1. Reviewing Business Returns and Implementing ORC 718 Changes to the Review Process
Richard Donnelly, Grove City
Robert Wright, Bowling Green
Mike Ryba, CCA
The following materials are for educational/demonstration purposes only and are not to be construed or relied upon as legal or tax preparation advice.

2. Sample Schedule X

3. Sample Schedule X

4. 1221 (Stock & Bond) Gains & Losses

5. 1231 Gains & Losses on Assets Owned for 1yr+

6. 1231 Losses on Schedule K Form 1120S Form 1065

7. Taxes: Based On Income & Other Taxes

8. Intangible Income (except 1221) Form 1120 Form 1120S

9. Intangible Income (except 1221) Form 1065 Form 1041

10. 1245 & 1250 “Depreciation Recapture”
Depreciation recapture is combined on Line 31 and subtracted from the 1231 gains for us so we don’t have to worry about them
Depreciation recapture (1245 & 1250 gains) are already removed from the amount included in Line 7… which is the line we’re picking up for Schedule X. The exception is the Section 291 adjustment which we’ll cover later.

11. Charitable Contributions on Schedule K Form 1120S Form 1065

12. Charitable Contributions on Form 1041

13. Domestic Production Activities Deduction: DPAD
Cannot Exceed 50% of the deduction for wages
Cannot Exceed 9% (for 2010+) of C-corporation federal taxable income without regard to the DPAD deduction
Make taxpayers that are not C-corporations provide a pro-forma 8903 if the municipal tax effect is material

14. Section 179 Deduction on Schedule K Form 1120S Form 1065

15. The Section 291 Adjustment to 1250 Gains
Complete Lines 25a and 25b.
Subtract Line 26g from Line 25b.
On Schedule X, the taxpayer should have reduced the 1231 gains on assets held more than one year (Line 7) by 20% of the amount calculated in Step 2 above.
If the 1250 property was acquired after to 1986, the 291 add-back is 20% of 25b since Line 26g = 0.
For federal tax purposes, only C-corporations make this adjustment.

16. Why We Don’t Worry about Guaranteed Payments
If we start with this number, the guaranteed payments have already been added back…
“Combine Schedule K, lines 1 through 11…”

17. Prohibited Health & Retirement Deductions: Partnerships
Smell Test: If there are no employees, then any employee benefits are probably misreported partner benefits.

18. Prohibited Owner’s Health Insurance Deduction: S-Corporations
Smell Test: If there are employee benefits: 1) health insurance is probably one; and 2) the officers are probably participating.

19. Apportionment of Income Between Multiple Tax Jurisdictions
Schedule Y
Apportionment of Income
Between Multiple Tax Jurisdictions

20. Sample Schedule Y

21. Zero Factor vs No Factor
Everywhere amount = 0, then no factor.
No property anywhere
No wages anywhere
Local amount = 0 but everywhere amounts are greater than zero, you have a zero factor that counts when averaging.
No local property, but property elsewhere
No local wages, but wages elsewhere

22. Everywhere Property: 1065
718.02(A)(1): taxpayers are to use the original value of property; not book value

23. Everywhere Rents Paid: 1065

24. Everywhere Wages: 1120 Cost of Labor:
May not be wages at all, but rather sub-contract labor;
May be all wages; or
May be a mix of wages and sub-contract labor.

25. Everywhere Receipts: 1120S
Whether or not you include gross rents in gross receipts depends on how your municipality treats the rental income: if it is a “business or profession”, include it in everywhere receipts. If it is “investment income”, don’t.

