House Biennial Budget Bill Includes Many Tax Changes–Next Stop: the Ohio Senate
The Ohio House of Representatives (the “House”) passed its version of the biennial budget bill, Sub. H.B. No. 49 (the “House Bill”), on May 2, 2017. In its version of the budget, the House restrains growth in all-funds spending below inflationary levels for the upcoming biennium. It also adds $170 million to fight Ohio’s opioid epidemic and supplements Governor Kasich’s education funding formula with an additional $90 million.
You may recall that Governor Kasich’s original budget proposal called for $3.2 billion of personal income tax reductions, offset by $3.1 billion of sales and use and other tax increases. See our previous SALT Buzz - Tax Analysis of Kasich's 2018 Budget. The Governor also included language that would centralize the filing and administration of Ohio municipal income tax on net profits that is paid by business entities. The Ohio Department of Taxation (“ODT”) estimated that businesses would save $800 million per year in administrative and accounting costs from this centralization of the net profits tax.
House Tax Provisions
The House Bill removes Governor Kasich’s proposed reform of Ohio’s personal income tax system, including the income tax reductions, the sales, severance, cigarette and tobacco tax rate increases, the addition of new taxable services, the elimination of the exclusion for interest and the limitation of the qualified distribution center exclusion under the commercial activity tax, and subjecting vapor products to the other tobacco products excise tax.
The most important provisions of the House Bill are summarized below, but we urge companies and taxpayers to review the actual language of the House Bill in order to more fully understand the impact these changes may have on their tax situations. If a business is negatively impacted by the House changes, now is the time to try to address these problems as the bill moves through the Senate.
Personal Income Taxes: The House Bill reduces the number of income tax rate brackets by eliminating the bottom two individual income tax brackets ($0 - $5,000 and $5,000 - $10,000). Individuals earning less than $10,000 would not owe any Ohio tax because the lowest tax bracket will now apply to income over $10,000 and up to $15,000. The tax for that lowest bracket will equal $74.25 plus 1.980% of the amount of income above $10,000 and less than $15,000. The current low-income tax credit, which eliminates liability for an individual with less than $10,000, is repealed by the House Bill because it is no longer needed.
The House Bill also adds a provision requiring ODT to separately report the amount of tax generated by business income and non-business (i.e., all other) income. This reporting requirement would become effective for tax years beginning on or after January 1, 2017.
ZHF Observation: This requirement may require ODT to make the personal income tax forms even longer in order to obtain such information from taxpayers.
Municipal Income Tax Reform Proposal: As discussed above, Governor Kasich proposed a bold plan to centralize the collection and administration of the municipal net profits tax. The House has rejected this proposal, failing to take this opportunity to alleviate this burden on businesses and enhance Ohio’s competitiveness with other states for business development.
Filing through the Ohio Business Gateway: The House adopted language to allow a business to file a single annual or estimated return through the Ohio Business Gateway, on which a business may report and pay the total tax due to all the municipalities in which the business earned net profits.
ZHF Observation: Business taxpayers have been able to file one return for multiple cities using the Ohio Business Gateway since 2005, so it is unclear as to why this “change” is necessary.
Throwback Rule Eliminated: In an attempt to eliminate the municipal tax throwback rule, Governor Kasich’s original budget proposal also adopted a destination-based approach for situsing sales of tangible personal property. Using destination could have increased the municipal tax burden on many businesses. The House eliminated the throwback rule that applies under current law for all taxpayers (including sole proprietors), while also retaining the destination treatment only for sales of tangible personal property when the seller is regularly engaged through its own employees in the solicitation or promotion of sales at the destination location and the sales result from such solicitation and promotion.
Tax Commissioner to Distribute Collected Tax: Under Governor Kasich’s original budget proposal, the state was required to remit collected net profit taxes to the cities on a quarterly basis. Many cities objected to this delay in receiving their tax revenue. The House Bill requires the tax commissioner to distribute municipal income taxes collected through the Ohio Business Gateway on a semi-monthly basis to each municipality. No fee will be charged to the municipalities under the House Bill.
ZHF Observation: Under current law, municipal taxpayers utilizing the Ohio Business Gateway have their taxes directly debited from their account by each municipality and the state never has possession of the funds. Therefore, keeping the current law might better address municipality concerns.
MeF Feasibility Study: The House Bill tasks ODT to study the feasibility of allowing municipal taxpayers to file city tax returns through the joint federal and state Modernized e-File program (“MeF”). The study is to be completed by December 31, 2017 and shall estimate the cost of accepting income tax returns through MeF, as well as establish a timeline for the incorporation of municipal tax filings into MeF.
