News and Analysis
The Tax Benefits of Being a Good Corporate Citizen
Slow-moving inventory is easy enough to discount or liquidate, but there’s another option that can give you more of a benefit: donate that stock or computer equipment to charity.
In general, when you donate inventory or property used in your business, your write-off is limited to the cost of the items or property. But under a special provision, corporations are allowed a higher deduction for gifts to organizations that serve the “ill, needy or infants.”
In this case, a C corporation can deduct the cost of the donated inventory, plus half the difference between the cost and the selling price. The limit under this provision is a deduction of up to twice the cost of the items. In some cases, the deduction is worth more to a corporation than what could be gained through liquidation or discounting. (S corporations, partnerships and sole proprietorships are limited to a straight cost deduction.)
In addition to the inventory tax break, another law provides similar benefits for donations of computer technology to primary and secondary schools.
One clearinghouse that handles distributing inventory to qualified charities is the National Association for the Exchange of Industrial Resources. For more information, go to www.NAEIR.org.
For more details about this tax break, contact your tax adviser.
From OMA Connections Partner, GBQ Partners LLC
Ruling Supports Tax Reform
Last Friday a Franklin county judge ruled in favor of Ohio’s new Commercial Activity Tax (CAT) against a challenge brought by the Ohio Grocers Association.
The CAT was an important component of the business tax reform that occurred in 2004 and was strongly supported by the OMA. The creation of the broad-base, low-rate CAT made possible the elimination of punitive taxes on investment and corporate income, and provided for personal income tax reduction in all brackets.
The Grocers generally seek exemption from the tax and argued the CAT was unconstitutional because the Ohio constitution prohibits the levying of an excise tax on the sale food. In Judge John Bessey’s decision, he affirmed the position of the Tax Department that the CAT is not an excise tax, but is instead a “privilege (to do business) tax”. See analysis on the decision by OMA Tax Counsel, Mark Engel, of Bricker & Eckler. This week the Grocers announced they will appeal the decision. A court ruling in favor of the grocers threatens the broad tax base which could drive up tax rates for manufacturers and other businesses.
Court Rules Ohio CAT Is Not An Excise Tax On Sales Of Food
On August 24, 2007, the Franklin County Court of Common Pleas issued a decision that rejected the arguments of a group of Plaintiffs that the Ohio Commercial Activity Tax (“CAT”) was an excise tax imposed on the sale of food in violation of the Ohio Constitution. Rather, the Court concluded the CAT was imposed upon all businesses for the privilege of doing business in Ohio. Ohio Grocers Association, et al. v. Wilkins, No. 06CVH02-2278 (Franklin Comm. Pleas, Aug. 24, 2007).
Legal Background: The Commercial Activity Tax was enacted by the Ohio in 2005 as part of a sweeping tax reform effort. The CAT is imposed upon the gross receipts of virtually all business activity in the State. Persons with annual gross receipts under $150,000 pay no tax; persons with annual gross receipts between $150,000 and $1 million pay a flat tax of $150; and persons with annual gross receipts in excess of $1 million pay $150, plus the product of .26% and annual gross receipts in excess of $1 million.
Section 3(C), Art. XII of the Ohio Constitution prohibits the imposition of an excise tax on the purchase of food for human consumption off the premises where sold. Section 13, Art. XII, imposes a similar proscription against excise taxes on ingredients and packaging for food.
Plaintiffs’ Arguments: In early 2006, a group of plaintiffs, headed by the Ohio Grocers Association, challenged the validity of the CAT on the basis that it was really an excise tax imposed on the sale of food, food ingredients, and packaging in violation of Sections 3(C) and 13 of Article XII. The plaintiffs contended that on its face and in operation and effect, the CAT was really a sales tax in disguise. As applied to the sale of food, it violated these two provisions.
The Tax Commissioner claimed the tax was not a sales tax, but rather was a tax imposed upon all business entities for the privilege of doing business in Ohio. As such, it was not an excise tax, but rather was a franchise tax. Even if it were an excise tax, the official claimed the tax was measured on gross receipts during a specified period, and not on individual transactions. In fact, it was impossible to determine the liability of a business for the tax with respect to any particular customer or transaction. As such, it was not a tax imposed upon an underlying component of the business, or on the transaction constituting the sale of food.
Court’s Decision: First, the Court determined the CAT was an indeed an excise tax. An excise tax is a tax that is imposed in exchange for some special privilege or immunity granted to some artificial or natural person. By its very terms, the CAT is characterized as a tax imposed upon the privilege of doing business in Ohio. Therefore, while the CAT is indeed a franchise tax, a franchise tax is merely a type of excise tax.
