Ohio Reforms Its Local Income Taxation

I remember having to quickly ramp-up on local taxes after moving to Cincinnati. I grew up in Florida, which has no state or local individual income taxes. We moved here from Georgia, which has a state but no local income taxes. I did not realize at the time that I was moving to a region which has approximately 80% or more of all the local income taxes in the nation – Ohio, Indiana, Pennsylvania and Kentucky.

The Kentucky local individual taxes are – for the most part – occupational taxes. If you do not work in one of those counties or cities, you generally do not have to worry about it. I live in Kentucky, for example, but I pay no Kentucky local income taxes. I do not work in Kentucky.

Indiana has county taxes, but they are filed with the state individual income tax return. Think of it as a “piggy-back” tax.

Ohio had to be different. For one thing, Ohio cities tax their residents, meaning that – if you live within the city – you have yet one more tax return to file. It doesn’t matter whether you work there (in contrast to Kentucky), and in many cases you have to file a return whether you owe tax or not. You might not owe tax, for example, if the city allows (at least some) credit for the local taxes paid to the city where you work (for example, if you live in a suburb but work downtown).

Add to this that each city has local autonomy to determine its taxable base, within the limits of Ohio law. One city could tax supplemental retirement benefits (SERPs), while another would not. One city could allow you to carry over a net operating loss (NOL) to future years, while another city would not.  Even if the city allowed an NOL, your city might allow a carryover of five years, while another would allow only three.

Even for a tax pro, it is a pain.

On December 19, 2014 the Governor signed a bill that promises to bring some standardization to the wild west of Ohio local income taxation. It is called the Ohio Municipal Income Tax Reform Act, and it will be effective for tax years beginning on and after January 1, 2016. The delay was intentional, as tax forms may need to be redesigned and instructions updated. A tax bill signed in December does not leave much time for that. 

Let’s go over the high points:

(1) The calculation of local taxable income will begin with federal adjusted gross income. The adjustments to federal AGI have been significantly standardized and include, for example, interest, dividends and capital gains.

NOTE: There are two cities in Ohio that start with Ohio adjusted gross income (from the Ohio state income tax return). Those two do not have to change to the new law. One of them is in Cincinnati and rhymes with Indian Hill. The effect for residents of Indian Hill is to tax their interest, dividends and capital gains. 

(2) Partnerships and LLCs will be taxed at the entity level only. Partners and members will subtract this income (as an adjustment under (1) above) when calculating their city tax.

That leaves Subchapter S shareholders to discuss.

(3) Subchapter S corporations will also be taxed at the entity level.

In addition, S shareholders may also continue to be taxed at the individual level if they live within 119 selected municipalities.

OBSERVATION: Obviously not as good as the rule for partnerships and LLCs. Why the difference? Who knows.          

(4) Losses from a passthrough entity (that is, a partnership, LLC, Subchapter S or (unlikely) a trust) may offset self-employment, rental, royalty and farming income. The reverse is also true.

(5) Net losses from (4) however cannot offset wages and salaries.

(6) Employee business expenses (that is, “Form 2106” expenses) will be deductible to the extent deducted for federal purposes.

(7) Ohio cities will have to limit their consideration of “domicile” to 25 common law-type tests. The cities are not permitted to add to these 25 tests.

NOTE: This is the “snowbird” test. I have had cities tell me they do not recognize snowbirds. A house there means you are taxed there, whether you spend much time at the house or not.

(8) An employee or sole proprietor is allowed to go into and out of a city for up to 20 days without triggering withholding for that city’s income tax.

NOTE: The previous threshold was 12 days. Notice that we are discussing withholding taxes only. A city may still contact a business for business income taxes if it spots business vans and work trucks stopping within the city.

(9) Pensions are not taxable.

NOTE: SERPs are considered to be wages, not pensions. SERPS are deferred compensation plans, usually funded exclusively by the employer. The tax reporting for a SERP is done on Form W-2 - the same reporting as one's wages or salary - so the cities take the position that SERPs are wages and not pension income.

(10)        Returns will be due (for a calendar year taxpayer) on April 15.

