Information Release

CF 1997-02 - Rev. 12/10/97 - Am. Sub H.B. No. 215, 122nd General Assembly (Budget Bill) Summary of Franchise Tax & Income Tax Provisions1 - September 18, 1997

Personal Income Tax

• Requires the Tax Commissioner to put the tax reduction percentage rate on the individual and estate income tax forms for taxable years beginning after December 31, 1996. ORC section 5747.08(G).
• Indexes the personal exemption to the growth in the Gross Domestic Product deflator, beginning in taxable year 2000. ORC section 5747.025(C).
• Increases the dependent care credit from 35% of the federal credit to 100% of the federal credit for individuals whose adjusted incomes are less than $20,000 (for taxable years beginning after December 31, 1996). ORC section 5747.054.
• Clarifies that the nonresident credit allocation and apportionment provisions apply only to determine the nonresident credit and the export sales credit (for taxable years beginning after December 31, 1997). ORC section 5747.21 and Budget Bill section 211.
• Makes the weighting of apportionment factors for the business income portion of the nonresident credit the same as the franchise tax weighting: property, 20%; payroll, 20%; sales, 60% (for taxable years beginning after December 31, 1997). ORC section 5747.21 and Budget Bill section 211.
• Provides for three separate nonrefundable credits that may be claimed against the individual income tax by the owners of a business that establish a day-care center, reimburse its employees for day-care expenses, or enter into an agreement to support day-care for the children of its employees (effective for taxable years beginning after December 31, 1996 but beginning prior to January 1, 2003). ORC sections 5747.34, 5747.35 and 5747.36.
• Provides that those electing to file the composite income tax return (out-of-state individuals investing in S corporations, partnerships, and LLC's taxed as partnerships) cannot claim personal exemptions or credits, cannot claim nonbusiness credits, and must pay tax at the highest rate (effective for taxable years beginning after December 31, 1997). ORC section 5747.08(D) and Budget Bill section 211.
• Extends (to December 31, 2000) the period within which to make qualifying purchases for the Manufacturer's Investment Tax Credit. ORC section 5733.33.
• Makes technical change in law establishing voluntary environmental cleanup tax credits. The bill substitutes the term "eligible area" for "economically disadvantaged area." (effective for taxable years beginning after 1997). ORC section 122.16 and Budget Bill section 212.
• Expressly states that an individual is subject to the Ohio individual income tax if the individual has nexus in or with the state under the U.S. Constitution (effective for taxable years ending after September 29, 1997). ORC section 5747.02(A) and Budget Bill section 222.
• Allows the taxpayer to request deviation from the statutory nonresident credit apportionment factors not only with the filing of the return but also with the timely filing of an amended return. Under previous law the request had to accompany the return (effective for post-1997 taxable years). ORC section 5747.21 and Budget Bill section 210.
• Codifies previous BTA decision which held that Ohio follows the "conduit theory" of income taxation for taxpayers that invest in flow-through entities (effective June 30, 1997). ORC section 5747.231 and Budget Bill sections 220 and 221.

Corporate Franchise Tax

(Unless otherwise indicated, these changes are effective for tax years 1999 and thereafter. See Budget Bill section 210.)