However, being an excise tax was not fatal to the CAT. The Court recognized that the privilege being taxed was not the sale of food or packaging for food. Rather, the tax was imposed upon the general privilege of doing business. Citing several decisions of the Ohio Supreme Court, the Court repeated the rule that an excise tax on the privilege of doing business did not turn the levy into a tax on some underlying component of the business. Therefore, the fact the tax was measured in part by gross receipts from the sale of food did not mean that the CAT was an excise tax imposed upon the sale of food.
The Court then turned to the claim that regardless of its name, the CAT was, in practical effect, a traditional sales tax. The plaintiffs claimed the economic incidence of the tax was the ultimate purchaser and was measured by gross receipts received from the sale of food. The Court disagreed. It noted the CAT is calculated on gross receipts over a specified period of time and does not relate to any single purchaser or transaction. While the cost of the tax may ultimately be passed to the customer in the form of a higher price, the person legally liable for the tax was the business entity. That the economic cost might be passed on to a customer is true for any tax that is imposed upon a business. Such indirect impact did not convert the incidence of the tax to the consumer.
Comments: Many critics of the CAT acknowledge that on is face, the CAT appears to be an excise tax on the privilege of doing business. However, those same critics urge that in effect, the CAT is really a sales tax. It was this latter factor that served as the basis for the litigation in this case. In this first review of the issue, the court rejected that argument and sided with the Tax Commissioner. However, there will undoubtedly be more rounds to this battle before a final decision is reached. According to published reports in the news media, an appeal is planned. From OMA Connections Partner, Bricker & Eckler LLP
Tax Provisions of Small Business and Work Opportunity Tax Act of 2007
On May 25, President Bush signed the Small Business and Work Opportunity Tax Act of 2007 (the “Act”). The Act provides small business tax relief in connection with an increase in the federal minimum wage. From OMA Connections Partner, Thompson Hine LLP
Levin Offers Compromise on Destination Sourcing Bill
Tax Commissioner Rich Levin testified Wednesday that SB160 proposes to do what four other bills approved by General Assembly have done before: delay destination sourcing. Specifically, SB160 “would stop Ohio’s conversion to destination based sourcing for in-state transactions.
“Unfortunately,” he added, “if that is done it would probably take us out of compliance with the Streamlined Sales and Use Tax Agreement (SSUTA).”
He went on to explain to the Senate Ways and Means and Economic Development Committee that Ohio is currently an associate member of SSUTA but faces a Jan. 1, 2008 deadline to be in full compliance with the streamlined sales tax agreement or the state will no longer be a member.
The sole remaining compliance issue for Ohio is sourcing. “You [the General Assembly] have already made many of the difficult decisions,” Levin said. He said there are “two important reasons” for Ohio to remain part of the streamline sales tax efforts: “fairness and revenue.” The fairness issue revolves around placing Ohio-based companies on an equal footing with companies not based in the state. Currently, “out-of-state sellers” have “an unfair price advantage … in competing with Ohio-based businesses” who must charge Ohio sales tax.
In addition, Ohio is losing revenue and, while difficult to estimate, Levin said his staff believes “state and local governments are currently losing somewhere between $350 million and $400 million annually due to remote sales.”
Levin said his staff has been working with Sen. Ron Amstutz (R-Wooster), chief sponsor of the bill and chair of the Senate Ways and Means Committee and with Rep. Bob Gibbs (R-Lakeville), chair of the House Ways and Means Committee and sponsor of the companion bill, HB165, on an alternative to the provision in both bills stopping conversion to destination based sourcing for in-state transactions.
He outlined the three-part alternative which he explained would not only have to be accepted by the General Assembly but also by Streamline Sales Tax (SST) Governing Board. Passage of the alternative, Levin said, would “create a credible option to get the SST Governing Board to listen to Ohio’s concerns and find a permanent solution to solving Ohio’s sourcing problem as it relates to retailers that make a de minimus amount of delivery sales.
“I believe that the proposal … will provide us with a permanent solution and that it has a reasonable chance of acceptance by the SST Governing Board,” Levin added. He said he has already started making calls seeking support. He also pointed out that, of the states that are members or associate members, Ohio is the largest. “It will be a big deal if we leave.”
According to Levin the proposal has three components:
• Ohio in-state vendors with less than $500,000 in annual delivery sales are given the option to continue to collect on the tax rate in effect at the business location.
• Out-of-state sellers with less than $500,000 in annual delivery sales are given the option to collect Ohio sales tax using the lowest combined state and local tax rate in the state (currently 5.5 percent plus .5 percent = six percent).