Municipal Tax Late Payment Penalty: The House Bill fixes a technical problem from H.B. 5 by changing the penalty provisions contained in Ohio Revised Code Chapter 718. The penalty for late payment of withholding taxes is changed from “50%” of the unpaid amount to “not to exceed 50%” of the unpaid amount.
ZHF Observation: This change helps affirm a municipal tax administrator’s discretionary authority to charge less than the full 50% penalty.
Sales and Use Taxes: The House has added a number of sales and use tax related provisions to the budget bill.
Remote Seller Collection: The House Bill requires an out-of-state seller to collect and remit sales tax if, during the previous or current calendar year, the seller has 200 or more Ohio transactions or $100,000 in Ohio sales. The provision also applies to sales of services.
ZHF Observation: This provision is similar to recent efforts by states to ignore the U.S. Supreme Court’s ruling in Quill v. North Dakota, which held that a physical presence is necessary in order to require an out-of-state vendor to collect sales tax. The Legislative Service Commission did not provide an estimate of the increased revenues that could result from this provision.
Also, this provision effectively eliminates the safe harbors found in R.C. 5741.17(a)(3) and (4) relating to agency relationships with a telemarketing business and owning specific printed product at an Ohio printer. Further, it appears that businesses meeting the new thresholds are required to register even if those businesses make no taxable sales.
Jukebox Music: The House Bill exempts purchases of digital multimedia, such as songs, sold through a digital jukebox from the sales and use tax. This provision would be effective on October 1, 2017.
ZHF Observation: A similar provision enacted during the last days of the previous General Assembly was vetoed by the Governor.
Unified Sales and Use Tax Returns: The House Bill requires ODT to provide a combined sales and use tax form for taxpayers.
ZHF Observation: Almost all taxpayers file their sales tax and use tax returns using the Ohio Business Gateway. Even with electronic filing, this proposal raises questions as to whether ODT would still require two separate accounts (one for sales tax and one for consumer use tax) and whether filing the unified return will start the statute of limitations for both types of taxes (especially if no tax is reported as due).
Prescription Eyewear: An exemption from sales and use tax is provided for prescription eyewear. The provision is effective for purchases made during fiscal year 2020—get it? (i.e., beginning on July 1, 2019).
Narrows Exclusion of Personal & Professional Services from Tax: Under current law, personal and professional services are not categorized as taxable automatic data processing, computer services and electronic information services (collectively referred to by ZHF as “Electronic Services”) if the true object of the transaction is to acquire Electronic Services. While personal and professional services continue to be excluded from the definition of these services, the true object test is modified by the House Bill. The proposed language removes “incidental or supplemental” from the true object test and effectively replaces it with a test asking whether the Electronic Services are being primarily provided to deliver, receive, or use another non-taxable service. If so, then the Electronic Services would not be taxable. The House Bill also adds electronic publishing to the list of Electronic Services. The changes would be deemed to apply to all cases pending or transactions occurring after December 31, 2007 (that’s not a typo—2007).
ZHF Observation: Depending on how one interprets “incidental or supplemental,” it could be argued that the new language just restates the same concept. Alternatively, it could also be argued that the new language narrows when Electronic Services are not the true object of a transaction (i.e., only when it is primarily used to deliver, receive, or use another service) and therefore not taxable. This latter interpretation would increase the taxability of more services than under current law. As mentioned below, policy makers might want to conduct a more thorough examination of the current tax statutes and update them for these modern transactions.
Direct Mail: The House Bill retains various definitions related to direct mail and adds that exemption certificates related to direct mail will only be valid if received by the vendor in the absence of bad faith.
ZHF Observation: “Absence of bad faith” is a very tough standard and is not a requirement for other exemption certificates if received within 90 days of the date of the sale. Why there would be a different standard seems odd. It should be noted that exemption certificates received after the 90-day limit do have a good faith standard applied to them.
Vendors’ Licenses: The House Bill retains a number of provisions proposed in Governor Kasich’s original budget related to vendors licenses, including the following:
Requires ODT to provide an online system for the county auditors to provide vendor licenses.
Allows ODT to cancel vendor and similar licenses where fraudulent or incorrect returns are filed.
Requires ODT to make public an electronic list of names and account numbers for vendors licenses, direct pay permits and sellers use tax account holders.
Real Property Taxes: The House Bill also adds a number of interesting changes to the property tax system.
Attorney’s Fees if Government Loses Its Appeal: If a County Auditor, the Tax Commissioner, or any board, legislative authority, or public official appeals a decision of a County Board of Revision to the Ohio Board of Tax Appeals or beyond, such official will be required to pay the property owner's reasonable attorney’s fees and court costs related to the appeal.