26. Reconciling Local Wages

27. Reconciling Wages: Fiscal Year
Slate Inc has a fiscal year-end of 3/31/09
Schedule Y reports $420,000 in local wages earned in Bedrock, Ohio
The net profit fiscal year covers the following withholding periods:
2nd Qtr 2008 $100,000
3rd Qtr 2008 $90,000
4th Qtr 2008 $120,000
1st Qtr $110,000
Total $420,000

28. Reconciling Wages
718.02(A)(2): compensation from which taxes are not required to be withheld under section are not to be included in the wage apportionment factor on Schedule Y

29. Reconciling Wages What this Means
Wages earned in your municipality under the occasional entrant rules cannot be considered for apportioning the net profit of the entity conducting business in your municipality.
Not only do you not receive taxes on the first 20 days of wages earned by the occasional entrant, but the employer does not have to report those as wages earned when calculating the wage factor on the Schedule Y.

30. Reconciling Wages What this Means
An entity qualifying as a “small employer” ( TT) who has employees earning wages in your city will not only be exempt from the withholding requirement, but will also not have to report those wages on the Schedule Y.

31. Reconciling Wages: Example 1
ABC Electric only location is in Grove City.
ABC Electric lands the contract to wire a new big box retail store in Dublin. The job takes 11 days, and is the only work performed by ABC Electric in Dublin all year.
ABC paid 15 employees a total of $40,000 in wages for the work performed in Dublin.
The employer withheld $800 in Grove City tax on those wages since Grove City was the principal place of work for all 15 employees.

32. Reconciling Wages: Example 1
When preparing its Grove City return, ABC Electric does not include the $40,000 in wages earned for work performed in Dublin as Grove City wages when calculating the wage factor. It does not matter that Grove City withholding was withheld on those wage per (C).
718.02(A)(2) requires that wages be earned “for services performed in the municipal corporation”. The services were performed in Dublin.

33. Reconciling Wages: Example 1
When preparing its Dublin return, ABC Electric does not include the $40,000 in wages earned for work performed in Dublin as Dublin wages when calculating the wage factor.
Dublin taxes were not required to be withheld on those wages under section

34. Reconciling Wages: Example 1
For both the Grove City and Dublin returns, the $40,000 in wages would also be excluded from the “everywhere” wages since workplace taxes were not required to be withheld on those wages.

35. Reconciling Wages: Example 2
XYZ Plumbing’s only location is in Trotwood.
XYZ Plumbing is a small employer.
XYZ performs 95% of work in Dayton.
XYZ withheld $2,700 in Trotwood tax on the $120,000 of wages XYZ paid in 2016.
Employees of XYZ earned $114,000 of the $120,000 of wages in Dayton.

36. Reconciling Wages: Example 2
When preparing its Trotwood return, XYZ does not include the $114,000 in wages earned for work performed in Dayton as Trotwood wages when calculating the wage factor. It does not matter that Trotwood withholding was required to be withheld on those wage per (E).
718.02(A)(2) requires that wages be earned “for services performed in the municipal corporation”.

37. Reconciling Wages: Example 2
When preparing its Dayton return, XYZ does not include the $114,000 in wages earned for work performed in Dayton as Dayton wages when calculating the wage factor.
Dayton taxes were not required to be withheld on those wages under section

38. Reconciling Wages: Example 2
For both the Trotwood and Dayton returns, the $114,000 in wages would also be excluded from the “everywhere” wages since workplace taxes were not required to be withheld on those wages.
This will produce a 100% wage factor for Trotwood ($6,000/$6,000).

39. Reconciling Wages: Example 3
Napkins-R-Us sells paper products by the truckload to institutional customers.
Katie was working at Napkins-R-Us as a non-traveling account representative when she had her baby and decided to quit to be a stay-at-home mom.
Napkins-R-Us, not wanting to loose Katie who is beloved by her assigned customers, begged Katie to work from home. Katie agreed.

40. Reconciling Wages: Example 3
Katie’s wages are not included in either the “municipal” or “everywhere” wages when calculating the wage factor.

41. Reconciling Wages: Example 3
718.02(C) excludes any wages from the wage factor calculation unless those wages are earned at a location:
owned, controlled, or used by, rented to, or under the possession of the employer, or a vendor, customer, client or patient of the employer (or a related party).
owned, controlled, etc. by a vendor, customer, client or patient of a vendor, customer, client or patient (or a related party).

