Taft is seeking consistency in overhaul plan

3/30/2003

COLUMBUS — For Cindy Clark, the municipal income-tax system in Ohio is like a maze.

As tax manager of the Bob Evans Corp., she and a five-member staff prepare 90,000 W-2 forms per year.

Since some Ohio municipalities require that compensation paid to employees under the age of 18 is taxable and others don't, Ms. Clark runs a special computer program each week to check the birth date of every employee.

With 160 Bob Evans restaurants in Ohio, Ms. Clark says she tries her best to track how municipalities impose the net profits tax, and which deductions and exemptions they allow.

“I just let them correct the return,” she says.

“We do business in 23 states, and Ohio clearly is the most difficult state to manage withholding. While we have local tax obligations in Kentucky, Michigan, and Pennsylvania, those states have uniform rules that apply for all cities,” she adds.

Gov. Bob Taft agrees that change is needed to help businesses. He wants legislators to overhaul state laws that govern the municipal tax system in Ohio so it is consistent and uniform.

“Ohio's municipal income tax is cumbersome and complicated for taxpayers, especially businesses with multiple locations in Ohio,” says state Tax Commissioner Tom Zaino. He says the cost to some businesses of complying with the various municipal tax rules is higher than the actual tax bill.

The goal is to do it without reducing the revenue of some cities, and increasing tax receipts for others, says Stephen Hall, assistant counsel to the state tax commissioner.

“Cities might be a winner or a loser, but we don't want that, “ he says.

The governor has the support of the Ohio Chamber of Commerce, but his plan has alarmed leaders of several municipalities including Toledo, where city hall says the plan could add $300,000 per year in administrative costs.

“I have been involved in economic development for 17 years, and I have never had one business complain about municipal income tax collection,” says John Loftus, the city's assistant chief operating officer.

Some critics assert that Mr. Taft, a Republican whose stated goal is to create a uniform municipal income tax base, has carved out tax breaks for corporate executives and businesses in several cities and villages.

In 2001, 541 cities and villages imposed income taxes that raised $3.2 billion.

A city or village council can set rates at or below 1 percent. Voters must approve rates above 1 percent. Toledo, which in 1946 became the first Ohio city to impose an income tax, has a rate of 2.25 percent.

The municipal income tax has three elements: a net profits tax on businesses, a personal income tax on individuals, and a withholding tax on businesses.

The personal income tax is imposed on people who work or live in a municipality, and statewide it generates 80 percent of municipal income tax revenue, Mr. Zaino says.

Businesses are required to withhold tax on wages, based on where their employees work.

The definition of what “wages” must be withheld varies among municipalities, a “compliance nightmare” for companies with employees who work in several municipalities, says Dan Navin, a veteran tax expert and lobbyist for the Ohio Chamber of Commerce.

Mr. Taft's proposal would create a uniform base for the municipal income tax on net profits by defining it as adjusted federal taxable income.

The governor's proposal also would create a uniform withholding base. It would be Box 5, which is Medicare wages and tips on the W-2 form. Section 125 plans would be added to the base, but non-qualified deferred compensation would not be added.

Simple? No way, say municipal officials.

Section 125 plans allow employers to deduct an employee's portion of the cost for two or more benefits, including medical benefits for noncovered services and disability insurance. They are also referred to as “cafeteria” plans because employees can choose those benefits.

“For state and federal purposes, that is not taxed,” says Martha Cross Funk, tax commissioner for the city of Sharonville, in suburban Cincinnati.

Some cities — such as Perrysburg, Oregon, Grand Rapids, and Port Clinton — do tax Section 125 plans under their municipal tax code. Others — such as Defiance, Bowling Green, and Toledo starting this year — don't.

Ms. Funk says the state officials decided to add Section 125 plans to a uniform withholding base because they know Mr. Taft's plan to exclude nonqualified deferred compensation from that base will cost municipalities money.

Most of that type of deferred compensation is supplemental retirement plans for corporate executives, she says.

“It's not across-the-board for employees. It's generally for the highly compensated. It's neither equitable, nor is it fair,” she says.

But state Rep. Sally Conway Kilbane (R., Rocky River), chairman of the House Ways & Means Committee, said it is fairer for municipalities to tax nonqualified deferred compensation when it is actually paid after several years — instead of requiring employers to withhold it when the money is deferred.

“The people may never receive that income, yet they have to pay taxes on it. They could move to another [municipality] and be taxed on it again,” she says.

If Mr. Taft's goal is to simplify the municipal tax system, his proposal won't do that, says Mr. Loftus, the city of Toledo's assistant chief operating officer. He is among city officials who believe that the state should pick Box 5 on the W-2 form as the uniform withholding base.

“In the city of Toledo, filing is accomplished primarily by employers who simply apply the city's tax against the income and remit payment to the city; simple,” he says.

Mr. Taft's proposal also would create a uniform system for how municipalities handle net operating loss carry forward. It would be five years.

That would not be a problem for municipalities such as Toledo and Bowling Green, which now allow five years.

If a business has a net operating loss, it can use that five-year period to offset the amount of municipal income tax it pays on future gains.

But two-thirds of Ohio municipalities, including Delta in Fulton County, do not allow any net operating loss carry forward, and so Mr. Taft's plan would reduce their revenue. If a company has a loss and a gain the next year, Delta fully taxes that gain.

“The state is trying to take control, and it is the smaller municipalities that will feel the brunt of it,” says Marlena M. Allwood, Delta's tax administrator.

Mr. Taft's plan also would enable businesses to file and pay municipal income taxes through a Web-based system that the state has formed, called the Ohio Business Gateway.

Mr. Zaino says the state would pick up the estimated $6 million cost over the next two years for the system. He says the Web-based system would not mean the state would collect or hold municipal income tax funds, saying the money would be transferred within two or three days.

Although Mr. Taft says centralizing filing and payment would make it easier for businesses, Ms. Funk disagrees.

“The municipalities still need a copy of the federal tax return. We will still need copies of the federal schedules. We will still need copies of the W-2s to do the audit,” she says.

Nonetheless, key Republican legislators say they are prepared to approve Mr. Taft's proposal, referring to municipal tax “reform” as one of the easier calls in the governor's sweeping package that includes $2.27 billion in tax increases over the next two years.

Ms. Kilbane, chairman of the House Ways & Means Committee,says she believes business groups and municipalities will reach a compromise.

“You give a little, and then you get a little,” she says.