- Adam L. Garn JD, CPA
SERP Benefit Not Subject to Municipal Income Tax
After working at National City Corporation for thirty eight years, William MacDonald III retired in 2006. Thereafter, he spent several years battling two Ohio cities, Cleveland (work city) and Shaker Heights (residence city), regarding the local taxation of a Supplemental Executive Retirement Plan ("SERP") benefit. Recently, The Supreme Court of Ohio held that the SERP benefit was a pension and not subject to municipal income tax under the City of Cleveland ordinances. Hopefully, Mr. MacDonald may now enjoy his retirement.
Facts
In MacDonald v. Cleveland Income Tax Bd. of Rev., Slip Opinion No. 2017-Ohio-7798, Mr. MacDonald participated in the National City Corporation SERP. The SERP did not involve a deferral of current wages or a set-aside of any amounts in a segregated account by National City Corporation, but was an unfunded promise for the company to pay him a benefit in the future. In 2006, Mr. MacDonald received a W-2 reporting the present value of the annuity payments in Box 5 (Medicare wages) of Mr. MacDonald's W-2. However, the present value of the annuity payments was not included in Box 1 (federal income tax wages) of Mr. MacDonald's W-2. Therefore, no federal income tax was due on this amount in 2006. Instead, Mr. MacDonald would be required to pay federal income tax on the amounts as they are received by him in his retirement years.
Although Mr. MacDonald had not received any cash from the SERP, the City of Cleveland assessed Mr. MacDonald on the amount reported in his Box 5 wages of his 2006 W-2. Mr. MacDonald asserted that the SERP was a pension and was not subject to City of Cleveland income tax under Cleveland Codified Ordinance 191.0901(d), which excluded pensions from City of Cleveland income tax.
Ultimately, the Ohio Board of Tax Appeals (BTA) held that the SERP was a pension under the City of Cleveland’s ordinances and agreed that Mr. MacDonald was not subject to City of Cleveland income tax. In a case involving the same taxpayer, the BTA had previously determined that the SERP was a pension under the City of Shaker Heights ordinances. This holding was affirmed by the Tenth District Court of Appeals. Although the case was granted a jurisdictional appeal from the Tenth District Court of Appeals to the Supreme Court of Ohio, the issue whether the SERP was a pension was not ultimately addressed by the Supreme Court in the Shaker Heights case.
To determine if the SERP was a pension in the Cleveland case, the Supreme Court reviewed the Cleveland ordinance for the definition of a pension. Although the City defined the term “pension” in its rules and regulations, the term “pension” was not defined in its ordinance. Therefore, the Supreme Court looked to the basic definition of a pension under Black's Law Dictionary and Webster's Third New International Dictionary and found that the SERP met both definitions. The Court therefore found the SERP was exempt from Cleveland tax and indicated that the interpretation of a SERP as a pension is “reinforced when the pension exclusion is read as a whole * * * (because) the language of the ordinance has broad reach, evincing an intent to reach a multitude of retirement, death, and disability payments.”
The city unsuccessfully argued that the term “pension” was more narrowly defined in its rules and regulations and that those rules and regulations could trump the ordinance. The Supreme Court ruled that Cleveland City Council did not vote to ratify the specific provision of the rules and regulations, and that the rules and regulations unlawfully changed the tax base to include a SERP and conflicted with Cleveland's ordinance. Therefore, the income from the SERP was exempt from the City of Cleveland income tax.
Next Steps
When House Bill 5 of the 130th General Assembly enacted sweeping changes to Ohio's municipal income tax, the term “pension” was left undefined because several court cases, including Mr. MacDonald's cases, were pending and undecided. At that time, it was conveyed to the policymakers that Ohio municipalities would follow the Supreme Court of Ohio's ultimate determination on the issue. However, several municipalities have nonetheless enacted conflicting definitions of the term “pensions.” Since the Supreme Court of Ohio has now ruled that a SERP is a pension, taxpayers should seriously evaluate their ability to take the position that SERP income is exempt from municipal income tax, notwithstanding any local ordinances to the contrary. Taxpayers should carefully review each specific plan document, the state law, and the local ordinance before a position is taken.
Zaino Hall & Farrin LLC has significant experience in advising clients on Ohio's municipal income tax. If you would like to discuss the taxation of SERP income for municipal income tax purposes or any other municipal income tax issue, please contact Adam Garn, Steve Hall, or another ZHF professional.
