It’s no secret athletes and entertainers are attracted to no-income tax states, such as Florida, Texas and Nevada.  Recently, the tax savings offered by these states was highly publicized as a motivating factor for the departure of Northeast Ohio’s brightest star. Avoiding Ohio’s combined state and local income tax rate (up to 9%) offers a substantial incentive for athletes and entertainers to become Ohio nonresidents. By properly supporting a change in residency, nearly all of the athlete’s income, including his salary, earnings from endorsements and investment income, will avoid Ohio income tax.  However, establishing Ohio nonresident status for an athlete with continuing connections to Ohio (or, frankly, any individual with multiple residences) is not as simple as presented by the national media. This post addresses two situations: 1) an athlete who has always resided in Ohio signs with a team outside Ohio, but continues to maintain an Ohio home with immediate family residing in Ohio; and 2) an athlete that grew up and lived outside Ohio comes to play for an Ohio based team, but retains a residence in his “home” state. 

Unless the irrebuttable presumption of non-Ohio residency applies, the athlete’s residency for Ohio personal income tax purposes is determined by the common law “domicile” test. One’s domicile is his permanent legal residence intended to be used for an indefinite period and to which, when absent, the person intends to ultimately return. The key focus is the athlete’s subjective intent as to his permanent residence – where he intends to remain indefinitely.

In the first example, assume the athlete plays for a team in a no-income tax state, but  retains a luxurious Ohio home where his family continues to reside and to which the athlete will return in the offseason. The athlete may also wish to participate in or hold charitable events in Ohio. In order to overcome the presumption of Ohio residency due to the retention of an Ohio home, the athlete must take certain steps to evidence his change in intent or bear the risk of remaining an Ohio resident for income tax purposes. Actions and public statements inconsistent with the athlete’s change in intent may lead to a challenge of his resident status.

In similar situations, albeit involving individuals with modest livings, taxpayers have been found to retain their Ohio residency even though they spent a majority of time outside Ohio for employment purposes, when the employment is temporary and the individual’s family stays in Ohio. One case even concluded that an individual’s five-year employment outside Ohio was temporary because he always intended to return to Ohio.

In the second hypothetical, assume the athlete grew up and attended college in a no-income tax state but ultimately plays professionally for an Ohio team. The athlete purchases an Ohio residence where he resides in-season but continues to maintain an offseason home in the no-income tax state where his family primarily resides. Despite spending a significant amount of time in Ohio, the athlete intends to ultimately return to his home state after his tenure with the Ohio team ends. While the athlete’s intent may appear clear – not to be domiciled in Ohio – this intent may be scrutinized if, again, his actions or public statements are inconsistent.

Although there is no cookie-cutter approach, through our substantial experience with Ohio personal income taxes and residency matters, we can outline and maintain a plan tailored to the athlete’s unique circumstances to support his bona fide intent to be domiciled in a no- or low-income tax state, despite maintaining a secondary Ohio residence and other connections to the state. Obviously, it is very advantageous to develop and implement this plan in conjunction with the individual’s change in domicile, rather than addressing it after the individual’s domicile is challenged.

You probably have been hearing a lot of news about so called “Amazon” laws being enacting to increase sales/use tax collection for Internet sales. Until recently, there have been essentially two types of these “Amazon” laws. The first presumes that a retailer has nexus with a state, requiring it to collect the state’s sales tax, by virtue of having affiliates in the state linking to the retailer’s website and the retailer realizing a certain threshold of sales from such weblinks. The second, recently becoming effective in Colorado, requires retailers who do not collect the state’s sales tax to provide the customer and state taxing agency with certain informational reports setting forth the sales made by the retailer which may be subject to the state’s sales/use tax. Both of these types of “Amazon” laws have garnered significant criticism and constitutional challenges. 

Oklahoma recently passed its own “Amazon” law, which is much less intrusive than the two types discussed above. Simply, Oklahoma H.B. 2359 requires retailers who do not collect sales to provide customers with notification on their website or catalog and invoices that use tax is owed and must be paid by the purchaser, unless the purchase is otherwise exempt. The notification requirement also applies to “online auction websites” (although, not required on invoices for such websites).  This law, however, is not effective until the Oklahoma Tax Commissioner enacts an administrative rule regarding the law. Pursuant to a proposed emergency administrative rule, the retailer’s notification to its customers must include the following: (i) the retailer is not required, and does not, collect Oklahoma sales or use tax, (ii) the purchase is subject to Oklahoma use tax unless it is specifically exempt from taxation, (iii) the purchase is not exempt merely because it is made over the Internet or by catalog, (iv) Oklahoma purchasers must pay use tax on all purchases that were not taxed and such purchases must be reported on either the individual’s income tax  return (Form 511) or a consumer use tax return (Form 21-1), and (v) the referenced forms and corresponding instructions are available on the Oklahoma Tax Commission website, www.tax.ok.gov/. 

As Oklahoma’s “Amazon” law will be become effective upon this proposed emergency administrative rule becoming effective, remote retailers should be prepared to include such a notice on their websites, catalogs and invoices. Other states will likely enact “Amazon” laws similar to Oklahoma’s law, at least until a determination as to the validity of the other types of “Amazon” laws is resolved.

