Ohio Board of Tax Appeals Holds That Employers in Columbus (and Possibly Some Other Ohio Municipalities) Were Not Required to Withhold Municipal Income Taxes on Deferred Compensation for the Year Earned

Date: June 30, 2015

A recent decision by the Ohio Board of Tax Appeals (“BTA”) sheds light on employer municipal income tax withholding obligations for benefits accrued under nonqualified deferred compensation arrangements. The decision relates to tax withholding on SERP benefits, but its application extends to all nonqualified deferred compensation arrangements.

In general, nonqualified deferred compensation benefits are subject to Ohio municipal income tax withholding when the benefits are “earned.” This is the same approach as used for FICA taxes. A recent BTA decision holds that if the applicable municipal tax ordinance is not consistent with this approach, then employers are not required to withhold municipal income taxes on the nonqualified deferred compensation benefits.

In Nationwide Mutual Insurance Company v. City of Columbus Board of Tax Appeals, the Columbus tax ordinance at issue provided that employers are obligated to withhold municipal income tax when compensation is “paid.” There was no mention of withholding taxes on nonqualified deferred compensation benefits when earned. As a result, the BTA held that the employer subject to that ordinance was not required to collect the municipal income taxes on the SERP benefits when such amount was earned. The BTA said that the municipal ordinance had to be revised to specifically require that employers withhold municipal income taxes when nonqualified deferred compensation benefits are earned. The BTA did not accept the employer’s position that certain 2003 revisions to the Ohio statute automatically revised the municipal ordinance on this point.

The result of the decision is that the SERP benefits were not subject to Columbus income tax withholding either when such benefits were earned or at any later date. While the decision does not address the employee tax liability, Columbus has also decided that employees are not liable for municipal income taxes on earned income for open years prior to a change in the Columbus ordinance.

Many Ohio municipalities have already made the appropriate changes to their tax ordinances since 2003 to address this issue. For example, during 2014, Columbus amended its ordinance to require both employee taxation and employer tax withholding in the year that nonqualified deferred compensation is earned—to match the FICA tax withholding. A few municipalities continue to have an ordinance similar to the pre-change Columbus version. Some municipalities have ordinances that might impact the employer’s tax withholding obligation but are properly worded with respect to the employee’s tax liability. For example, the Cleveland tax ordinance is properly worded with respect to both the employee tax liability and the employer withholding obligation. On the other hand, the Cincinnati tax ordinance is properly worded with respect to the employee’s tax liability but could be clearer with respect to the employer withholding obligation.

Points for immediate consideration by employers:

  • Review the municipal income tax ordinance for the employer’s place of business to determine if either the employer tax withholding or the employee tax liability for nonqualified deferred compensation is limited to the time of payment.
  • For employees who reside outside of the municipality where employed, consider a communication to employees to review the tax ordinance for the municipality where the employee resides.
  • If the municipal income tax ordinance for the employer’s place of business imposes taxation on the employee when nonqualified deferred compensation benefits are earned but limits the employer withholding obligation to when amount the benefits are is paid, consider what action, if any, should be taken.
  • For any open prior years, consider the possible refund amounts at issue and monitor whether there is merit to filing refund claims prior to April 15, 2016 (or January 2016).
  • For employers that have SERP arrangements, revisit the applicable municipal income tax ordinance for the application of the pension exemption to both 2015 and post-2015 years.
  • We hope this information is useful and would be glad to discuss in more detail.

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FOR MORE INFORMATION

For more information, please contact:

Francesco A. Ferrante
937.443.6740
Francesco.Ferrante@ThompsonHine.com

J. Shane Starkey
513.352.6737
Shane.Starkey@ThompsonHine.com

Nathan E. Holmes
937.443.6820
Nathan.Holmes@ThompsonHine.com

Alexander Song
513.352.6541
Alexander.Song@ThompsonHine.com

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