This year, the Ohio House Ways and Means CommitteeThe Committee on Ways and Means, more commonly referred to as the House Ways and Means Committee, is one of 29 U.S. House of Representative committees and is the chief tax-writing committee in the U.S. The House Ways and Means Committee has jurisdiction over all bills relating to taxes and other revenue generation, as well as spending programs like Social Security, Medicare, and unemployment insurance, among others. has the opportunity to consider changes to their municipal income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. code, which is the most complex local income tax structure in the United States. Unlike any other state that levies local individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. es, Ohio problematically allows over 600 municipalities to define tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. s and set their own rules for collection, auditA tax audit is when the Internal Revenue Service (IRS) conducts a formal investigation of financial information to verify an individual or corporation has accurately reported and paid their taxes. Selection can be at random, or due to unusual deductions or income reported on a tax return. ing, and income calculation.
This creates substantial compliance burdens associated with income tax filing, withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. , and accounting which are especially prevalent in industries where employees travel between municipalities in the course of their duties. As an example, one Ohio electrical contractor once filed 221 W-2 forms for 19 employees, along with 39 business returns, most having a tax charge of $5 or less.
One bill, HB5, has been in the Ohio House Ways and Means Committee for several months and represents a start at addressing some of the more uniquely egregious portions of the state’s municipal income tax practices.
In recent days, a substitute bill (LSC 130 1581-2) has been introduced that substantially alters many of the provisions of HB5, keeping just a few positive aspects and changing many provisions for the worse. Here, we list the substantive changes and provide commentary on how the changes will affect reform efforts this year and in years to come.
Substitute Bill Retains Few Beneficial Provisions of Original
- Require municipalities to eventually allow a five year carryforward of net operating losses. These provisions allow businesses and individuals with cyclical income to have tax rates that track their average income and thus permit them to avoid being sharply taxed during highly productive years. Still, a five year standard is very short compared to the nation-wide standard of twenty years.
- Include a casual exemption rule, which means that municipalities may not tax the income of employees who work fewer than twenty days in a municipality. However, there are several nuances to this law. For example, an employer may elect to withhold taxes for all days a nonresident works in the municipality (including the first twenty days), and the taxpayer would have to seek a refund later if the tax ends up not being owed.
The Substitute Bill Substantially Limits Many Positive Reforms of Original
The substitute bill:
- Eliminates the Municipal Tax Policy Board set forward in HB5, which would be tasked with bringing uniformity to the municipal forms and other documents in an aim to reduce compliance costs of taxation.
- Allows pass-through entities to be taxed at the entity level and also allows owners to be taxed on a share of their profits. This double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. was avoided in HB5, which eliminated taxation of pass-throughs at the entity level.
- Would allow non-uniform taxation of employees under eighteen years of age by allowing, but not requiring, municipalities to exempt their income from taxation.
- Eliminates the requirement that individuals be both domiciled in a municipality and be an Ohio resident under the state’s “bright-line” residency test in order to be treated as a resident for municipal income tax purposes. The substitute bill only requires that an individual be domiciled in a municipality.
- Retains the five year net operating loss carryforwardA Net Operating Loss (NOL) Carryforward allows businesses suffering losses in one year to deduct them from future years’ profits. Businesses thus are taxed on average profitability, making the tax code more neutral. In the U.S., a net operating loss can be carried forward indefinitely but are limited to 80 percent of taxable income. provision but slows the phase-in of the rule from 2020 until 2022. Further, instead of phasing in gradually between 2015 and 2020, taxpayers will only be allowed to deduct half of the net operating losses between 2017 and 2021, with the full carry-forward beginning in 2022.
Many Poor Tax Practices in Ohio’s Local Income Taxes Remain Overlooked
Neither HB 5 nor the proposed substitute bill include:
- A provision to prevent taxation in multiple jurisdictions on the same dollar of income. Currently, municipalities are allowed to choose whether or not to offer a credit against taxes paid to other municipalities, resulting in double taxation if a municipality does not offer credits.
- A uniform structure for how credits should be calculated when they are given. This increases compliance costs on tax filers and adds confusion for professionals who must file in multiple jurisdictions.
- A cap on municipal tax rates that are customary in most states’ local income and sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. codes.
- Reasonable filing thresholds. Both HB5 and the substitute bill require taxpayers to file a return to a municipality even when they do not owe enough tax to meet the minimum payment threshold ($5 in HB5, $10 in the substitute bill). This results in situations where taxpayers are filling out tax forms for unreasonably low tax bills.
Of the seventeen states that levy local income taxes, Ohio subjects its taxpayers and businesses to the most complex laws. In Maryland, the local income tax compliance is just five simple lines on the state income tax form. By contrast, Ohioans spend valuable time and money each year complying with a system that lacks uniformity or concrete rationale. The consideration of municipal income tax reform was the bright spot of tax discussions in Ohio this year, but this recent effort represents a watered-down attempt to declare victory on a complex issue that deserves real legislative attention.
 See Greg Lawson & Scott Drenkard, In the State Tax Battle, The Tar Heels Soar Above The Buckeyes, Forbes, Sept. 23, 2013, http://www.forbes.com/sites/realspin/2013/09/23/in-the-state-tax-battle-the-tar-heels-soar-above-the-buckeyes/.
 See Scott Drenkard, Ohio’s Local Income Taxes: Complex and in Need of Reform, Testimony before Ohio House Ways and Means Committee, May 7, 2013, https://taxfoundation.org/article/ohios-local-income-taxes-complex-and-need-reform.
 For a fuller analysis, see Ohio Legislative Service Commission, Sub. Bill Comparative Synopsis of H.B. 5. 130th General Assembly (House Ways & Means), Doc. R-130-2278.