I remember having to quickly ramp-up on local taxes after moving to Cincinnati. I grew up in Florida, which has no state or local individual income taxes. We moved here from Georgia, which has a state but no local income taxes. I did not realize at the time that I was moving to a region which has approximately 80% or more of all the local income taxes in the nation – Ohio, Indiana, Pennsylvania and Kentucky.
The Kentucky local individual taxes are – for the most part – occupational taxes. If you do not work in one of those counties or cities, you generally do not have to worry about it. I live in Kentucky, for example, but I pay no Kentucky local income taxes. I do not work in Kentucky.
Indiana has county taxes, but they are filed with the state individual income tax return. Think of it as a “piggy-back” tax.
Ohio had to be different. For one thing, Ohio cities tax their residents, meaning that – if you live within the city – you have yet one more tax return to file. It doesn’t matter whether you work there (in contrast to Kentucky), and in many cases you have to file a return whether you owe tax or not. You might not owe tax, for example, if the city allows (at least some) credit for the local taxes paid to the city where you work (for example, if you live in a suburb but work downtown).
Add to this that each city has local autonomy to determine its taxable base, within the limits of Ohio law. One city could tax supplemental retirement benefits (SERPs), while another would not. One city could allow you to carry over a net operating loss (NOL) to future years, while another city would not. Even if the city allowed an NOL, your city might allow a carryover of five years, while another would allow only three.
Even for a tax pro, it is a pain.
On December 19, 2014 the Governor signed a bill that promises to bring some standardization to the wild west of Ohio local income taxation. It is called the Ohio Municipal Income Tax Reform Act, and it will be effective for tax years beginning on and after January 1, 2016. The delay was intentional, as tax forms may need to be redesigned and instructions updated. A tax bill signed in December does not leave much time for that.
Let’s go over the high points:
- The calculation of local taxable income will begin with federal adjusted gross income. The adjustments to federal AGI have been significantly standardized and include, for example, interest, dividends and capital gains.
- NOTE: There are two cities in Ohio that start with Ohio adjusted gross income (from the Ohio state income tax return). Those two do not have to change to the new law. One of them is in Cincinnati and rhymes with Indian Hill. The effect for residents of Indian Hill is to tax their interest, dividends and capital gains.
- Partnerships and LLCs will be taxed at the entity level only. Partners and members will subtract this income (as an adjustment under Item #1 above) when calculating their city tax. That leaves Subchapter S shareholders to discuss.
- Subchapter S corporations will also be taxed at the entity level. In addition, S shareholders may also continue to be taxed at the individual level if they live within 119 selected municipalities.
- OBSERVATION: Obviously not as good as the rule for partnerships and LLCs. Why the difference? Who knows?
- Losses from a passthrough entity (that is, a partnership, LLC, Subchapter S or (unlikely) a trust) may offset self-employment, rental, royalty and farming income. The reverse is also true.
- Net losses (from Item #4 above) however cannot offset wages and salaries.
- Employee business expenses (that is, “Form 2106” expenses) will be deductible to the extent deducted for federal purposes.
- Ohio cities will have to limit their consideration of “domicile” to 25 common law-type tests. The cities are not permitted to add to these 25 tests.
- NOTE: This is the “snowbird” test. I have had cities tell me they do not recognize snowbirds. A house there means you are taxed there, whether you spend much time at the house or not.
- An employee or sole proprietor is allowed to go into and out of a city for up to 20 days without triggering withholding for that city’s income tax.
- NOTE: The previous threshold was 12 days. Notice that we are discussing withholding taxes only. A city may still contact a business for business income taxes if it spots business vans and work trucks stopping within the city.
- Pensions are not taxable.
- NOTE: SERPs are considered to be wages, not pensions. SERPS are deferred compensation plans, usually funded exclusively by the employer. The tax reporting for a SERP is done on Form W-2 - the same reporting as one's wages or salary - so the cities take the position that SERPs are wages and not pension income.
- Returns will be due (for a calendar year taxpayer) on April 15.
- The returns will be automatically extended if a federal extension is requested.
- Estimated individual income taxes will be required only if the estimated tax due is $200 or more.
- Any tax due (before withholdings or estimates) of $10 or less will be reduced to zero.
- NOTE: You still have to file the tax return, though.
- Any interest due will charged at the federal rate plus 5% (Ohio’s rate is federal plus 3%).
- Net operating losses are standardized.
- Beginning January 1, 2017 all cities will allow a uniform 5-year carryover (with a phase-in).
- Earlier NOLs will be permitted as allowed by pre-change city law.
- City NOLs will be calculated using federal limitations such as passive activity, basis or at-risk limitations.
- NOTE: This is a subtle but very significant change – in favor of the cities.
- Certain administrative changes, such as requiring the cities to send out an assessment notice -clearly marked “ASSESSMENT” – before they can change your numbers on the city return.
The Ohio Society of CPAs was an outspoken advocate of these changes. I am sympathetic to arguments the cities raised, but I am nonetheless thankful for some standardization. I prepare or review local returns. I have to bill for this, as this is my profession. I have routinely seen business clients with multiple local returns where the cumulative tax is a fraction of the professional fee to prepare the returns. I submit that a tax is unfair when the preparation fee routinely exceeds any tax so raised. Call it Hamilton's razor if you wish.
By the way, I would apply the same razor to federal and state taxes. A corollary to the razor would require Congress to reduce its revenue estimates from any proposed tax by the compliance costs (that is, the professional fees) of complying with said proposed tax. I suspect we wouldn't see as much nonsense as we presently have in the tax Code.
About the author
Steven D. Hamilton is a career CPA, with extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.