1. Reviewing Individual Returns
OML Conference 2017
Patricia Chittock * Tina Timberman

2. Federal Form 1040: U.S. Individual Income Tax Return
This form is the backbone of municipal returns
It can indicate whether or not taxable income has been earned by the individual, even before seeing other documents
Fields to consider when a 1040 is given:
Name and Filing Status fields
These will both confirm identity and alert the auditor if any name updates or filing changes (between separate and joint)
Address fields
These fields will provide insight into movement within, into, or out of a given municipality—as well as potential use of a mailing address
Social Security Number fields
These fields confirm identity, and should be checked against both the auditor’s system and any additional documents

3. Federal Form 1040: U.S. Individual Income Tax Return
Line 7: Wages, salaries, tips, etc.
Indicates presence of W-2
Line 12: Business income or (loss)
Indicates presence of Schedule C
Line 17: Rental real estate, royalties, partnerships, S corporations, trusts, etc.
Indicates presence of Schedule E, and possibly Schedule E pg. 2 with K-1
Line 21: Other income
May indicate presence of gambling winnings (W-2G), or miscellaneous income not recorded on a Federal Schedule (1099-MISC or 1099-K)

4. Federal Form 1040, Page 2
Page 2 of the Federal Form 1040 is not required, and often is not requested
If page 2 is provided, Line 40: Itemized deductions or your standard deduction may indicate the presence of a Schedule A, and thus possibly a Form 2106
If the taxpayer does not provide page 2; Schedule A; Form 2106; and does not indicate anywhere that they intend to take a deduction predicated on 2106…
…The absence of these documents does not prompt a request for additional information

5. Form W-2
If Federal Form 1040 is the backbone of the municipal return, Form W-2 is the heart of it
It is the most common supplemental form an auditor will cross
Highlighted fields to considering when auditing:
Confirm the employee’s social security number (Box A), name, and address (Box E) against your records
Confirm the employer’s address (Box C) against the withholding locality name (Box 20)
“Total”, “All City”, or something similar in Box 20 will indicate the presence of multiple W-2s, or of a W-2 withholding breakdown
A blank space in Box 20 may indicate work in a township, or a home office that exists out of state
Use “Medicare wages” (Box 5) or “Local wages, tips, etc.” (Box 18)—whichever is higher—as the total income when calculating a municipal return
Apply the withholding credit based on “Local income tax” (Box 19)
Confirm that the number of “Wages, tips, other compensation” (Box 1) matches Form 1040, Line 7
If this number does not match, this will indicate the presence of multiple W-2s

6. Forms 1099-MISC and 1099-K When auditing a 1099-MISC/K:
A Form 1099-MISC is issued when a freelancer, independent contractor, or otherwise non- employee is paid
Form 1099-K is a relatively new form, and is issued to non-employee workers with ride-sharing companies like Uber or Lyft
But it behaves like—and should be treated the same as—a 1099-MISC
When auditing a 1099-MISC/K:
Confirm whether or not the 1099-MISC/K income is already part of the Schedule C—and if it is, the 1099-MISC/K income should not be taxed separately
Check the total amount of the 1099-MISC/K against the gross income listed on the Schedule C
If the 1099-MISC/K income is separate from a Schedule C, the entire amount of the MISC/K should be taxed
Often, this income will appear on Line 21 of the Federal 1040 as “other income”

7. Schedule C - Business Profit/Loss
This document is generated using information pulled from a taxpayer's 1099-MISC or 1099-K
If Form 1040, Line 12 does not match Schedule C, Line 31, that indicates an additional Schedule C
Taxpayers may send Forms 1099-MISC or K in addition to the Schedule C
Let Form 1040 once again be your guide as to whether those 1099 Forms constitute additional income or are indeed part of the Schedule C already

8. Auditing Schedule C (Business Profit/Loss)
Highlighted fields to consider when auditing:
Business name, FEIN/SSN, and address
Gross receipts or sales (Line 1)
Wages reported on the return that were paid on a corresponding withholding account (Line 26)
If the income is allocated, verify that wages on allocation match the withholding account
Make sure the total deductions were added correctly (Line 28)
Check that the net profit/loss was added correctly (Line 31)