• Ohio in-state vendors and out-of-state sellers with more than $500,000 in annual delivery sales will be required to collect taxes from their customers based on the state and local sales tax rate in effect at the delivery location of the customer (destination sourcing).
He estimated that this latter provision would affect less than 5,000 of 135,000 Ohio businesses that pay sales tax.
He also noted that the use of the “lower than average tax rate may have a limited negative impact on revenue distributed to the counties, so we are committed to working with county commissioners and the members of the General Assembly to ensure a fair distribution of the tax collected by the remote sellers using this procedure.”
Levin added that, “Creating a small delivery seller exemption in state law would allow Ohio to seek an amendment to the national agreement without taking us completely out of compliance.
“Considering that the Ohio General Assembly has already made a number of difficult decisions to conform Ohio law to the agreement, I submit that we should remain committed to achieving the shared goal of leveling the playing field for Ohio’s businesses by making it possible to collect sales tax from remote sellers (out-of-state companies).”
Asked about this proposal, former Senate president and former chair of the Senate Ways and Means Committee Richard Finan called it “better than nothing.” Finan, who had been a member of the SST Governing Board, said that one problem is that “as a simplification measure, it doesn’t cut it.”
He added, “If we don’t do this, there will be huge revenue losses.
“Ohio is going to have to make the switch sometime. The only question is when. [Big] businesses will talk with the federal government and force Ohio to do it.”
The preceding article is an excerpt from The Hannah Report, Ohio’s daily legislative newsletter providing independent, timely and comprehensive coverage of state government. For more information, please contact Hannah News Service at 614.228.3113. From Hannah News Service
New Tax Law: Who Wins and Who Looses
Minimum Wage Goes Up
Under the new law, the hourly minimum wage will increase from $5.15 to $7.25 over the next two years according to this schedule:
1. The first increase to $5.85 will go into effect on July 24, 2007 (60 days after the bill was signed into law).
2. Next, the minimum wage will rise to $6.55 one year later.
3. The final increase will occur two years later in July of 2009, when the minimum wage will rise to $7.25.
Congress last raised the minimum wage in 1997.
Keep in mind that federal and state laws require employers to display posters with current minimum wage information.
Important Changes Affecting Businesses
On May 25, President Bush signed a wide-ranging law that increases the federal minimum wage and gives businesses some important tax breaks to help offset the cost. The minimum wage hike and tax provisions were attached to legislation funding the war in Iraq.
While parts of the new law will benefit businesses, other parts will hurt families who are saving money in the names of their children because of a critical change in the “Kiddie Tax” rules. College students are potentially exposed to the tax until the year they turn 24. This is one of the ways that the new law funds the tax breaks for businesses.
In a series of articles, we will detail the highlights of the Small Business and Work Opportunity Tax Act of 2007. Here are six changes affecting businesses:
Section 179 Deduction
One lucrative provision in the new law for businesses is an increase in the “Section 179” first-year depreciation allowance for equipment and software. Under this tax break, you can immediately deduct 100 percent of the cost of most new and used business assets other than real estate.
The new law extends the current favorable Section 179 deduction rules through the 2010 tax year and makes some favorable changes as well:
• Maximum Deduction Increased to $125,000. For tax years beginning in 2007, the maximum Section 179 deduction is generally increased to $125,000 (up from the $112,000 figure that applied before the new law). For tax years 2008 through 2010, the $125,000 amount will be indexed for inflation.
• Liberalized Phase-Out Rules. If a taxpayer adds qualifying property (typically equipment and software) in excess of the annual threshold, the maximum Section 179 deduction for the year gets reduced (phased out). For tax years beginning in 2007, the phase-out threshold is generally increased to $500,000 of qualifying property (up from the $450,000 threshold that applied before the law). The $500,000 amount will be indexed for inflation for tax years 2008 through 2010.
• Most Software Qualifies for the Deduction. The provision that allows Section 179 deductions for the cost of most off-the-shelf software products is extended through the 2010 tax year.
• Favorable Amended Return Rules Extended. A provision that allows Section 179 elections to be changed or revoked on amended returns is extended through tax years beginning in 2010.
Key Point: Unless Congress takes further action the unfavorable “old-law” rules will kick back in starting with tax year 2011. Under the old-law rules, the maximum annual Section 179 deduction will fall back to $25,000. The deduction phase-out threshold will decrease to only $200,000. Software costs will be ineligible, except for software that is bundled with qualifying hardware. Finally, taxpayers will not be allowed to change or revoke Section 179 elections on amended returns.
