Publications

Overview

On June 30, 2005, Governor Taft signed the Ohio budget bill (the "Bill"), which makes several major changes to Ohio tax law. The centerpieces of the Bill are the phaseout of the corporate franchise tax and the tangible personal property tax for most taxpayers, a reduction in personal income tax rates, and the enactment of the Commercial Activities Tax (the "CAT"), a gross receipts tax that applies not only to "C corporations" but also to S corporations, partnerships, limited liability companies, sole proprietorships, and estates. This bulletin provides a brief overview of many of the tax provisions of the Bill.

Individual Income Tax Reduction

The Bill gradually phases in an across-the-board 21% reduction in personal income tax rates, with the rates decreasing from current rates by 4.2% for the 2005 tax year and for each of the four following tax years. The highest tax rate will be 5.925% when the reduction is fully phased in for the 2009 tax year.

The Bill also creates a nonrefundable credit for taxpayers whose Ohio taxable income does not exceed $10,000.

Commercial Activities Tax

The CAT is a gross receipts tax imposed on business con-ducted in Ohio, effective July 1, 2005. The first return and tax payment are due February 15, 2006 for the period from July 1, 2005 to December 31, 2005. After that, returns must be filed on a quarterly or annual basis, depending on the amount of the taxpayer's taxable gross receipts.

The CAT generally applies to every person or entity that does business in and has substantial nexus with Ohio, including "C corporations," "S corporations," limited liability companies, partnerships, sole proprietorships, and estates. Certain businesses are not subject to the CAT, including businesses with less than $150,000 in taxable gross receipts during the calendar year (the "De Minimis Exception"), nonprofit organizations, and certain types of businesses that will remain subject to other taxes, such as financial institutions, insurance companies, and "dealers in intangibles."

Nexus with Ohio

A person or entity has substantial nexus with Ohio, and is therefore subject to the CAT for a calendar year, if the person or entity has a certificate authorizing it to do business in Ohio, owns or uses all or part of its capital in Ohio, or is deemed to have "bright-line" presence because the person or entity has any of the following: (i) Ohio payroll of at least $50,000 during the year; (ii) taxable gross receipts sourced to Ohio of at least $500,000 during the year; (iii) at any time during the calendar year, property in Ohio with a value of at least $50,000 (with leased property deemed to have a value for this purpose of 800% of the annual net rental charge); or (iv) at least 25% of its total property, payroll, or sales in Ohio during the year.

Computation of the Tax

The CAT has a bifurcated structure. Assuming the tax- payer does not qualify for the De Minimis Exception, the first $1 million of taxable gross receipts are subject to a flat tax of $150. The tax rates that apply to taxable gross receipts in excess of $1 million are as follows:

Taxable Gross Receipts

The CAT applies to receipts that are (i) "gross receipts" and (ii) sourced to Ohio. In computing gross receipts, a taxpayer must use the same method of accounting it uses for federal income tax purposes. The term "gross receipts" means the total amount realized, without reduction for cost of goods sold or other expenses, from activities that contribute to the production of income (including receipts from transactions with related corporations unless an election is made to file as a "consolidated elected taxpayer" as discussed below). However, certain specified types of receipts are excluded from gross receipts, including the following:

• interest income (other than interest on credit sales);
• dividends or distributions from corporations, and the distributive or proportionate share of receipts or income of a pass-through entity;
• receipts from the sale of capital assets (as defined in Internal Revenue Code §1221) or assets the seller has used in the seller’s trade or business (as defined in Internal Revenue Code §1231);
• proceeds attributable to the repayment of a loan, bond, mutual fund, certificate of deposit, or marketable instrument;
• compensation received or to be received by an employee for services rendered;
• contributions to capital or proceeds from the issuance of taxpayer’s own stock, options, warrants, puts or calls, or from the sale of treasury stock;
• gifts, charitable contributions, or membership dues received;
• sales and use taxes and excise taxes on the sale of gasoline, cigarettes, motor fuel, and alcohol collected by a vendor; and
• the sale, at various stages, of motor fuel.