• Extends (to December 31, 2000) the period within which to make qualifying purchases for the Manufacturer's Investment Tax Credit. ORC section 5733.33.
• Makes technical change in law establishing voluntary environmental cleanup tax credits. The bill substitutes the term "eligible area" for "economically disadvantaged area." (effective for taxable years beginning after 1997). ORC section 122.16 and Budget Bill section 212.
• Makes various changes in the "Edison Credit" new technology credit for taxable years ending after June 29, 1997. (ORC sections 122.15(B), 122.15(D) and Budget Bill section 2²):
  • Requires that an Ohio entity have at least 50% of its gross assets and (instead of "or") 50% of its employees located in the state.
  • Replaces the "related member" test with an "insider" test . An insider is an individual owning, controlling, or holding power to five percent or more of the outstanding securities of a business.
  • Makes other minor technical changes.
• Provides for three separate nonrefundable credits that may be claimed against the corporate franchise tax for a business that establishes a day-care center, reimburses its employees for day-care expenses, or enters into an agreement to support day-care for the children of its employees (effective for the 1999, 2000, 2001, 2002 and 2003 tax years). ORC sections 5733.36, 5733.37, and 5733.38.
• Modifies the net worth tax for all C corporations, other than financial institutions, as follows:
  • Exempts qualified holding companies from paying the net worth tax (but not the net income tax). ORC sections 5733.04(L) and 5733.06(C).
  • Replaces current net worth base with a more simple base (generally, net worth = net book value of assets less net carrying value of liabilities). Under previous law a corporation (i) could deduct from net worth goodwill, appreciation, abandoned property, investment in production credit association, land in Ohio devoted exclusively to agriculture, and property within Ohio used exclusively in qualified research and (ii) had to add to net worth unearned income and deferred income taxes. ORC sections 5733.05(A) and 5733.05(C)(1).
  • Uses the net income base three-factor formula to apportion the net worth base. ORC section 5733.05(C)(3).
  • Reduces net worth tax rate from 5.82 to 4.0 mills. ORC section 5733.06(C).
  • Caps net worth tax at $150,000 for each corporation other than financial institutions. ORC section 5733.06(G).
• Apportions net income and net worth using a property-payroll-sales weighting of 20-20-60, respectively. ORC section 5733.05(B)(2).
• Reduces the top net income tax rate from 8.9% to 8.5%. ORC section 5733.06(B).
• Requires all corporations which are related members to share the lower tax rate on the first $50,000 of taxable income. ORC section 5733.06(F).
• Expands the application of the 1991 passive investment company loophole-closer to disallow corporate income reductions created by direct or indirect sales or other dispositions of accounts receivables to related entities. ORC section 5733.042(A)(3).
• Expands the application of the 1991 passive investment company loophole-closer by eliminating that portion of the law which limits the loophole-closer to affiliate groups that have sales during the taxable year of at least $50 million or have total assets whose value is at least $25 million or have taxable income of at least $500,000. ORC section 5733.042(B).
• Imposes an exit income-based tax on corporations which dissolve or withdraw from Ohio after 1997 by taxing income earned in the partial year or years of operation. ORC section 5733.06(H).
• Eliminates the provision which allows situsing of sales based on the location of the solicitation. Thus, for sales other than sales of tangible personal property, the location of solicitation will no longer control the situs of the sale, and sales other than sales of tangible personal property will be sitused based solely on "costs of performance". ORC section 5733.05(B)(2)(c)(ii).
• Codifies previous BTA decision which held that Ohio follows the "conduit theory" of income taxation for taxpayers that invest in flow-through entities. (effective September 29, 1997). ORC section 5733.057 and Budget Bill section 222.
• Amends the definition of "taxable year" to address periods involving short taxable years (effective on the ninety-first day after the Budget Bill is filed with the Ohio Secretary of State. The ninety-first day is September 29, 1997; so, the amendment is effective for taxable years ending after September 28, 1997³). ORC section 5733.031 and Budget Bill section 222.
• Adopts the federal classification of an entity for purposes of the corporate franchise tax. Any entity that is classified as a corporation for federal income tax purposes will be treated as a corporation for purposes of Chapter 5733. Under previous law an entity that was legally organized as a partnership or other noncorporate entity but treated as a corporation for federal income tax purposes (because it possessed more of the attributes of a corporation than of a partnership) was not treated as a corporation for franchise tax purposes (effective on the ninety-first day after the Budget Bill is filed with the Ohio Secretary of State. The ninety-first day is September 29, 1997; so, the amendment is effective for taxable years ending after September 28, 1997). ORC section 5733.01(E) and Budget Bill section 222.
• Expands the tax commissioner's authority to require combined reporting by repealing (in section 206 of the Budget Bill, effective June 30, 1997 per Budget Bill sections 220 and 221), the last paragraph set forth in section 162 of Amended Substitute House Bill 298, 119th General Assembly:

"For tax year 1992 and thereafter, the existence between a related member and a taxpayer of a relationship, with respect to the use of intangible property, of lessor and lessee, respectively, licensor and licensee, respectively, of creditor and debtor, respectively, or the existence between a related member and a taxpayer of any similar relationship pursuant to which the taxpayer directly or indirectly pays or accrues to a related member any expense or costs for the use of intangible property shall not by itself be sufficient grounds for the Tax Commissioner to require that the taxpayer and any such related member file combined returns. For purposes of this section, the term "related member" has the same meaning as in division (A)(6) of section 5733.042 of the Revised Code as enacted by this act."

• Expressly states that a corporation is subject to the corporation franchise tax if the corporation has nexus in or with the state under the U.S. Constitution (effective for taxable years ending after September 28, 1997). ORC section 5733.01(B) and Budget Bill section 222.
• Allows the taxpayer to request deviation from the statutory apportionment factors not only with the filing of a report but also with the timely filing of a petition for reassessment or with the filing of an amended report within the statute of limitations period. Under previous law the request had to accompany the report. ORC section 5733.05(B)(2)(d) and Budget Bill section 210.
• Extends from December 31, 1997 to June 30, 1999 the franchise tax enterprise zone benefits for taxpayers who hold a tax incentive qualification certificate. ORC section 5709.62(C).
• Limits the use of the credit for investment in qualified subsidiaries to pre-1999 tax years. ORC section 5733.067(B).

Financial Institutions

(Except as otherwise indicated, effective for taxable years ending after June 29, 1997. See Budget Bill sections 220 and 221.)

