax treatment of pass-through entities, the point at which an employer must withhold taxes on an employee, net operating loss (NOL) carryovers, and consolidated return elections. Most of the changes in H.B. 5 are effective for tax years beginning on or after Jan. 1, 2016.
Details of some of the key changes under H.B. 5 include:
Number of days required for withholding
Current Ohio municipal income tax laws require an employee to work more than 12 days during the calendar year in a municipality outside of his/her base of operations before the employer is required to withhold income tax. Under H.B. 5, the number of days is increased to more than 20 days. After an employee exceeds the 20-day threshold, withholding is required for any subsequent days for which the employee is paid qualifying wages in that municipal jurisdiction. Furthermore, the bill removes a provision mandating that employers supply municipalities with a list of employees working in the city for less than 20 days.
Five-year NOL carryover period
Presently, many municipalities can choose whether to recognize NOLs and how long to permit them to carry forward for individual and business taxpayers. House Bill 5 enforces statewide application of a five-year NOL carryover period effective for NOLs incurred in tax years beginning on or after Jan. 1, 2017.
The NOL carryforward rules will be phased in over a five-year period, imposing a 50 percent per year limit beginning with the 2018 tax year. This will delay the ability to utilize 100 percent of NOL carryovers until tax year 2023.
Increased threshold for estimated tax payments
Another area of great disparity amongst Ohio municipalities is the requirement for estimated tax payments and the imposition of penalties and interest when a taxpayer fails to remit a sufficient amount prior to the filing deadline. Increasing the threshold for mandatory estimated payments, the new provision in H.B. 5 exempts taxpayers from estimated payments until their annual liability exceeds $200. This represents a $100 increase from the current minimum in effect for many cities.
Consolidated net profits return election
Taxpayers filing on a consolidated basis for federal purposes may elect to file a consolidated city net profits return encompassing the activity of all members. The consolidation election remains binding for five years and remains in effect afterwards until the taxpayer discontinues the election. Cancellation of the election must be reported to the taxing municipality in writing. A municipality may require taxpayers to file on a consolidated basis if the facts and evidence point to an inequitable representation of income when filed on a separate basis.
Taxation of individuals and pass-through entities
Residents of an Ohio municipality remain subject to tax on their full distributive share of pass-through entity (PTE) income. At its discretion, a municipality may grant a partial or full credit to residents for taxes paid on their behalf by the PTE– whether paid directly or indirectly by the PTE. Differing income and loss amounts from PTEs may be offset during a year, though wages remain excluded as an item offset by PTE losses.
Unless a municipality previously conducted a vote to permit the taxation of the shareholder’s distributive portion of S corporation income, compensation remains the only type of taxable S corporation income for purposes of an individual’s tax return. Corporate and business owners of PTEs should exclude from taxable income their share of PTE income previously taxed by the municipality.
The current municipal tax laws contain language requiring the sourcing of certain property sales to their city of origin. This applies to municipalities where the taxpayer does not regularly operate, solicit or promote its products through employees but does make delivery to a final destination within the municipality. This throwback provision was originally expected to be stricken as a result of H.B. 5, but striking language was not included in the final version of the bill signed by Gov. Kasich.
If a taxpayer believes the standard three-factor apportionment formula inaccurately represents the company’s business activities, a written appeal may be submitted to the appropriate municipal tax authority. The request may be attached to an original or amended return, sent separate from a tax filing or as a component of an assessment appeal. For example, taxpayers may request to use a different accounting method or modify the impact of one or more apportionment factors (e.g., sales, payroll, property, rent).
H.B. 5 formally codifies a set of common law factors for application by municipalities when determining if an individual has established domicile and, by association, residency. This group of 25 factors creates the potential for an individual to be deemed a resident for municipal income tax purposes despite qualifying as a non-resident for Ohio income tax purposes.
H.B. 5 represents significant municipal tax reform and the overall simplification of municipal tax compliance for individuals and businesses operating within Ohio. Since provisions of H.B. 5 apply to tax years beginning in 2016, this represents an opportunity to start planning for the new structure immediately, while also monitoring how cities react in an effort to compensate for lost revenue. Finally, a number of other changes were enacted that are not included in this alert, and taxpayers should consult with their tax advisors to determine the applicability of this legislation to a particular taxpayer’s situation.