Navigating Ohio Tax Reform

1
Navigating Ohio Tax Reform

• David A. Tumen Mark A. Snider
• March 14, 2006

2
Principles of Tax Reform

• Encourage capital investment in Ohio
• Encourage job creation in Ohio
• Replace certain selectively burdensome taxes with
  system that applies more evenly to all business
  sections and entity types
• Reduce taxes on Ohio-based business by broadening
  tax base to include non-Ohio-based businesses
  that do business in Ohio
• Reduce rates by broadening tax base and limiting
  carve-outs and exemptions

3
Tax Changes -- Overview

• Taxes Repealed or Cut
• Tangible personal property tax repealed over four
  years
• Corporate franchise tax repealed over five years
• Personal income tax cut by 21 over five years
• State portion of sales tax reduced from 6.0 to
  5.5

• New Taxes
• New commercial activity tax (CAT) phased in over
  five years
• 10 real property tax rollback eliminated for
  commercial and industrial properties

4
Repeal of Personal Property Tax

• Elimination over four years of the PPT
  considered the most onerous Ohio tax against
  making capital investment in Ohio
• 2005 rates 23 tax on inventory, 25 tax on
  furniture fixtures and existing machinery
  equipment
• All new machinery equipment acquired after
  1/1/2005 not taxed
• All other tangible personal property taxed at
  18.75 in 2006, 12.5 in 2007, 6.25 in 2008, and
  no tax in 2009 and later

5
Repeal of Corporate Franchise Tax

• Before tax reform Corporate franchise tax
  penalized high profit C corporations with rate of
  up to 8.5
• Tax paid on higher of net income or net worth
  basis
• Tax eliminated in 2010
• Tax phased-out over five years, at 20 per year
  
• 2006 80 of 2004 rate
• 2007 60 of 2004 rate
• 2008 40 of 2004 rate
• 2009 20 of 2004 rate
• Tax retained for certain industries, such as
  financial institutions

6
Corporate Franchise Tax Credits

• All remaining ME credits converted into grants
• Grants can be used to offset corporate franchise
  tax liability until tax is fully phased out in
  2009
• Grants not usable against CAT liability
• Grants can continue to be used by industries not
  subject to phase out

7
Reduction of Personal Income Tax

• Ohio 2004 personal income tax rates ranged from
  0.7 to 7.5, with the highest 7.5 rate imposed
  on Ohio taxable income over 200,000
• Ohio taxable income is federal adjusted gross
  income, with few adjustments, minus individual
  Ohio exemptions
• Across-the-board tax reduction of 4.2 per year
  between 2005 and 2009 total cut of 21 in 2009
  and beyond over 2004 rates
• Personal income tax cut is designed to offset
  some of the new CAT tax that pass-through
  entities will pay

8
Overview of CAT

• Commercial Activity Tax is a broad-based,
  low-rate business privilege tax measured by a
  persons Ohio-based gross receipts
• Tax is imposed on all persons, which includes
  businesses large and small, however organized,
  and whether engaged in manufacturing, retail,
  services, or other industries
• Person includes sole proprietors, C
  corporations, S corporations, partnerships, LLCs,
  Q subs, single-member LLCs, trusts, estates, and
  any other entities

9
Who Pays the CAT?

• Ohio-based taxpayers with Ohio gross receipts of
  more than 150,000 per year
• Out-of-state businesses that meet any of the
  following criteria (know as bright-line
  presence)
• --- have more than 500,000 in taxable gross
  receipts in Ohio
• --- have more than 50,000 in real or personal
  property in Ohio
• --- pay more than 50,000 in payroll in Ohio
• --- conduct more than 25 of business activity
  in Ohio
• Physical presence in Ohio is not required for the
  CAT
• Constitutional issues?

10
Who Pays the CAT Planning Tip

• Locating property and payroll in Ohio does not
  significantly increase a businesss Ohio CAT
  because any business with significant sales of
  goods or services or rental income in
  Ohiowhether physically located in Ohio or notis
  subject to the CAT
• By locating property and payroll in Ohio,
  however, a business may be able to significantly
  decrease the amount of state taxes paid in other
  jurisdictions. Most other states impose their
  business taxes (usually corporate
  franchise/income taxes) based on a combination of
  sales, property, and payroll located in that
  state.
• Therefore, locating property and payroll in Ohio
  does not increase a businesss Ohio CAT but
  should decrease its business taxes in other
  states.

11
Who Is Exempt?

• Certain individuals and businesses are not
  subject to the CAT
• --- Financial institutions that pay Ohio
  franchise tax
• --- Public utilities that pay Ohio gross
  receipts tax
• --- Insurance companies that pay Ohio premiums
  tax
• --- Dealers in intangibles that pay Ohio
  intangibles tax
• --- Non-profit organizations
• --- Government entities
• --- Persons with less than 150,000 in annual
  Ohio gross receipts
• --- Individuals who do not operate their own
  businesses employee compensation, salaries,
  wages, commissions, and benefits are not
  taxable under the CAT

12
What is a Gross receipt?

• Gross Receipt
• receipts from sales of tangible and intangible
  personal property
• receipts from sales of real property, if dealer
  inventory
• receipts from sales of services
• rental receipts

• Not a Gross Receipt
• W-2 compensation
• interest, dividends, distributions from
  flow-through entities
• federally-defined capital gains
• stock issuance, contributions and returns of
  capital
• gifts, life insurance proceeds
• proceeds from loans, stocks, bonds, mutual funds,
  trusts, and pensions
• litigation damanges
• motor fuel receipts until 6/07