• Revises the definition of a "financial institution" to include all regulated financial institutions with the exception of credit unions, production credit associations, and similar institutions. ORC section 5725.01(A).
• Continues to exempt financial institutions from the franchise tax net income base and does not change the computation of the net worth base for financial institutions. That is, in determining the value of issued and outstanding shares subject to apportionment financial institutions may continue to exclude from net worth the same exempted assets that they were entitled to exclude under the prior law and must continue to include in net worth the same reserves that they were required to include under the previous law. ORC sections 5733.05(A) and 5733.06(D) and Budget Bill section 210.
• Apportions the current net worth base by applying the Multistate Tax Commission's proposed formula, which utilizes the sales, payroll, and property factors, but with a ratio of 70-15-15, respectively (effective for post-1997 tax years). ORC sections 5733.05(A) and 5733.056(C) and Budget Bill section 222.
• Allows a financial institution to use an alternative apportionment formula which is based on a single deposits factor, if the financial institution has at least 10% of its total deposits in Ohio and after May 31, 1997 engages in a merger under Riegle-Neal (or similar state or federal law, depending on the type of financial institution) which results in a financial institution with offices in multiple states. The alternative apportionment applies only for the 1998, 1999, 2000, and 2001 tax years. ORC section 5733.056(G).
• Reduces the millage rate from 15 mills to 14 mills in tax year 1999 and to 13 mills for post-1999 tax years. ORC section 5733.06(D).

Pass-through Entity Tax

(Effective for taxable years beginning after 1997 per Budget Bill section 211)

• Applies to S corporations, partnerships, and limited liability companies treated as partnerships for federal income tax purposes; however, the tax does not apply to RIC's, REMIC's, REIT's, and certain publicly-traded partnerships. ORC section 5733.40(N).
• Imposes a 8.5% entity level tax on pass-through entities for distributive shares of income to (i) corporations not paying the Ohio corporation franchise tax, (ii) partnerships which are themselves investors in a pass-through entity if the partnerships' ultimate owners are either corporations not paying the Ohio corporation franchise tax or nonresident individuals, and (iii) trusts which are investors in pass-through entities if the beneficiaries of the trust are ultimately either corporations not paying the Ohio corporation franchise tax or nonresident individuals. Provides for a compensating nonrefundable corporation franchise tax credit and a compensating refundable individual income tax credit equal to this 8.5% tax. ORC sections 5733.40(I), 5733.41, and 5733.0611.
• Imposes a 5% withholding tax on pass-through entities for distributive shares of income to nonresidents individuals who are investors in the pass-through entity. Provides for a compensating refundable income tax credit equal to this 5% withholding tax. ORC sections 5733.40(I), 5747.41, and 5747.059.
• Also imposes a 5% withholding tax on a trust's distribution to nonresident beneficiaries of the trust. The tax is imposed only on distributions of profit attributable to real estate located in Ohio and tangible personal property located in Ohio. Provides for a compensating refundable income tax credit equal to this 5% withholding tax. ORC section 5733.40(C).
• Requires that such pass-through entities make estimated tax payments on the fifteenth day following the end of each quarter of the pass-through entity's taxable year. The annual reconciliation return is due the fifteenth day of the fourth month following the end of the pass-through entity's taxable year. ORC sections 5747.42 and 5747.43.

Miscellaneous

• Codifies the Tax Commissioner's common law authority to apply the doctrines of "economic reality," "sham transaction," "step transaction," or "substance over form." The law requires that the Tax Commissioner bear the burden of establishing by a preponderance of the evidence that those doctrines should apply (effective for taxable years beginning after 1997). ORC sections 5733.111 and 5747.131 and Budget Bill section 211.
• Requires that the portion of an assessment not paid within thirty days after the assessment was issued shall bear interest from the day the Tax Commissioner issued the assessment until the assessment is paid. (effective for assessments issued after December 31, 1997). ORC sections 5733.11(C) and 5747.13(C) and Budget Bill section 213.
• Authorizes the Tax Commissioner to intercept any tax refund and apply that tax refund towards any other unpaid tax or fee administered by the Tax Commissioner (effective September 29, 1997). ORC sections 5733.121 and 5747.12 and Budget Bill section 222.

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¹You can access the Budget Bill on the internet at http://www.legislature.state.oh.us/. If you have additional questions about this summary, please contact Jeffrey Sherman at 614-466-5285. The Ohio Relay Service number is 1-800-750-0750.

²Generally, budget bill amendments to the Ohio Revised Code becomes effective either on the date that the legislation becomes effective or on a later date if the legislation expressly indicates a subsequent effective date. No portion of the Budget Bill indicates that the amendments to ORC section 122.15 have a delayed effective date. So, generally, the amendment would be effective on June 30, 1997 per Budget Bill sections 220 and 221. However, because of the Ohio Supreme Court's decision in Lakengren, Inc. v. Kosydar (1975), 44 Ohio St. 2d 199, any corporation franchise tax change applies only to taxable years ending on and after the effective date of the amendment. Since Governor Voinovich signed the Budget Bill on June 30, 1997, then the amended Edison Credit provisions will apply only to taxable years ending after June 29, 1997.

³Even though Budget Bill section 222 states that the amendments to ORC section 5733.031 take effect on the ninety-first day after the act is filed with the Ohio Secretary of State (the ninety-first day is September 29, 1997), because of the Lakengren decision (see footnote #1), the new legislation is effective only for taxable years ending on and after the date that the amendment becomes effective. Hence, those franchise tax amendments to the Ohio Revised Code which become effective on September 29, 1997 will apply only to taxable years ending after September 28, 1997.