42. Reconciling Wages
(F) allows a municipality and an employer to agree to ignore the 20 day occasional entrant rule and following different rules… say the old 12 day rule.
If you have an agreement with the employer under (F) that requires withholding from hour one, then wages earned on the first 20 days are not excluded from the wage factor calculation.

43. Reconciling Wages
Many employers’ software cannot handle the new 20 day rule.
Many employers’ don’t want to bother with the HB-5 “simplification” of counting days and want to withhold by the hour from hour 1.
Put an “Election to Withhold Under the 12 Day Rule” form on your website and ask the employer to attach a copy to their net profit return.

44. Attachments
HB-5 restricts the documents municipalities can require to be submitted with original returns that are not requesting a refund to the taxpayer’s:
1041
1065
1120
1120-S
1120-REIT
1120F ORC718.05(F)(3)

45. Attachments
HB-5 does not restrict the documents municipalities can require to be submitted with original returns that are requesting a refund or with amended returns.
ORC718.05(F)(3)

46. Attachments
HB-5 does not restrict the documents municipalities can request be submitted after an original return that is not requesting a refund is filed.
ORC718.05(F)(3)
Your instructions should ask for all needed documents: “In order to prevent receiving a request for documents, taxpayer should attach the following forms to their net profit returns…”

47. Attachments
Go ahead and send your request for additional information if you don’t have the documents you need to complete your review of the return.
Don’t worry about the new audit rules unless you are compelling the taxpayer to appear in your office or meeting the taxpayer at their office.

48. Related Parties
Deductions that are not “ordinary, necessary, and reasonable” do not become ordinary, necessary, and reasonable just because they are paid to a related party is not a “related member” under ORC (NN) or a “related entity” under ORC (OO).

49. Related Parties
Management fees for most industries range from 3% of gross sales to 8% of gross sales.
Some management fees are based on the size of the asset portfolio.
It is rare for both types of management fees to be charged at the same time.
Google is your friend.

50. Guaranteed Payments
For tax years beginning on or after 1/01/16, guaranteed payments for the use of capital are no longer disallowed deductions.
Payments for the use of capital = payments treated as interest payments on a loan by the IRS.

51. Guaranteed Payments
Guaranteed payments to current partners for services rendered are not deductible.
Guaranteed payments to retired partners are not deductible.

52. Guaranteed Payments
Payments similar to guaranteed payments are not deductible.
Look for consulting fees, sub-contractor fees, management fees, or other similar sounding fees. They were probably paid to a partner for services rendered in the partner’s “non-partner” capacity.

53. Guaranteed Payments
The argument goes: These payments are payments under USC 707(a) not 707(c), so they are not guaranteed payments and are therefore deductible.

54. Guaranteed Payments
707(a)(1) In general - If a partner engages in a transaction with a partnership other than in his capacity as a member of such partnership, the transaction shall, except as otherwise provided in this section, be considered as occurring between the partnership and one who is not a partner.

55. Guaranteed Payments
707(c) Guaranteed payments - To the extent determined without regard to the income of the partnership, payments to a partner for services or the use of capital shall be considered as made to one who is not a member of the partnership, but only for the purposes of section 61(a) (relating to gross income) and, subject to section 263, for purposes of section 162(a) (relating to trade or business expenses).

56. Guaranteed Payments
Any payment to a partner that qualifies for 707(a) treatment is similar to a guaranteed payment under 707(c).
Don’t disallow the deduction as “a guaranteed payment”. Disallow the deduction “a payment similar to guaranteed payment”.
Under Ohio’s rules of construction, there must be a type of payment that is not a guaranteed but that is similar to a guaranteed payment.

