Login | November 26, 2020

Legislature can centralize local business taxes, court rules

DAN TREVAS
Supreme Court
Public Information Office

Published: November 16, 2020

The state of Ohio has the authority to create a centralized system for the collection of all municipal business income taxes but cannot charge local governments a fee to cover its administrative costs, the Ohio Supreme Court ruled recently.
A Supreme Court majority partially upheld and partially rejected the validity of two state laws adopted in 2014 and 2017. The laws enable companies to opt in to a centralized system where a business could pass along all the local business income taxes it collects to the state, which in turn would distribute the funds to the hundreds of cities and towns that impose local income taxes on businesses. More than 100 municipalities, including Akron, Elyria, and Athens, filed lawsuits , arguing that the new system violates the “home-rule” authority granted to them in the Ohio Constitution.
Writing for the majority, Justice Michael P. Donnelly stated that the municipalities have the power under home rule to levy income taxes, but that two other provisions in the Ohio Constitution authorize the Ohio General Assembly to limit local taxation. The constitution allows state lawmakers to enact a set of rules governing how to assess, collect, and distribute the business income taxes, which are known as net-profits taxes.
The fee imposed on local government to pay for the administration of the tax collection program is not a “limit” on local power. That portion of the statutory scheme, violates the home-rule rights of municipalities, the majority ruled.
Chief Justice Maureen O’Connor and Justices Patrick F. Fischer and Melody J. Stewart joined Justice Donnelly’s opinion.
Justice Sharon L. Kennedy concurred in part and dissented in part. She stated that she would reverse the Tenth District Court of Appeals decision in its entirety and hold that the General Assembly did not have the authority to abolish all municipal income tax collection ordinances and force local governments to adopt a uniform statewide program in order to collect net-profits taxes.
Justice R. Patrick DeWine also concurred in part and dissented in part, writing that the General Assembly not only had the authority to develop the statewide tax collection program, but also could impose the 0.5 percent collection fee. Justice Judith L. French joined Justice DeWine’s opinion.
State Seeks More Unified Tax Collection System
Ohio cities and villages began imposing local income taxes in 1946. As of 2019, 649 municipalities had a local income tax. In 1957, state lawmakers began enacting laws to make municipal income taxation more uniform with the goal of making it easier for taxpayers to comply. In 2014, the legislature enacted House Bill 5, which forbid municipalities from imposing an income tax unless they adopted the provisions of R.C. Chapter 718 and levied taxes according to the provisions in state law.
In 2017, lawmakers enacted H.B. 49, which established a centralized system for the administration of municipal net profit taxes. A business owing net-profit taxes in multiple municipalities had the option of sending its total local income tax obligation to the state, which in turn would distribute the appropriate amount of funds to the municipalities. The new system required the municipalities to report to the state the tax information for each business that joined the state’s collection system so that the state could ensure it was collecting and paying each municipality its fair share. R.C. 718.85(B) provided that 0.5 percent of the municipal tax payments paid to the state would be credited to the “municipal income tax administrative fund.”
The new system was scheduled to take effect in January 2018. In late 2017, a lawsuit was filed in Franklin County Common Pleas Court by Athens and more than 100 other municipalities, challenging the constitutionality of H.B. 5 and H.B. 49, and seeking to block the new collection system from starting. A second set of local governments led by Elyria then joined the lawsuit, and Akron filed its own challenge.
The common pleas court denied the challenges and let the law take effect. The municipalities appealed to the Tenth District, which affirmed the trial court’s decision. The local governments appealed to the Supreme Court, which agreed to hear the case.
Court Analyzes Constitution’s Local Tax Provisions
Justice Donnelly explained that Ohioans authorized home rule in the 1912 version of the constitution. Article XVIII, Section 3 allows local governments to adopt local police, sanitary, and other laws as long as they do not conflict with any state “general law.” The opinion noted the Court has consistently identified taxation as a home-rule power. But local taxation power is not unlimited, the opinion noted. Two other provisions of the constitution grant the General Assembly the power to curb local taxation. Article XVIII, Section 13 authorizes state lawmakers to “to limit municipalities to levy taxes and incur debts for local purposes.” Article XIII, Section 6 allows the legislature to restrict municipal taxation, lending, and borrowing “so as to prevent the abuse of such power.”
The majority opinion explains the essence of the local governments’ argument is that the state has the power to limit local taxation, but not to control it by taking over the administration of the tax system and charging a fee to operate it.