13
What is a Gross Receipt?

• Gross receipts include the total amount realized,
  without deduction for the cost of goods sold or
  other expenses, for transactions that contribute
  to the production of gross income
• Deductions are allowed for the following
• --- cash discounts allowed and taken
• --- returns and allowance
• --- bad debts from receipts upon which the CAT
  was paid for a prior period
• --- amount realized from the sale of an account
  receivable

14
Situsing Gross Receipts

• Only Ohio taxable gross receipts are subject to
  the CAT
• Detailed situsing statutes and rules provide
  guidance to determine whether a gross receipt
  should be sitused to Ohio
• In general, sales of property are sitused to the
  place where the property is ultimately received
  after all transportation has been completed (thus
  property moved into an Ohio warehouse but then
  out of Ohio is not taxed)
• In general, sales of services are sitused to the
  physical location where the purchaser ultimately
  uses or receives the benefit of the service
  provided

15
CAT Pyramiding

• There is no sale-for-resale exclusions and,
  thus, a certain degree of pyramiding is inherent
  in the CAT
• There is an option to elect to file a group of
  related taxpayers as one consolidated taxpayer
  group if that election is made, entities within
  the group can exclude their intragroup gross
  receipts from the CAT
• Result integrated business lines may encounter
  lower CAT costs than non-integrated businesses

16
CAT Rates

• 0 to 150,000 in Ohio gross receipts No CAT
• 150,000 to 1 million flat 150 per year
• Over 1 million 150, plus the CAT rate
  multiplied by Ohio gross receipts in excess of 1
  million
• Rates
• --- 7/2005 through 3/06 0.06
• --- 4/06 through 3/07 0.104
• --- 4/07 through 3/08 0.156
• --- 4/08 through 3/09 0.208
• --- Thereafter 0.26

17
CAT Registration Returns

• Each taxpayer subject to the CAT must register
  with the Ohio Department of Taxation
• Yearly returns are due on or about February 10
• Quarterly filing is required for those with Ohio
  gross receipts of more than 1 million annually

18
CAT Taxpayer Groups

• Entities more than 50 commonly owned must either
  file as a combined group or may elect to file as
  a consolidated taxpayer group
• Combined or consolidated taxpayer groups are
  entitled to only one 1 million exemption (flat
  tax of 150)
• Common ownership is determined under a vertical
  ownership test, with no federal attribution or
  horizontal rules

19
Common Ownership
A
100
20
B
C
40
20
Common Ownership

• Partnership A, LLC B, and Corporation C are all
  members of the same taxpayer group
• Partnership A directly owns more than 50 of LLC
  B
• Although LLC B owns only 40 of Corporation C,
  Partnership As direct ownership of 20 of
  Corporation C and ownership of an additional 40
  of Corporation C constructively through LLC B is
  sufficient to continue the vertical chain to
  include Corporation C

21
Combined or Consolidated?

• Combined
• Because intragroup gross receipts are not
  exempt, filing as a combined group probably only
  makes sense if a commonly owned entity has
  significant Ohio gross receipts but wants to
  contest nexus

• Consolidated
• Consolidated is generally preferred if members
  of a commonly owned group have significant
  intragroup gross receipts and are likely to be
  unsuccessful in contesting nexus for any of the
  members

22
CAT Taxpayer Groups

• Theoretically possible to have both a
  consolidated group and a combined group. If
  entities elect to consolidate at the 80 common
  ownership level, any affiliates owned more than
  50 but less than 80 would be put into a
  combined group if they have bright-line presence
• 50/50 joint venture can be in two consolidated
  groups
• A group of commonly owned entities may elect
  consolidated at any time, but once election is
  made, it is binding for eight quarters
• Department will permit separate combined group
  filing if necessary to protect sensitive
  information from other group members

23
CAT Other Issues

• Can the CAT be recovered from customers? The
  statute prohibits the CAT from being billed or
  invoiced to another person, but an amount
  sufficient to recover the CAT can be part of an
  overhead charge or built into the purchase price
• Contractual agreements should be considered
• The lack of physical presence standard under the
  CAT will probably be contested by an out-of-state
  entity in the future
• If tax collections for the CAT are less than 90
  or more than 110 of projections, the CAT rate
  may change

24
Tax Reform Winners and Loser

• Winners
• C corporations
• Ohio-based companies
• Manufacturers and others with large amount of
  tangible personal property located in Ohio
• High profit companies
• Companies with significant Ohio payroll

• Losers
• High volume, low margin business
• Out-of-state companies making many sales in Ohio
• Certain service providers (but recall 21 cut in
  personal income tax rate)

25
Ohio Tax Incentives

• Ohio Job Creation Tax Credit (must create at
  least 25 full-time jobs and pay 150 of federal
  minimum wage)
• Ohio Job Retention Tax Credit (for businesses
  that employ at least 1,000 full-time employees
  and make a capital investment of at least 200
  million)
• Ohio Research and Development Investment Tax
  Credit (RD credit)
• Training Tax Credit

• Ohio Manufacturing Machinery Equipment Grant
  (new investment in new Ohio-based equipment)
• Technology Investment Tax Credit
• RD Sales Tax Exemption
• Warehouse Machinery Equipment and Inventory Tax
  Credits
• Enterprise Zones
• Foreign Trade Zones
• Community Reivestment Areas