Ohio’s complex municipal tax code is finally going to be reformed and modernized. Governor Kasich signed into law House Bill 5 (HB5) on Friday, December 19th, with most provisions taking effect on January 1, 2016. HB5 represents a major legislative victory, overhauling Ohio’s Municipal Tax System. Ohio has long had the reputation of the most complicated local income tax system in the United States, but with the passage of HB5, Ohio will become more competitive for attracting new business in the state.
Net Operating Loss (NOL) Carryforward
HB5 provides a mandatory five-year carryforward period for NOLs first incurred in taxable years beginning on and after January 1, 2017. As a result, NOL carryforwards for jurisdictions that did not otherwise allow a NOL may first be used on annual net profit returns due in April 2019 for the 2018 tax year. Note that there is a phase-in for the new NOL carryover provision. For tax year 2018, 50% of the NOL carryforward will be allowed and full utilization occurs in tax year 2023. This phase-in limits the impact on cities that have never previously allowed NOL carryforwards. Additionally, NOLs that existed prior to tax year 2017 will still be permitted to be carried forward if that municipality allowed NOLs in the past.
Pass-Through Entity Treatment – Other than S Corporations
Pass-through entities include sole proprietors, S corporations, partnerships, and limited liability companies where the income or loss of the entity are given pass-through treatment for federal and Ohio income tax purposes. Prior to HB5 passage, the income of the pass-through entity varied across the local jurisdictions with regard to the tax on the net profits of the business, the tax on the owner with respect to the income of the business, and whether the owner was a resident or nonresident. Moreover, for business owners with more than one pass-through entity, inconsistent rules applied in the hundreds of local jurisdictions as to whether the business owners could offset the income from one pass-through entity with the loss from another pass-through entity.
With the passage of HB5, S corporations will remain as taxed under current law.1 Other pass-through entities, however, will be taxed at the entity level and individual owners will be subject to tax only in their resident city and receive a credit for taxes paid by the entity to other cities.
20-Day Occasional Entrant Rule
Currently, if an employee spends 12 days or less in a municipality, no withholding is required in that city. HB5 changes this period to 20 days. Consequently, if you have employees who spend 20 days or less in a municipality, no withholding is required for this municipality and instead the employer will be required to withhold tax for the municipality, if applicable, in which the employee’s principal place of work is located. If you think that the employee will spend more than 21 days in a new municipality, you should withhold tax from day one in the new municipality.2
These provisions will ensure that in most instances a jurisdiction will receive tax revenue.
Small Business Exception for Withholding
Furthermore, HB5 authorizes a simplified approach to employee tax withholding for small employers. The provision provides that small employers only have to withhold municipal income tax to their fixed location municipality, without regard to the 20-day rule. A small employer is a business that has overall gross receipts of less than $500,000.
Other Key Provisions
Other key provisions include municipalities determining domicile by looking at common law factors.
Presently, the state of Ohio uses a bright line residency test to determine domicile by the number of days spent in Ohio, so in effect you could be a resident of the state of Florida (applying Ohio standards) but still considered a resident by the town where you have a home in Ohio. Under HB5, Ohio municipalities will look at common law tests, including where you are registered to vote, where your driver’s license is issued and the location of your banks and doctors, to determine if an individual is a resident of a particular town.
Unreimbursed employee business expenses, otherwise known as Form 2106 expenses, are deductible to the extent allowed for federal purposes. Pensions will still be exempt with the passage of HB5, along with intangible income such as patents and royalties. And companies who sell goods into areas that they do not regularly engage in business may be subject to tax in their own municipality under the Throwback Rule. The throwback rule is a carryover from prior year and is essentially unchanged by HB5.
Finally, HB5 creates uniform treatment of filing requirements – extensions, penalties and due dates. All municipal returns will be due April 15th and all municipalities will accept a copy of the federal extension. Previously, different cities had different extensions even if no money was due.
In summary, the passage of House Bill 5 represents a long attempt to reform Ohio’s local taxing system. It should reduce the cost of tax compliance and improve Ohio’s competitiveness. Businesses should be aware of these changes taking effect and CSH is here to help you. Contact your CSH representative for any questions you may have on HB5.
1. Currently, 119 municipalities in Ohio tax resident S corporation owners at the shareholder level. This treatment will continue with the passage of HB5.
2. The 20-day rule does not apply to entertainers and professional athletes. They are taxed on their earnings in a municipality from day 1.