57. Net Operating Losses (NOL)
718.01(E)(8): Mandates a five year NOL for all taxing municipalities beginning with tax years starting 1/1/17+.
Impact will begin with the filing of tax returns for tax years beginning 1/1/18+ when those losses incurred will actually be allowed to offset net profits in your municipality; however
For tax years beginning in a taxpayer may not deduct more than 50% of the available NOL created in tax years
For those municipalities allowing an NOL prior to 2017, the taxpayer must be allowed to deduct the full amount of the pre-2017 NOL prior to the 50% allowance.

58. NOL Carry Forwards before Tax 2017
NOL cannot be used to offset qualifying wages
Starting In 2018, 2017 NOLs are used on pre-allocation basis (before Schedule Y) with a 50% reduction
For tax year 2017 returns, exiting NOLs are used after allocation (post Schedule Y)

59. 2016 NOLs
For municipalities that allowed NOLs before HB 5, review your tax year 2016 and forward ordinance regarding treatment of 2016 NOLs. The OML Sample Ordinance did not address 2016 NOLs since HB 5 did not require NOLs to be allowed until tax year 2017.
A business cannot claim a NOL for a tax year which it had no situs to your municipality

60. NOL Review Committee:
Created to evaluate and quantify the fiscal impact of the NOL allowance for municipalities that did not allow an NOL prior to passage of HB5.
Requires a “reporting municipal corporation” to provide impact statistics for tax years ending in 2018 and 2019 using the microsimulation model adopted by the Committee.
The review committee shall review the results and provide a report on or before May 1, 2022 discussing the revenue impact.

61. The Joy of REITS

62. The Joy of REITS
You drive by a storefront, jot down the name of the store, get back to your office, check to see if the store has an account.
If you don’t find the account, you send a letter.
If you do find the account, all is good.

63. The Joy of REITS
Wrong.
There are two businesses operating at almost every piece of commercial property.
The business you see; and
The landlord.

64. The Joy of REITS
In the field of commercial real estate, especially in the United States, a net lease requires the tenant to pay, in addition to rent, some or all of the property expenses that normally would be paid by the property owner (known as the "landlord" or "lessor").[wiki]

65. The Joy of REITS
These include expenses such as property taxes, insurance, maintenance, repair, and operations, utilities, and other items.
These expenses are often categorized into the "three nets": property taxes, insurance, and maintenance. In US parlance, a lease where all three of these expenses are paid by the tenant is known as a triple net lease. [wiki]

66. The Joy of REITS
Those Schedule E residential rental properties that you spend so much energy on are almost all money pits for the landlord.
Commercial property with triple net leases shift a huge chuck of the costs of owning commercial real estate to the tenant.

67. The Joy of REITs
Even when the tenant is struggling to stay in business, the landlord of commercial property is likely raking it in.
REITs own lots of commercial real estate.
REITs are mostly headquartered outside of Ohio (as is “What’s a city tax?”)

68. The Joy of REITs
The County Auditor is your friend in identifying the property owners of commercial real estate for free.
Haines & Company sells tools to make it easier to identify the property owners.
Keep pushing until you get the returns of the commercial property owners (REIT or not).

69. The Joy of REITs
A run of the mill REIT will own hundreds or thousand of properties from the size of a mall to a single restaurant.
You are not going to get a Schedule E or Form 8825 from a REIT that gives you a nice income statement for the property you are looking at. Don’t freak out. A REIT does a Schedule Y like a retailer.

70. The Joy of REITs
Nervous about this strange form called a 1120-REIT? Don’t freak out.
A 1120-REIT is just an 1120 that ends (for us) at line 20 on page 1.

71. The Joy of REITs

72. The Joy of REITs
Many REITs have faced revolts from investors over management fees paid to related party management companies.
If you are feeling adventurous, Google the REIT and look for lawsuits, or threats of lawsuits that result in lower management fees. Then consider disallowing excessive management fees deducted in prior years.

73. Thank You Questions/Comments
For further information feel free to
Richard
Robert
Mike