(11)        The returns will be automatically extended if a federal extension is requested.

(12)        Estimated individual income taxes will be required only if the estimated tax due is $200 or more.

(13)        Any tax due (before withholdings or estimates) of $10 or less will be reduced to zero.

NOTE: You still have to file the tax return, though.

(14)        Any interest due will charged at the federal rate plus 5% (Ohio’s rate is federal plus 3%).

(15)        Net operating losses are standardized.

a.     Beginning January 1, 2017 all cities will allow a uniform 5-year carryover (with a phase-in).

b.     Earlier NOLs will be permitted as allowed by pre-change city law.

c.      City NOLs will be calculated using federal limitations such as passive activity, basis or at-risk limitations.

NOTE: This is a subtle but very significant change – in favor of the cities.

(16)        Certain administrative changes, such as requiring the cities to send out an assessment notice -clearly marked “ASSESSMENT” – before they can change your numbers on the city return.

The Ohio Society of CPAs was an outspoken advocate of these changes. I am  sympathetic to arguments the cities raised, but I am nonetheless thankful for some standardization. I prepare or review local returns. I have to bill for this, as this is my profession. I have routinely seen business clients with multiple local returns where the cumulative tax is a fraction of the professional fee to prepare the returns. I submit that a tax is unfair when the preparation fee routinely exceeds any tax so raised. Call it Hamilton's razor if you wish. 

By the way, I would apply the same razor to federal and state taxes. A corollary to the razor would require Congress to reduce its revenue estimates from any proposed tax by the compliance costs (that is, the professional fees) of complying with said proposed tax. I suspect we wouldn't see as much nonsense as we presently have in the tax Code.
 

If I Had A Pony, I Would Ride It On My (Tug) Boat

If you have a business, and especially if that business has real estate, odds are very good that your tax advisor will talk to you about the “repair regulations” this filing season.

The IRS and taxpayers have spent decades arguing and going to court over whether an expenditure is a repair (and immediately deductible) or a capital improvement (which cannot be deducted immediately but rather must be depreciated over time). Eventually the IRS decided to pull back, review the existing court cases and develop some rhyme or reason for tax practice in this area. They were at it for years and years.

And now we have the “repair regulations.”

I debated whether to write on this topic, as one can leave the pavement and get lost in the weeds very quickly. It is like a romper room for tax nerds. Still, we have to at least discuss the high points.

Let’s set this up. Say that you have a tug boat. The boat is expected to last you approximately 40 years, if you maintain and keep it up. Every 4 or so years, you anchor the tug and give it a good overhaul, replace what needs replacing and rebuild the engine. This is going to cost you well over $100 grand.

Question: is this a repair (hence deductible) or a capital improvement (not immediately deductible but depreciable over time)?

It is not immediately clear. This costs a lot of money, so one’s first response is that it has to be capitalized and depreciated. However, regular use of a tug presumes heavy maintenance of this kind over its life. That sounds more like a repair expense.

The IRS has introduced the concept of a unit of property. We have to base the repair versus capitalization decision on the unit of property. Is the engine the unit of property (UOP) or is it the overall boat?

The main test for UOP is “functional interdependence.” The placing in service of one thing depends on the placing in service of something else.

Well, a tug boat engine without a tug boat to put it in is not of much use to anybody, so we would say that the overall boat is the unit of property.

Progress. Do we now know whether to capitalize or deduct the engine?

Nope.

Onward.

We next climb through a fence we will call the “BAR,” which stands for

·        Betterment

·        Adaptation

·        Restoration

If you get stuck on any rung of the “BAR,” you have to capitalize the cost. Sorry.

Let’s have a quick peek at which each term means:

·        Betterment

o   You made the thing larger, stronger, more efficient.

We did not turn the thing into a “monster” tug. Let’s move on.

·        Adaptation

o   You tweaked the thing for a different use or purpose.

Nope. It’s still a tug. Can’t fly it or drive it on a highway.

·        Restoration

o   Returning the thing to a usable condition after you have run it into the ground, either because you neglected it (and it fell apart) or it just got too old.      

Doesn’t sound like it. We are not neglecting the tug in any way, and it still has many years of use left.