Gross receipts generally are considered as arising from Ohio sources in connection with (i) the rental of real estate and the sale of real estate held for sale in the ordinary course of business, if the real estate is located in Ohio; (ii) the rental of tangible personal property, and the sale of tangible personal held for sale in the ordinary course of business, if the property is received by the purchaser in Ohio; (iii) the sale or license of intellectual property (generally to the extent the amount paid is based on use of the property in Ohio); (iv) the sale of services to the extent of the ratio of the purchaser’s benefit in Ohio to the purchaser’s total benefit every- where; and (v) the sale of transportation services by a common or contract carrier in proportion to the mileage traveled in Ohio to the total mileage traveled. The Bill includes a provision authorizing the Tax Commissioner to promulgate rules with alternate sourcing rules for persons engaged in similar business or trade activities and allows a taxpayer to contend that the otherwise applicable sourcing rule does not accurately represent the person’s Ohio gross receipts.

Combined and Consolidated Returns

The CAT treats all entities having more than 50% of their ownership interests owned or controlled "through related interests" as one "combined taxpayer" for the purpose of applying the De Minimis Exception and the $1 million threshold beyond which the flat tax no longer applies. All gross receipts from transactions between the members of the "combined taxpayer" are taxable unless the members thereof elect to be treated as a "consolidated elected taxpayer." If the election is made, it must be made with respect to all entities that qualify for inclusion in the consolidated elected group. The election has the effect of exempting all sales between members of the consolidated elected group, but also means that all members are deemed to have nexus with Ohio and are thereby subject to the CAT.

Tax Credits

The CAT provides for five types of credits: (i) a nonrefundable jobs retention credit, (ii) a nonrefundable credit for qualified research expenses, (iii) a nonrefundable credit for research and development loan payments, (iv) a nonrefundable jobs creation credit, and (v) a credit allowed in connection with a qualifying Ohio net operating loss carryover under the Ohio franchise tax (available starting in 2010).

Corporate Franchise Tax Provisions

The Bill phases out the corporate franchise tax for all corporations other than banks and financial institutions, insurance companies, and certain other entities excluded from the CAT. As the franchise tax is being phased out, a taxpayer subject to the franchise tax would pay the greater of the minimum tax or the amount of tax otherwise due reduced by a specified percentage. The specified percentage is 20% for 2006, 40% for 2007, 60% for 2008, 80% for 2009, and 100% for 2010. The Bill would also phase out the pass-through entity tax with respect to most corporate owners of an interest in a pass-through entity, reducing the applicable rate by 20% from its current rate for the 2005 tax year and each year thereafter until the tax is eliminated with respect to most corporations in 2009.

The Bill provides that the credit against the franchise tax for the purchase of new manufacturing machinery and equipment is not available for any equipment purchased after July 1, 2005 and provides that no taxpayer may take the credit against the franchise tax for any tax year ending on or after July 1, 2005. Any existing credits under the program are to be converted into grants administered by the Department of Development that can be applied against the franchise tax.

The Bill permits an entity that will become subject to the CAT to claim a credit against the CAT beginning with the 2010 tax year for its unutilized Ohio franchise tax net operating loss carryovers which are in excess of $50 million and meet certain requirements.

Personal Property Tax Provisions

As described below, the Bill phases out the tax on tangible personal property except for property owned or leased to a public utility (for this purpose, a telephone, telegraph, or interexchange telecommunications company is not a public utility). The timing of the phaseout differs with respect to different types of property

The Bill exempts from the property tax all manufacturing equipment first used by a manufacturer in business in Ohio on or after January 1, 2005. For inventory and all other property used by a business other than a public utility, the Bill maintains the current assessment rates for the 2005 tax year (25% for most property) and reduces those rates to 18.75% for the 2006 tax year and further reduces the rates by 6.25 percentage points each tax year thereafter, so that the assessment rate for 2009 and thereafter is 0%.