9. Schedule E – Supplemental Income/Loss
Page one of the Schedule E (commonly just called “Schedule E”) is primarily used to record income or loss related to rental property
It may also be used to record income or loss related to royalties, land ownership, and more
It is uncommon (but not necessarily rare) to come across income on Line 4: Royalties received
Often related to royalties from oil or natural gas wells, this line is also used for royalties related to creative works, such as books or musical compositions
Only royalties from oil, natural gas, land ownership, and the like (tangible sources) is taxable
Royalties from intangible sources (artwork usage, musical compositions, book sales, etc.) is not

10. Auditing Schedule E (Supplemental Income/Loss)
Highlighted fields to consider when auditing:
The name and social security number
The physical address of the rental property (Line 1a, sub-lines A, B, and C)
The type of property (Line 1b, sub-lines A, B, and C), in conjunction with the list in the box below those fields
Income received (Lines 3 and 4), which indicates both amount and nature (rent or royalty)
Verify that total expenses (Line 20) add up to the expenses listed (Lines 5 through 19)
The resultant income or loss becomes the number used on the municipal return (Line 21)
Check the total rent real estate and royalty income or loss against the number listed on Form 1040, Line 17
If the numbers do not match, there is either a second Schedule E, or there’s a Page 2 to the Schedule E

11. Schedule E, Page 2 and Schedule K-1
Schedule E, Page 2 and Schedule K-1 go together like bacon and eggs
Schedule E, Page 2 is often informed by income or loss as listed on Schedule K-1

12. Schedule E, Page 2
Individuals will use Schedule E, Page 2 to report income or loss from Partnerships, S Corporations, and Trusts
Municipalities are really only concerned with income and loss from Partnerships and S Corporations
And in the case of S Corporations, it may depend upon where the S Corporation is located—more on that in a bit
Highlighted fields to consider when auditing:
Confirm that name and social security number are accurate and consistent with the 1040 and the other supplemental documents
Confirm names of businesses (Line 28, grid rows A-D) and types of businesses (Line 28b) match information on Schedule K-1
Verify that losses and gains (Line 28f-j) equal totals listed (Line 32)
Losses may be applied universally, regardless of municipality in which the business is located

13. Schedule K-1
A Schedule K-1 will record income or loss from either a Partnership or S Corporation
Partnership income may be taxed (and loss applied), regardless of where the Partnership is located
Rules concerning the taxation of S Corporation income (and use of S Corporation loss) are contingent upon prior ballot issues, and may be municipality- specific
Right to tax all S Corporations – 11/04/2003
Right to tax only Ohio S Corporations – 11/02/2004
If these ballot issues were not passed by your municipality, your municipality cannot tax S Corporations

14. Auditing Schedule K-1 Highlighted fields to consider when auditing:
The business’s name, address, city, state, and ZIP code (Part I, Line B)
This information will indicate if a potential credit for taxes paid to another locality might be extended to the taxpayer (with a copy of the other city’s return)
Confirm that the individual’s name, address, and social security number match the other supplemental documentation (Part II, Lines E and F)
Verify the ordinary business income or loss matches the information presented on Schedule E, Page 2, Line 28e-j (Part III, Line 1)
Verify that the other income or loss (Part III, Line 11), Section 179 deduction (Part III, Line 12), other deductions (Part III, Line 13), and self-employment earnings or loss (Part III, Line 14) match the information presented on Schedule E, Page 2, Line 28e-j

15. Deductions: Schedule A and Form 2106
Form 2106: Unreimbursed Employee Expenses and Schedule A: Itemized Deductions go together like peanut butter and chocolate
A Form 2106 cannot exist without a Schedule A—but a Schedule A can exist without Form 2106

16. Form 2106: Unreimbursed Employee Expenses
The only deduction allowed at the municipal level that appears on the Schedule A is the Form 2106 deduction
Total Expenses (Line 6) as listed on Form informs Schedule A, Line 21—which in turn informs the 2106 deduction calculation

17. Schedule A: Itemized Deductions
As stated previously, Unreimbursed Employee Expenses (Schedule A, Line 21) are the only Schedule A deductions allowed on municipal returns
This amount totals $14,680
The taxpayer is allowed to take the Form deduction, but with a credit limitation
This limitation is based on the AGI (Line 25, or $85,070 in this case), at 2% (which amounts to $1,701 on Line 26)