This is looking pretty good for our tug.

Let’s go through a few more rules, just in case.

If your CPA prepares audited financial statements for you, the IRS will not challenge your deducting something up to $5,000 as a repair as long as you did the same thing on your financial statements.  

That tug thing costs way more than $5,000. Let’s continue. 

NOTE: BTW, if you do not have an audit, the IRS drops that dollar limit down to $500.

If we are talking about “materials and supplies,” the IRS will not challenge your deducting something as long as it costs $200 or less. Fuel for that tug would be considered “materials and supplies.” 

That tug work blew past $200 like it was standing still. Let’s proceed.

If you capitalize the thing on your books and records, the IRS will not argue that you should have deducted it instead.

            Downright charitable of them. Let’s move on.

If a repair is expected to be done more than once over the life of the UOP, then the IRS will not challenge your deducting it as a repair.

Whoa. We have something here. That boat is expected to last somewhere around four decades. The heavy maintenance has to be done every so many service hours, generally meaning every three or four years. Looks like we can deduct the repairs to our tug.

Let’s dock the tugboat and briefly discuss a building. Perhaps we can see our tug from our building.

The IRS is taking the position that a building is both one unit of property and more than one unit of property.

I do not make this up, folks.

The IRS wants certain systems of a building – like its HVAC or its elevators – to also be considered a separate UOP. Let’s take an example. Let’s say that you are replacing a bunch of windows on that building. You would then evaluate whether it is a repair or an improvement by reference to the building as a whole. This is a good thing, as it would take a lot to “improve” the building as a whole. This makes it more likely that the answer will be a deductible repair.

However, say that you replace an elevator. The IRS says that you have to look at elevators separately from the overall building. We’ll, it does not take much to improve an elevator if you are just comparing it to an elevator. This is a bad thing, as it makes it more likely that the result will be a capital improvement.

BTW there is a separate test if your building costs less than a $1 million when you bought it. The IRS will “spot” you a certain amount before it will challenge whether something is a repair or not. It’s for the smaller landlords, but it is something.

And there you have the highlights of the repair regulations.

Depending on your fact patterns, there may be elections and forms that you have to attach to your tax return. Your tax advisor may even request that you change your underlying bookkeeping – like expensing stuff under $5000/$500 on your general ledger, for example. Some of these will require extra work, and hence additional fees, by and from your advisor.

And there is one more thing.

Let’s go back to the tugboat.

Let’s say that you did the major overhaul four years ago and capitalized the cost. You are now deducting those repairs over time as depreciation. The new rules now allow you to deduct the cost immediately as a repair. Had we only known!

Is it too late for us? Four years back is one more year than the statute of limitations permits, so we cannot go back and amend your return.

The IRS – to their credit – realized the unfairness of this situation, and it will let you go back and apply these new rules to that old tax year. The IRS calls it a “partial disposition,” and you can deduct what’s left of that capitalized tugboat repair on your 2014 tax return. It is called a “Change in Accounting Method” and is yet another multi-page form with your return, but at least you can get the deduction. But only on 2014. Let it slip a year and you can forget about it.

If any of the above rings a bell, please discuss the “repair regulations” with your tax advisor. Seriously, after 2014 you may be stuck. Tax does not have to be fair.

Lyle Lovett - If I Had A Boat 

What ObamaCare Tax Forms Should You Expect For Your 2014 Return?

Are you wondering what, if any, new ObamaCare tax forms you will either be receiving in the mail or including with your tax return come April?

This was a topic at a tax seminar I attended very recently. What may surprise you is that the ObamaCare tax forms are still in draft; yes, “draft,” and I am writing this in the middle of December.

Let’s go over the principal tax forms you may see and how they fit into the overall puzzle. The 2015 filing season will be the initial launch, and some rules have been relaxed or deferred until the 2016 filing season. This means you may or may not see or receive certain forms, depending upon the size of your employer and what type of insurance is offered. Let’s agree to speak in general terms and not include every technicality, otherwise we will both be pulling out our hair before this is over.

The key form (I suspect) you will receive is Form 1095-B.