As the deemed consumer, a contractor must pay Ohio sales/use tax (“tax”) on its purchases of materials incorporated into real property, unless an exemption exists. The contactor’s related transaction with the property owner is characterized as a construction contract. Since tax was already paid on the contractor’s purchases, no sales tax needs to be collected from the property owner on the construction contract. 

Alternatively, if the materials do not become real property upon installation, the contractor must collect sales tax from its customer on the contract price, including materials and installation labor.  In these circumstances, the contractor’s purchase of materials is exempt from tax pursuant to the resale exemption. However, if the contractor fails to claim the resale exemption, it is not entitled to offset the tax erroneously paid on its purchases against the sales tax required to be collected from its customer. Likewise, tax erroneously collected by a contractor from its customer cannot be used to offset the tax due on the contractor’s purchases of materials consumed in the performance of a construction contact. 

Thus, it is important for the contractor to correctly determine whether the materials it purchases will constitute real property after installation or remain personal property. In Ohio, “real property” includes a building, fixture, improvement or structure (and of course, land), each of which is further defined in R.C. 5701.02.  Real property does not include “business fixtures”, which are items of tangible personal property that become permanently attached or affixed to the real property but that primarily benefits the business conducted by the occupant of the premises and not the realty. R.C. 5701.03(B). Accordingly, special purpose components of a building or structure generally are not real property. Business fixtures include signs; storage bins and tanks; transportation, transmission, and distribution systems; machinery, equipment, and foundations and supports therefor; and improvements specifically designed, constructed and used for the business conducted on the realty.  Specifically excluded from the definition of “business fixture” are general purpose property common to all buildings, such as heating, ventilating, and air conditioning systems, utility lines, and electrical and communication lines.  

Since the Ohio Supreme Court’s 2004 decision in Funtime, Inc. v. Wilkins (2004), 105 Ohio St.3d 74, the characterization of property as either real property or a business fixture has become increasingly difficult, seemingly expanding the definition of business fixture to include any property particular to the business being conducted on the land.  In Funtime, special use buildings and structures, including a water ride, roller coaster, a “Skyscraper” and the station house sheltering patrons standing in line for a roller coaster (Mind Eraser), were held to be business fixtures.  The Court found these items to be personal property because there was no evidence that the rides would be of any benefit to a buyer of the land who engaged in a different business. 

Nonetheless, subsequent decisions by the Ohio Board of Tax Appeals (“Board”) appear to limit business fixtures to distinct items of tangible personal property that:

• do not become part of a permanent fabrication or construction on the property whose removal would cause "significant injury to the land"; and
• have a specific business purpose.

Often, it is difficult to determine at the time of the contractor’s purchase whether materials will become real property upon installation – meaning the contractor owes tax on its purchases – or if such materials will remain personal property – meaning the contractor’s purchases are entitled to the resale exemption.  A contractor can be protected from uncertain classification by requesting a written certification from the property owner, before entering into a construction contract, as to whether the improvement will be real or personal property.  As it is entitled to rely upon the owner’s certification, the contractor can simply pay or collect Ohio sales/use tax consistent with the owner’s certification of the property as being either real or personal property, with the risk of erroneous classification being transferred to the property owner. 

Additional considerations, to be addressed in subsequent articles, include exemptions available on a contractor’s purchase of materials which will become real property upon installation (Part II) and how to address mixed transactions, whereby some of the improvements provided under a construction contract will become real property while others constitute business fixtures and will remain personal property (Part III). Please contact us if you need help classifying property as either real or personal property.

Steve will be speaking at the American Society of Women Accountants - Northeast Regional Conference which will take place on August 20, 2010 at the Sheraton Suites in Cuyahoga Falls, Ohio.  Steve's presentation is scheduled at 10:15 a.m.  His topic will be, Ohio Sales/Use Tax:  Recent Trends, Developments and Planning Opportunities.  Click here for more information.

Generally, all property primarily used or consumed during the manufacturing operation is exempt from Ohio sales and use tax. Therefore, the scope of the manufacturing exemption is determined by the beginning and end of the taxpayer’s “manufacturing operation”. A manufacturing operation commences upon the commitment of raw materials, which occurs at the earliest point where: (i) material handling from initial storage ceases, or (ii) materials are mixed, measured, blended, heated, cleaned, or otherwise treated or prepared for the manufacturing process.

A common misconception is that one’s manufacturing operation begins with the first process whereby the state or form of the raw materials is changed or transformed. However, such a change or transformation need not occur. Rather, nearly any affirmative act taken with respect to the raw materials for purposes of preparing such materials for production will begin the manufacturing operation. After raw materials are committed, property used to handle or process the materials are exempt from Ohio sales and use tax.

Ohio Administrative Code Section 5703-9-21 contains several examples regarding the commitment of raw materials. If you need help determining the scope of your “manufacturing operation” for Ohio sales and use tax purposes, please feel free to contact us.