Municipalities across Ohio are banding together to challenge a law some city leaders say could lead to state control of all local-government income taxes.

At issue is a portion of House Bill 49, which is Gov. John Kasich's two-year budget. A provision in the bill would make it possible for business owners to file net-profit income-tax returns with the Ohio Department of Taxation instead of the municipality where their business is located.

The municipal-net-profit tax is the tax rate applied to a business' income after expenses are factored out, said Gary Gudmundson, communications director for the department of taxation.

Some city leaders say the HB 49 provision would constitute an erosion of home rule in addition to a loss of revenue, but state leaders see it as an option to streamline the tax-filing process for business owners.

The Central Ohio Mayors and Managers Association of 17 central Ohio cities recently approved filing legal action to challenge portions of HB 49, and more than 70 cities have committed to support or have expressed interest in joining a lawsuit against the state, said Ben Kessler, who serves as COMMA chairman and mayor of Bexley.

Who is participating?

The central Ohio cities that have expressed interest in participating in a lawsuit include Bexley, Canal Winchester, Dublin, Grove City, Hilliard, New Albany, Pickerington, Powell, Reynoldsburg, Upper Arlington, Westerville, Whitehall and Worthington, Westerville City Manager Dave Collinsworth said.

The cities have different requirements for engaging law firms, Kessler said, and some require a council approval to participate in lawsuits.

For example, Whitehall City Council approved its participation Oct. 3 and New Albany City Council was expected to vote Oct. 17 on a resolution to participate in the suit against the state.

Cities aren't the only government agencies that would be affected by state collection of municipal-net-profit income taxes, New Albany City Manager Joe Stefanov said.

In New Albany, the interests of the New Albany-Plain Local School District and the Plain Township Fire Department are important because the city shares income-tax revenue with both to offset property tax abatements for some businesses in the New Albany International Business Park, he said.

Why are they challenging it?

Kessler said he is concerned that if municipalities don't challenge this provision of HB 49, the state eventually could decide to take control of all municipal income-tax collections.

Grove City Mayor Ike Stage said he agreed with that concern. He also said the option for state collection of corporate-net-profit taxes would be "a terrible replication of effort."

Collinsworth said the provision in HB 49 is the most recent example of the erosion of home rule, a part of the Ohio Constitution that recognizes local governments should generally have the ability to run their affairs as they see fit.

"It's a great concern for all municipalities across the state of Ohio, big and small," he said.

Stefanov said he believes the collection of corporate net profits is a step toward centralized collection of income taxes.

Upper Arlington City Manager Ted Staton also attested to the negative effect of the provision.

Staton said city officials have estimated that if all companies that do business in Upper Arlington elected to file through the state, it would cost the city more than $10,000 per year because the state will charge a service fee on the collections.

That estimate assumes all businesses that have filed income-tax returns in the past would elect to file with the state instead of the Regional Income Tax Authority, which many municipalities hire to collect their income taxes, he said.

As for the service fee, Matt Chafin, chief legal counsel with the Ohio Department of Taxation, said HB 49 permits the state to collect a fee of one-half of 1 percentage point of annual revenue from corporate municipal-net-profits tax returns. The fee would be charged only on collections from businesses that choose to file directly with the state, he said.

Because the state eliminated the tangible personal-property tax and the estate tax, local income taxes have become cities' core revenue source, Collinsworth said.

The tangible personal-property tax on machinery, equipment, computers and inventory was repealed beginning in 2006 and fully phased out in 2008, Gudmundson said. The estate tax, which was levied on the taxable value of estates exceeding a certain threshold, was repealed in January 2013, he said.

Thus, income-tax revenue is essential for "bread-and-butter services," such as police forces, fire-safety units and street maintenance, Collinsworth said.

He said he is concerned the service fee of one-half of 1 percentage point eventually could increase.

"What's that going to be 10 or 12 or 15 years from now, after the state goes through its next fiscal crisis?" Collinsworth asked.

Other concerns about the state collection of municipal corporate-net-profits tax returns include a hindrance to effectively auditing businesses and the interruption of cash flow to city governments, Kessler said.

Auditing would be more difficult because the state would have the business records and not the cities, he said.

As for the cash flow, the taxation department would send the revenue to cities on a monthly basis, Gudmundson said.

Why did the state enact HB 49?

Joe Testa, director of the Ohio Department of Taxation, said the HB 49 provision originated with the business community. More than a year ago, state officials discussed impediments in tax law with business associations and city chambers, he said.

"The common thread was municipal net profits," he said.

A number of business owners have expressed frustration with the filing of taxes on municipal net profits, said Jeff McClain, director of tax and economic policy with the Ohio Chamber of Commerce.

The provision is a step in the right direction for improving a convoluted Ohio municipal-tax system, he said.

Under the current terms, businesses would be able to opt in to state collection early next year, Chafin said, and could begin making estimated payments during that year for their corporate municipal net profits. In 2019, businesses could file a return directly with the state.

A business owner would file one form that includes information for multiple municipalities, Gudmundson said.

Currently, businesses have to file a corporate-net-profits tax return in every municipality in which they do business, Chafin said.

Amy Arrighi, chief legal counsel with RITA, said the single form already is in place for her organization.

"As for the RITA tax form, businesses that have an obligation to file a tax return with a taxing jurisdiction that uses RITA for tax collection file only one form with RITA -- whether that filing is for one taxing jurisdiction or four taxing jurisdictions," she said.

Central Ohio cities that use RITA for municipal income-tax returns include Bexley, Gahanna, Grandview Heights, Grove City, Hilliard, Johnstown, New Albany, Powell, Upper Arlington and Worthington, according to the RITA website.

RITA withholds 3 percent of annual income-tax revenue from each municipality, Arrighi said. After conducting a year-end audit to figure out actual expenses, RITA reimburses each city the difference between the 3 percent retained and the actual cost of collections. The cost covers business net profits, employer withholding and individual taxpayers.

RITA officials said on average, the organization retained about half of the revenue from the 3 percent withheld to process all income-tax returns last year in each of its more than 300 taxing jurisdictions.

Last year, costs for seven cities in central Ohio -- Gahanna, Grove City, Hilliard, New Albany, Powell, Upper Arlington and Worthington -- ranged from $323,766 (1.07 percent of the 3 percent withheld) in New Albany to $154,958 (2.56 percent) in Powell, according to RITA.

ThisWeek reporters Kevin Corvo and Nate Ellis contributed to this story.

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