Work Opportunity Tax Credit
The Work Opportunity Tax Credit is intended to give employers a tax incentive to hire members of certain targeted groups of people, such as veterans, high-risk youths and welfare recipients. Unfortunately, the rules are very complicated.
In a nutshell, the credit amount is generally based on a limited amount of wages paid to qualified employees for limited periods. It was scheduled to expire for wages paid to employees who begin work after 12/31/07. Now, the new law extends the Work Opportunity Tax Credit for an extra 44 months to cover wages paid to qualified employees who begin work before 9/1/11. The new law also adds some new targeted groups, such as qualified disabled veterans.
Effective Dates: For wages paid to certain types of qualified employees who begin work after 5/25/07 and more generally, for wages paid to qualified employees who begin work after 12/31/07.
Employer Tip Credit
Under tax law, employers can receive a business tax credit for their portion of Social Security and Medicare taxes (collectively referred to as FICA) paid on employee cash tips, which are in excess of amounts used to meet federal minimum wage standards. The Small Business and Work Opportunity Tax Act includes a provision to ensure that the employer tip credit won’t be reduced when the federal minimum wage goes up, which is scheduled to happen in stages over the next two years.
Effective Date: For tips received on services performed after 12/31/06.
Limited AMT Relief
The Small Business and Work Opportunity Tax Act includes a new provision that allows both individual and corporate alternative minimum tax (AMT) liabilities to be reduced by the Work Opportunity Tax Credit and the employer tip credit.
Effective Date: For credits generated in taxable years beginning after 12/31/06 and carrybacks of such credits.
The Small Business and Work Opportunity Tax Act made several favorable changes to the federal income tax rules that apply to businesses operating as S corporations, including banks. For an extensive discussion of these changes, click here.
Spouses in Business
An unincorporated husband-wife joint venture, which is treated as a partnership for federal tax purposes, must file an annual Form 1065 partnership return and issue each spouse a separate Schedule K-1. Since partnership returns are complex, this is a tax compliance headache. The Small Business and Work Opportunity Tax Act includes a new rule that allows some husband-wife ventures to elect out of the partnership rules for federal tax purposes. To be eligible, the spouses must file jointly and the operation must be a qualified joint venture.
A qualified joint venture is a trade or business operation in which:
• The husband and wife are the only members of the venture,
• Both spouses materially participate in the venture’s trade or business, and
• Both spouses agree to elect out of the partnership tax rules for the venture.
After electing out, the spouses must separately report their respective shares of the federal income tax items from the venture on the appropriate IRS forms (for example, on separate Schedules C). Similarly, the spouses must separately report their respective shares of net self-employment income from the venture on separate Schedules SE. Each spouse will then receive credit for his or her share of the net self-employment income for Social Security benefit eligibility purposes.
Effective Date: Tax years beginning after 12/31/06.
(In a future article, we’ll explain how these new tax breaks will be paid for — in the form of tax increases on wealthy families, penalties on people who don’t comply with IRS rules and more.)
Gulf Opportunity Zone
The new law includes provisions that:
• Extend enhanced Section 179 deductions for qualified property in the Gulf Opportunity Zone (GO Zone), which includes areas devastated by Hurricanes Katrina and Rita.
• Extend and expand special low-income housing credit rules for the GO Zone.
• Establish special tax-exempt bond financing rules for loans to repair and reconstruct residences in the GO Zone.
House To Ban Public Investment In Global Companies
Members of the House Financial Institutions Committee have continued hearings on legislation that would prohibit public investment in certain global companies with business ties in Iran. A substitute version of House Bill 151 was offered that will only apply to foreign domiciled companies in the energy industry.
While the OMA recognizes the good intentions behind the legislation, OMA advocacy staff continues to express concerns over precedent that this type of ban creates. Additionally, questions have arisen, most notably by the Columbus Dispatch (linked above), about the appropriate role of state legislators in the foreign policy arena.
Dispatch Editorial on Topic
Pension Board Urged To Shun Iran
Substitute Version of HB 151
Unanimous House Vote on Budget May Predict Senate Action
Signaling what may be the Senate Republicans’ approach to the proposed FY08-09 budget, Sen. John Carey (R-Wellston), chair of the Senate Finance and Financial Institutions Committee, reminded Ohio Department of Job and Family Services Director Helen Jones-Kelley, who had spent a good part of her testimony seeking restoration of a wide range of cuts to her department by the House, that “there was broad consensus for this budget in the House.”
She replied that efforts still need to be made to restore cuts to the governor’s proposal which she had earlier characterized as a “complete package,” urging legislators not “to pick apart” the provisions and approaches used. Altering provisions in one area “put stress” on others.