Elyria argued the term “levy” under Article XVIII, Section 13 implies the state can control the taxes imposed by a local government, but not control the operation of it. Athens and Akron asserted that the word “limit” in the same section similarly means the state can control what type of tax laws can be passed, but not how they are administered. Athens also argued that the collection fee was unconstitutional and that R.C. 718.85(B) could not be severed from the rest of the law and, if so, the whole centralized system would be unconstitutional.
Definitions Too Narrow, Majority Ruled
The majority opinion noted that both the local government and the state turned to the definition of “levy” in several different dictionaries to argue whether the word limits the state’s authority to impose taxes or if it allows for the control of tax collection programs. The Court ruled that “levy” includes both the imposition of the tax and the administration of the taxes, including the collection and disbursement of tax revenues.
The Court noted that on a more limited scale, the state already had been operating a centralized administration of net-profit taxes for more than 20 years. The opinion stated the lawmakers required the centralized collection of net-profits taxes paid by electric utilities and assessed the local governments a 1.5 percent fee to administer the program and disburse the funds. Telephone companies were added to the program later, and the Court noted it could not find any constitutional challenges to those laws.
Because the state’s limit on the local government’s taxation power is authorized by the constitution, the legislature could also require local governments to adopt the state rules into their local codes in order to receive their share of the payments, the Court ruled.
Fee Not Authorized
While the state can impose the collection scheme, the Court stated that under home rule, municipalities are immune from general state laws when they are exercising their home-rule powers — in this case, taxation. The opinion stated that any power the state would have to tax or impose a fee on the local governments would come from the two constitutional provisions allowing for the limitation of local taxation.
“Quite simply, Article XVIII, Section 13, and Article XIII, Section 6 confer the power to limit or restrict municipal actions, not the power to tax municipal revenues,” the opinion stated.
The Court rejected Athens’ argument that the law could not stand if the fee was severed. The Court severed the fee language in R.C. 718.85 and found the remaining sections can remain in effect.
Entire System Unconstitutional, Concurrence Maintained
Justice Kennedy wrote that the General Assembly’s power to limit taxation does not allow it to abolish municipal income taxes on the books and compel the municipalities to adopt a uniform scheme. She disagreed with the majority’s conclusion that state lawmakers could force cities and villages to “cede their sovereignty over matters of local self-government to the state in exchange for revenue essential to their survival.”
Justice Kennedy explained that the majority’s holding is inconsistent with the language of the state constitution’s home-rule amendment adopted in 1912. She stated that the constitution does not grant the General Assembly the right to “coerce or compel” municipalities to enact legislation in areas of local self-government.
“Nor does the Constitution authorize the legislature to abolish municipal taxation altogether or commandeer the collection, administration, and enforcement of the municipalities’ own tax systems,” she wrote.
State Law, Including Fee, Constitutional, Separate Concurrence Asserted
One would think the right to impose a small fee to defray the administrative cost goes hand in hand with the power to administer a centralized tax system, Justice DeWine stated. But instead the majority plucks “the fee from the rest of the scheme” and says that it is unconstitutional because no provision in the state constitution explicitly authorizes it.
Justice DeWine explained this logic might be appropriate if a court were considering a claim about the enumerated powers of the federal government, but not when reviewing a state law. Citing the Court’s 1950 Angell v. Toledo decision, he noted that an “act of Congress is not valid unless the federal Constitution authorizes it. On the other hand, the General Assembly of Ohio may enact any law which is not prohibited by the Constitution.”
He wrote that nothing in the state constitution prohibits the collection fee, and the state can charge a fee “for a service that it lawfully provides to a municipality.” He noted a similar administrative fund has been in place for nearly 20 years for municipal taxation of electric and telephone companies, and until the majority’s opinion, no one ever suggested the fee violated the state constitution.
The partially concurring and partially dissenting opinion argued that under the majority’s logic, the legislature could completely prohibit municipalities from taxing net profits, replace it with a state tax and keep every dime that used to go to the cities and villages. But instead, lawmakers chose to return 99.5 percent of the funds collected and the majority finds that by doing so the legislature violates the constitution, the opinion stated.
“Does that make any sense?” asked Justice DeWine.
The case is cited 2019-0693 and 2019-0696. Athens v. McClain.


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