Real Property Tax Exemption: The House Bill provides a real property tax exemption for property that meets all four of the following conditions: (1) less than 75% of the rentable square footage is rented to tenants, (2) it is owned by a municipality, after being conveyed by a Community Improvement Corporation (“CIC”), (3) it was conveyed to that CIC by a federal agency, and (4) the property is subject to an agreement that requires the municipal corporation to convey the property back to the CIC before the property may be developed. The exemption applies beginning in tax year 2016 and all years thereafter.
CAUV: The House Bill adds two new factors to be considered in calculating the current agricultural use value (CAUV), “typical cropping and land use patterns” and “typical production costs”, while deleting one existing factor—“market value”. The House Bill also provides that the equity yield rate used to calculate the capitalization rate equals the 25-year average of the “total rate of return on farm equity” published by the U.S. Department of Agriculture and the holding period for the purposes of calculating the components of capitalization is 25 years (rather than just 5 years).
Valuation for Oil and Gas Reserves: The House Bill clarifies the correct methodology for determining the true value of oil and gas reserves for real estate tax purposes. The true value of crude oil and natural gas reserves for real estate tax purposes will be determined using a net income capitalization valuation approach. The House Bill will make it clear, using clarifying language, that this methodology is the only methodology that may be used to value such property.
Board of Revision Decision Time Extended: The House Bill increases the amount of time Boards of Revision have to decide property tax complaints.
In the ten most populous counties, the time frame is increased from 90 days to 180 business days;
For all other counties, the time frame is increased from 90 days to 90 business days.
Tax Administration: The House Bill adopts a unique and dramatic provision intended to prevent ODT from asserting that a transaction is taxable when it has not issued any formal guidance indicating its taxability. Under the provision, the Tax Commissioner or ODT employee is not permitted to issue an assessment or undertake any informal action against a taxpayer that would subject to a tax or fee a category of persons, income, receipts, activities, transactions, services, or personal or real property that no tax official had explicitly considered to be subject to the tax or fee in any formal guidance, assessment, or informal action adopted, issued, in effect, or undertaken at any time during the three years after the authorizing legislation date related to that assessment or informal action. The language does not limit the Tax Commissioner’s authority to provide such guidance on a prospective basis.
ZHF Observation: This is dramatic and far-reaching language that will give ODT significant consternation. However, the language is likely the result of taxpayer frustration which often occurs in the area of taxable services. For instance, many taxable services were defined in the 1980s and early 1990s and do not take into account current business methods. Another option to this dramatic prohibition would be for policy makers to make a concerted effort to study and update Ohio’s tax laws to reflect current business methods.
Economic Development Incentive: In its version of the budget, the House is proposing several changes to various economic development incentives.
Data Center Exemption: The time period for making capital expenditures under the data center sales and use tax exemption is increased from 5 years to 6 years.
Job Creation Tax Credit: Employees who work from home would now qualify to be included in the job creation totals for purposes of measuring the job creation tax credit.
Motion Picture Credit: The motion picture tax credit is changed by: requiring that a project must have 50% of financing secured to be eligible; requiring that priority be given to television or miniseries projects; authorizing the Director of the Development Services Agency to charge an application fee equal to 1% of the estimated credit or $10,000, whichever is less; and allowing unused credits to roll into the next year.
Regional Transportation Improvement Project (RTIP): Counties will be permitted to participate in a RTIP to create a financing mechanism similar to a TIF district and to make a $250,000 appropriation for RTIPs involving Carroll, Columbiana and Stark counties.
Tourism Development Districts: The permissible amount of land for a tourism development district is increased to 600 acres and these districts will sunset on December 31, 2020.
Enterprise Zones: The ability of a county or a municipal corporation to enter into an Enterprise Zone Agreement with a business is made permanent.
ZHF Observation: Under current law, this authority will expire on October 15, 2017.
Miscellaneous Taxes: The House has adopted several changes to various other taxes.
Kilowatt Hour Tax: Electricity used in the chlor-alkali manufacturing process would be exempt from the Kilowatt Hour Tax.
Lodging Taxes: A number of special lodging tax provisions were adopted by the House that essentially adds authority for certain counties to increase their tax rate or change how the tax revenue is utilized.
Fuel Excise Tax: Stickers would need to be placed on retail service station fuel pumps outlining the federal and state excise tax rates.
The House Bill will go to the Senate for consideration, followed by a Conference Committee in June. After Governor Kasich’s line-item vetoes, if any, the final budget bill should become law by July 1, 2017. Businesses should review the actual language from the House Bill to fully understand the Bill’s impact and stay tuned for any change the Senate may make, as well.
If you would like to discuss how any of these specific provisions may apply to you or your company, please contact one of our tax professionals.