The Bill also phases out the tangible personal property tax with respect to property of a telephone, telegraph, or interexchange telecommunications company, beginning with the 2007 tax year. The assessment rate for such property is 20% for 2007 and decreases five percentage points each year until the assessment rate reaches 0% in 2011.

For an electric company other than a rural electric cooperative, the Bill reduces the assessment rate for transmission and distribution equipment from 88% to 85% and for all other property from 25% to 24%, effective for the 2006 tax year and thereafter. Property owned or lease to rural electric cooperatives will continue to be taxed as under current law.

The Bill also eliminates the property tax exemption for patterns, jigs, dies, and drawings for electric utilities other than rural electric cooperatives, effective with the 2006 tax year.

Sales and Use Tax Provisions

The Bill makes the state-wide sales and use tax rate 5.5%, effective July 1, 2005. The rate had been 5% until 2003, when the rate was increased to 6% for the period ending June 30, 2005. Under continuing law, local governments have the right to impose additional sales and use taxes.

The Bill provides that the discount for promptly remitting sales tax collections remains at 0.9% of the amount shown as due on the sales tax return through June 30, 2007. The applicable rate had been 0.9% but was scheduled to return to 0.75% on July 1, 2005.

The Bill repeals the current law sales tax exemption for sales of investment metal bullion and investment coins and creates new sales tax exemptions for (i) sales by a telecommunications service vendor of 900 services other than "information services" to a subscriber and (ii) value-added, non-voice data services.

If a party desires to claim a sales tax exemption in connection with the purchase of digital goods, computer software (other than software delivered to a customer at the vendor's place of business), or a service, and intends at the time of the purchase to use such digital goods, software or service at locations in more than one jurisdiction, the Bill provides a special sourcing rule and requires a purchaser asserting a sales tax exemption to provide a sales tax exemption certificate claiming multiple points of use.

The Bill also clarifies the sourcing rules for prepaid telephone service and prepaid cellular telephone service and establishes detailed sourcing rules for "private communications service," which is defined as a service that entitles a customer to exclusive or priority use of a communications channel or group of channels between or among termination points.

Real Property Tax Provisions

The Bill eliminates the 10% "rollback" in real property taxes for all real property other than property used for farming, property leased for farming, and one, two, or three-family dwellings, effective for the 2005 tax year.

The Bill removes the sunset date on the authority of cities, townships, and counties to create one or more tax incentive financing districts (an "Incentive District") and declare improvements within an Incentive District exempt for a period of time to the extent of a designated portion of the subsequent increase in assessed value. Under prior law, these authorities had the power to create an Incentive District, but only through June 30, 2007. However, the Bill also provides that such authorities may not adopt an ordinance or resolution that creates an Incentive District if more than 25% of the taxable value in such jurisdiction is already subject to an exemption in connection with an Incentive District. Under certain conditions, this limitation will not apply to an Incentive District created by an ordinance or resolution adopted by a city, township, or county prior to January 1, 2006.

The Bill also provides that the consent of the county (in the case of an Incentive District created by a city or township) or the city or township (in the case of an Incentive District created by a county) must be obtained if the proposed exemption exceeds 75% of the increase in value or will last more than 10 years. Under continuing law, the consent of the school district must also be obtained for an exemption that exceeds the specified thresholds.

Other Tax Provisions

The Bill increases certain taxes on tobacco products from $0.55 per pack to $1.25 per pack.

The Bill creates a tax amnesty program, to be open from January 1, 2006 to February 15, 2006, under which taxpayers who voluntarily pay certain outstanding state taxes, personal property taxes, and school district income taxes are not required to pay penalties and are excused from paying 50% of the otherwise applicable interest.

The grain handling tax is phased out, reducing the tax rates in half in 2006 and eliminating the tax in 2007.

For More Information

Please contact Jim Balthaser, Thomas E. DeBrosse, J. Shane Starkey, or William R. Stewart or any member of our Tax practice group for more information.

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