In the state budget that he released on Feb. 5, Ohio Gov. John Kasich proposed the most sweeping changes in Ohio’s tax structure since the state income tax was adopted over 40 years ago. Among other things, the proposal extends the Ohio sales tax to most services (broadly defined), significantly increasing sales tax revenues. There are four major elements of the proposal:
- Income tax rate cuts. State income tax rates would be reduced a total of 20% over three years. This rate change, net of revenue increases from eliminating some deductions, is projected to reduce Ohio income taxes by an aggregate $5.2 billion during fiscal years 2014-2016.
- Special income tax break for pass-through entities. Pass-through entities (such as S corporations and businesses that are taxed as partnerships for federal purposes) would receive a special tax break that effectively makes half of each owner’s share of Ohio business income (not to exceed $750,000 for each single or married filing jointly tax return) exempt from Ohio’s state income tax. This change would result in a $1.9 billion reduction in Ohio income tax paid by owners of pass-through entities over a three-year period.
- Sales tax changes. The sales tax would apply not only to sales of goods and to a few listed services, but to all services and all payments for intangible property (other than financial instruments) that are not specifically exempt. Almost all services and intangible assets used or consumed by businesses would be subject to sales tax. The budget bill, as introduced, has a broad definition of “services” that includes commercial real estate rental payments. The state sales tax rate would be reduced from 5.5% to 5%, however, and there would be similar reductions in local “piggyback” sales tax rates. The net of all of these changes would be to increase Ohio’s state and local sales tax revenues by $5.2 billion over the three-year period.
- Extraction taxes. The governor’s budget proposal would raise $565 million over a three-year period from new or increased taxes on oil natural gas, natural gas liquids and condensates that are extracted in Ohio. A similar proposal was made by the governor in 2012 but was not approved by the General Assembly at that time.
From the state’s standpoint, the combination of tax rate reductions and broadening of the tax base would be a net reduction in taxes paid and collected. Proposed tax increases of $5.7 billion over a three-year period (state fiscal years 2014-2016) would be more than offset by over $7 billion in tax reductions over that same period. From an individual business’ standpoint, the results could be significantly different. For example, if a service business does not currently pay state sales taxes, what amounts to a five plus percent tax on their gross receipts (or a substantial portion of them) is not likely to be offset by the income tax reductions.
The administration has released a partial list of services that would be subject to tax under the new proposal. It is a partial list because the proposal would actually tax any service that is not specifically exempt from tax under the law, and the list of exemptions is fairly narrow. This situation is different from current law, where services are exempt from tax unless they are on a list of specifically taxable services, such as hotel rooms and landscaping services. Some of the taxable services would include:
- Admissions to movies, stadiums, concerts, bowling alleys, billiard parlors, racing events, etc.
- Architectural and engineering services
- Bail bonds
- Bank service charges (other than interest)
- Cab fare
- Cable TV
- Coin operated laundries
- Custom software
- Digital downloads, such as books and music
- Hair care services (barbers and hair stylists)
- Interior design and decorating
- Investment services, including insurance services other than policy premiums
- Legal and accounting services
- Magazine subscriptions
- Mailbox rental
- Management consulting
- Many loan closing costs, such as loan broker, appraisal and title fees
- Marine towing
- Packing and crating
- Process server fees
- Real estate commissions
- Rental of films by theaters
- Rental of non-residential property and of second or vacation homes
- Secretarial and court reporter services
- Tax return preparation
- Trailer park overnight stays
- Travel agent services
The following services, among others, would remain exempt from the sales tax:
- Construction and mining services (including services used in producing oil and natural gas)
- Education and personal instruction
- Electricity, natural gas (sold by a utility) and water
- Food storage
- Health care services (hospital, physician, dentist and nursing charges, medical lab fees, etc.)
- Interstate air fare
- Labor on real estate repair or remodeling
- Local (intracity) bus fare
- Rental of a primary residence
- Residential waste collection
- Social assistance services
- Veterinary services (for livestock only)
There are many open questions regarding the scope of taxable services that will need to await more specifics from the governor’s plan. That plan is expected in the coming weeks and days as the budget and its tax elements work their way through the Ohio General Assembly. Ultimately, decisions as to what portions of the governor’s proposals will become law will be made by the General Assembly between now and the end of June.
If you are interested in learning more about the proposal and how it might impact your business or receiving updated information as the budget process proceeds this spring, please let us know. We will monitor this situation closely and will likely work with a number of clients who will seek to influence the legislative process on these very important tax issues.