Form 1095-B

You will be receiving the “B” from the employer’s insurance company. Its purpose is to show that you had health insurance (“minimum essential coverage” or “MEC,” in the lingo), as failure to have health insurance will trigger a penalty. The form has four parts, as follows:

(1) The name and address of the principal insured person (probably you)

(2) The name and address of the employer

(3) The name and address of the insurance company

(4) The name and social security number of every person covered under the policy for the principal insured person. There are boxes for all 12 months, as the ObamaCare penalty is a month-by-month calculation.

What if your employer did not provide health insurance and you purchased coverage on the exchange? Now we are talking Form 1095-A, and the exchange will send it to you. It has three parts:

(1) The name of the principal insured person, as well as information about the marketplace itself and some policy information.

(2) The names and social security numbers of those covered under the policy.

(3) Monthly information, such as the premium amount and the amount of any subsidy (“advance payment”) received.

Form 1095-A

You will have received this form because you or a family member obtained health insurance through the exchange. You already know that the principal insured person (likely you) has to settle up with the IRS at year-end, comparing his/her household income, any subsidy received and any subsidy actually entitled to. The information on the “A” will – in turn – be reported on that form, which we will discuss in a minute.

We still have one more “1095” to talk about: the 1095-C. Frankly, I find this one to be the most confusing of the three.

Form 1095-C

The employer issues the “C.” Not all employers, mind you, only the “large employers,” as defined and subject to the $2,000/$3,000 penalty for not offering health insurance or offering health insurance that is not affordable.

You will not receive a “C” in 2015. Rather, you will receive one in 2016 if you were a full-time employee anytime during 2015. It can be included with your 2015 W-2, should your employer choose.

It has three parts:

(1) Employee and employer information, including identification numbers and addresses

(2) Recap of insurance coverage offered the employee, detailed for each month of the year. There are a series of codes to fill-in, depending upon a matrix of minimum essential coverage, minimum value, affordability and availability of family coverage.

(3) The third part applies only if the employer is self-insured.

BTW, you may have read that there is 2015 transition relief for employers having between 50 and 99 employees. That applies to the penalty, not to filing this paperwork. An employer with between 50 and 99 employees still has to file the “C.” You will receive this form in 2016 - if your employer has at least 50 employees.

NOTE: The IRS has said that employers can file this form “voluntarily” in 2015 for the 2014 tax year. Uh, sure.

Let’s recap. You would have received the “A”or “B” from a third party and (unlikely) a “C” from your employer. You now have to prepare your individual tax return. What new forms will you see there?

If you acquired insurance on an exchange, you will receive Form 1095-A. You will in turn use information from the “A” to complete Form 8962. Since you are on an exchange, you have to run the numbers to see if you are entitled to a subsidy. Combine this with the possibility that you received an advance subsidy, and you get the following combinations:

(1) You received a subsidy and it is exactly the subsidy to which you are entitled. I expect to see zero of these in my practice.

(2) You received a subsidy and it is less than you are entitled to. Congratulations, you have won a prize. Your tax preparer will include the difference and your tax refund will be larger than it would otherwise be.

(3) You received a subsidy and it is more than you are entitled to. Sorry, you now have to pay it back. Your refund will be less than it would otherwise be.

(4) You received no subsidy and you are entitled to no subsidy. I expect this to be the default in my tax practice. I suspect that we will not even have to file the form in this case, but I am waiting for clarification.

What if you did not have insurance and you did not go on the exchange? There are two more forms:

(1) If you have an exemption from buying insurance, you will file Form 8965. You have to provide a reason (that is, an “exemption”) for not buying health insurance.

(2) All right, technically the next one is not a form but rather a “worksheet” to Form 8965. The difference is that a worksheet may, but does not have to be, included with your tax return. A “form” must be included.

Form 8965

Form 8965 Instructions and Worksheet 

You are here if you did not go on the exchange and you do not have an exemption. You will owe the ObamaCare penalty, and this is where you calculate it. The penalty will go from here to your Form 1040 as additional taxes you owe.

And there you have it.

By the way, expect your tax preparation fees to go up.