Auditing Business Returns Schedule Y OML Tax Conference July 12, 2018

Business Returns HB 5 and other “Uniformity” law changes made the Audit of a Business Net Profit return basically a reconciliation of the local business return to the federal return. Definition of AFTI Cincinnati focus on reviewing Schedule Y The Business Allocation Formula ORC 718.02

Why focus on Schedule Y? 718.02 (B) Tax Administrator may REQUIRE an alternative apportionment method. Fair and Equitable Standard Language allows for much interpretation. Limited access to accurate data Time consuming

We will need to change “nonresidents” to businesses

Schedule Y Property Payroll Point of Sale Three Factors– 3 P’s Question- What if business has no Employees Do you use two or three factors? In a meeting with Mayor Cranley on HB5 and the “throwback rule” that he spoke about during HB5.

Step 1-Property Explanation ORIGINAL COST- (Net Book Value) Real and tangible personal property Examples of tangible personal property are computers, furniture, tools, machinery, signs, equipment, leasehold improvements, supplies, and leased equipment. Owned or USED Rental Values – Annual Rent * 8 Has anyone ever looked into the values companies provide in Step 1? What about leased office machines? Billboards?

Step 1-Property Audit Items Mobile Asset Rule- Cincinnati Pre-HB5 Regs. The basis for allocation of the value of motor vehicles, as well as other mobile equipment is on the actual time used in the trade or business in generating the sales so reported in Step 3. If no records of the time the equipment is used in and out of the Municipality are available, the sales factor percentage is to be used as the determinant for mobile equipment in Step 1. Review when Step 1 is 0% or very low relative to the other Steps. Example-Contractors Mobile Assets- Cars, Trucks, Equipment, Cranes, Backhoes….

Sample Mobile Asset Rule As Filed Everywhere Cincinnati % Step 1 Property 300 0 0 Rents NA Step 2 Wages 180 60 33.33 Step 3 Sales 1,200 600 50.00 Total 83.33 Average 27.78

ADJUSTED Everywhere Cincinnati % Step 1 Property 300 0 50.00 Step 2 Wages 180 60 33.33 Step 3 Sales 1,200 600 50.00 Total 133.33 Average 44.33

Step 1-Property Discovery Opportunity Rents Paid- If Significant Amount Request Name, Address, Amount Paid and Tax ID for those recipients of Real Estate Rents and/or Leases in the City. Might find non-filers of rental income. If Amounts are Significant Especially if Real Estate

Step 2 Payroll 718.02 (A) (2) Wages, salaries, and other compensation paid during the taxable period to individuals employed in the business or profession for services performed in the municipal corporation to wages, salaries, and other compensation paid during the same period to individuals employed in the business or profession, wherever the individual's services are performed, excluding compensation from which taxes are not required to be withheld under section 718.011 of the Revised Code;

Step 2-Payroll Explanation Wages earned by individuals employed in City Does not include 718.011 wages (20 Day Rule) Does not include subcontractors or independent contractors Questions: Employees of company only? 718.02 (C) Include Guaranteed Payments to Partners? How do you deal with Leased Employees, Paymasters, other third party providers? What about PPB Our Code specifically excludes subcontractors or independent contractors. 718.02 (C) As used in division (A)(2) of this section, "wages, salaries, and other compensation" includes only wages, salaries, or other compensation paid to an employee for services performed at any of the following locations: 718.01 (W) "Employee" means an individual who is an employee for federal income tax purposes. § 31.3401(c)-1 Employee- Employee- employer relationship

Step 2-Payroll Audit Compare Wages in Municipality to the amount of Wages subject to Withholding Tax in Municipality EX: Cincinnati payroll as reported per your 2017 Cincinnati Income Tax Return, Schedule Y, Step 2 $500,000 is not in agreement with wages withheld on for the same period of $57,000. Please advise as to the difference or remit additional tax due. WARNING- You might find that the company is overstating their Schedule Y. Especially true in Cincinnati - Tri-State area - Cincinnati Postal Code is used by businesses Two different departments within the business

Step 3- Sales Explanation Sales- Throwback Rule- Discussed later Gross Receipts-Everywhere Amounts should be easily verified from the Federal Return Rentals- In Cincinnati we make every effort to have the taxpayer exclude rents and separately report profit/loss after allocation. Services- Where performed. We use to require reconciliation- not so much now.

Step 3- Sales Audit Pre “Throwback” elimination---If Sales % was very low in respect to other two factors we would ask “How are sales solicited and by whom?”

Alternative Method Language (B) (1) If the apportionment factors described in division (A) of this section do not fairly represent the extent of a taxpayer's business activity in a municipal corporation, the taxpayer may request, or the tax administrator of the municipal corporation may require, that the taxpayer use, with respect to all or any portion of the income of the taxpayer, an alternative apportionment method involving one or more of the following: (2) A taxpayer request to use an alternative apportionment method shall be in writing and shall accompany a tax return, timely filed appeal of an assessment, or timely filed amended tax return. The taxpayer may use the requested alternative method unless the tax administrator denies the request in an assessment issued within the period prescribed by division (A) of section 718.12 of the Revised Code.

Alternative Method Procedures-Per Cincinnati Regulation R-17 Prefer the request be made before the return is filed Prefer the request is submitted directly to Tax Commissioner- The Commissioner will respond in 60 days Prefer taxpayer use Certified/Registered Mail Pre HB5 Approved methods remain in tact Tax Commissioner has three years to deny the method.

Case Study April 2016 T/P Requested using Single Factor -Sales Only Claim-Profits distorted because R&D and Admin in Cinti Said they would now include “throwback sales” “throwbacks” were already to be included Pending legislation may require exclusion Denied Request but can reapply when return filed. September 2017 Return filed- Denied- Issued Assessment Appealed Assessment- Requested Solicitor’s Opinion- Negotiated Settlement Property and Payroll factors were adjusted and they agreed to continue including royalty income. Taxpayer has a global presence Denied because did not show business model required any adjustments

Contact Information Ted Nussman Tax Commissioner City of Cincinnati (513) 352-3821 ted.nussman@cincinnati-oh.gov