Along those lines, Sen. Gary Cates (R-West Chester) commented that the committee doesn’t have the money to restore the cuts, meaning “it needs to be taken from somewhere else. What would be the position of the administration if we were inclined to take it from the $50 million/year added for nursing home reimbursement?”
She answered that the administrative is very concerned about this House addition, explaining that it “contravenes legislative action in HB66-126,” “negating a key provision of the pricing model … that will delay the progression of nursing homes toward a more cost efficient and competitive environment.”
While spending the bulk of her time detailing the governor’s proposed budget, Jones-Kelley did highlight the impact of House cuts in the following areas:
• She asked that the $1.8 million cut from the child welfare budget means they “will not be able to implement recommended solutions [in Ohio’s foster care system] set forth by the Fiesel working group and recently introduced by members of the General Assembly.” (Fiesel was the foster child in Southwest Ohio whose foster parents were convicted of murder in his death.
• Jones-Kelley encouraged the Senate committee to decouple the increase in rates for child care providers from the “Step Up to Quality” rating system.
• She asked that administrative cuts for the food stamp and Medicaid programs be restored. “As both of these programs continue to experience caseload growth, this reduction in state support will further stress a system with high caseloads and high county staff turnover.”
• There were a lot of questions over the funding for the Benefit Bank, which the House cut and which Jones-Kelley said connects clients with unclaimed tax credits and public benefits for which they are eligible.
• She said cuts in Medicaid administration “jeopardizes our ability to administer existing and new initiatives … [and] may prevent the implementation of several important projects and long awaited technology improvements that the General Assembly and several oversight bodies have expressly called for such as MITS (Medicaid Information Technology System); improvements to the Data Warehouse and Medicaid Decision Support System; and Money Follows the Person initiative.”
• She repeatedly defended the administration’s desire to receive authority to prior authorize mental health drugs, estimating the cost at $47 million if they can’t.
• Jones-Kelley also noted that “the criteria utilized by the Department of Insurance that oversees and approves capitation payment rates for Medicaid managed care goes beyond the intent and will create significant costs to Medicaid.”
• Jones-Kelley urged the committee to restore eligibility cuts to expansions of Medicaid including children in households with incomes over 300 percent of poverty and working parents with incomes between 90 and 100 percent of poverty.
• A final area she stressed the need for the restoration of House cuts was in information technology systems where the $17.8 million cut jeopardizes “the deployment of the Statewide Automated Child Welfare Information System, Medicaid Information Technology System, and Benefit Eligibility System … These systems are difficult to maintain which requires a higher commitment of time and resources than would new systems in order to stay current …..” She added that it is even difficult “to hire persons with the outdated skill sets needed to operate these systems.”
Among the questions senators asked and the answers were the following:
• Carey: What is being done to make the workforce development system statewide and not determined by the regions which are dominated by bureaucrats? The Tiger Talent Team is looking at what makes sense for Ohio as we look at this “virtual merger” of DJFS and development.
• Stivers: Why isn’t the department moving forward with altering an existing contract to implement third party liability measures? Other vendors are interested and we are taking a very different approach to what is being done now.
• Cates: Shouldn’t parents earning up to 200 percent of poverty be able to afford health coverage and shouldn’t we provide better services to “the poorest of the poor?” This expansion will only serve those without insurance. We don’t know when catastrophic health issues will arise and health costs are the number one cause of bankruptcy.
• Niehaus: Are you willing to look at cost sharing for families in the 200 to 300 percent of poverty range, and use the savings to fund the low-income parents up to 100 percent of poverty? Families in the 200-300 range can still have a hard time getting coverage and under the State Children’s Health Insurance Program, enhanced federal match is available.
• Padgett: Why can’t families access both the Early Learning Initiative and child care subsidy? Looking at this with policies that relate to providing access.
• Niehaus: How will the state be able to sustain the programs expanded with TANF dollars? By jump starting these programs, they will be able to be sustained by savings at the back end.
• Padgett: Why were fatherhood initiatives not funded? Some funding has just been moved around – some programs are “not earmarked but continue in a number of other contexts.”
• Padgett: Why do you want prior authorization authority for mental health drugs? One of the tough decisions. “This will help us get control.”
• Niehaus: Why were Boys and Girls Clubs not funded as before? Another tough decision: “This is not to denigrate the value of Boys and Girls Clubs. We hope they won’t suffer because they lost some funds from us. There are other opportunities for funding.”
The preceding article is an excerpt from The Hannah Report, Ohio’s daily legislative newsletter providing independent, timely and comprehensive coverage of state government. For more information, please contact Hannah News Service at 614.228.3113. From Hannah News Service