18. Determining 2106 Deduction: Method A
As stated in ORC (A)(2):
In computing the municipal taxable income of a taxpayer who is an individual, the taxpayer may subtract, as provided in division (A)(l)(b)(i) or (c) of this section, the amount of the individual's employee business expenses reported on the individual's form 2106 that the individual deducted for federal income tax purposes for the taxable year, subject to the limitation imposed by section 67 of the Internal Revenue Code. For the municipal corporation in which the taxpayer is a resident, the taxpayer may deduct all such expenses allowed for federal income tax purposes. For a municipal corporation in which the taxpayer is not a resident, the taxpayer may deduct such expenses only to the extent the expenses are related to the taxpayer's performance of personal services in that nonresident municipal corporation.
Thus, the preferred method of calculating the deduction is to take the 2106 deduction less 2% of the AGI

19. Determining 2106 Deduction: Method A
So, the calculation looks like this:
$14,860 – $1,701 = $12,979
Thus, $12,979 is the allowed deduction for municipal returns in this scenario
If the above calculation were to produce a zero or a negative number, no deduction would be allowed for expenses
But per Tina, there is an alternative method to determining the deduction

20. Determining 2106 Deduction: Method B
The rationale behind the second method is that since there are both expenses and other expenses in the Job Expenses and Miscellaneous Deductions section, the 2% limitation may be allocated between the two
One would calculate this allocation by dividing Line 21 ($14,680) by Line 24 ($16,830)
$14,680/$16,830 = 0.87, or 87%
So, this calculation shows us that the expense is 87% of the total amount

21. Determining 2106 Deduction: Method B
Using this method, one would then take 2% of the AGI (previously determined to be $1,701) and multiply that number by 87%
This gives us $1,480 as the new offset
From here, the calculation is as it was in Method A:
$14,680 - $1,480 = $13,200
Thus, $13,200 is the allowed deduction for municipal returns in this scenario

22. Determining 2106 Deduction: Comparison
Comparison between the two methods:
Method B - Allocation $13,200.00
Method A – Whole Deduction $12,979.00
Difference $221.00
While Method B requires more steps, it results in a larger deduction for the taxpayer
In cities allowing both methods, it is up to the accountants or taxpayers as to how they decide to calculate the expense deduction

23. Method A in Action
Subtract 2106 expenses as derived by the Method A calculation (Column 2) from total wages or compensation (Column 1)
Record the resulting net wages or compensation (Column 3) an on page one (Table A, Section A-2, Column 1)

24. Method B in Action
Subtract 2106 expenses as derived by the Method B calculation (Line 1C) from taxable earnings (Line 1B)
Record the resulting total W-2 wage income (Line 2)

25. Lakewood: Universal Offset
We all recognize that HB 5 has drastically changed the landscape for many cities with regards to the offset
Cities across Ohio updated their forms for tax year 2016 to compensate for these changes…
…and will be doing so again for the 2017 tax year (re: carryforward)
That said, there are primarily two schools of thought on how to approach the calculation of the universal offset—either one perhaps more generous in some cases than the other
But in spite of any differences of opinion as to application, we seem to be able to agree that we will take what we’re given, as-is

26. The Lakewood Table Inspired by CCA’s table Developed by Brunswick
Streamlined variation of CCA’s table for independent suburbs
Developed by Brunswick
Informed/Critiqued by Euclid and Lakewood
Adopted/adapted by Lakewood
Nicknamed “B.E.L. Table”
Customizable and fairly straightforward
Cuyahoga Falls also employs a variation of the table, tailored to their needs
Resembles Lakewood’s prior Schedule table, but greatly expanded
Too many unfamiliar changes too quickly can cause people to become frustrated

27. The Lakewood Table: Preliminary Calculation
Starting with Line 3, the income and loss of each Schedule is recorded into columns labeled by locality
This will make a proper application of the 0.5% credit easier later
The total amount of positive net profits is recorded on Line 6 ($17,951)
Each municipality’s income is divided by Line 6’s total, which gives us the apportionment percentage (72% and 28%, respectively) on Line 7
All losses are tallied and recorded on Line 8 ($10,000)
Subtract Line 6’s total income from Line 8’s total loss and record the resulting total taxable income on Line 9 ($7,951)
This number gets carried over to vestigial Line 4 on Lakewood Form L-1, Page 1

28. The Lakewood Table: Apportionment
Multiply the total loss on Line 8 by the apportionment percentages on Line 7, and record the resulting allowable losses on Line 10 in their respective columns ($7,200 for Lakewood, $2,800 for Columbus)
Subtract the losses on Line 10 from the income listed by municipality on Line 5, and record the net profits after loss application on Line 11 in their respective columns ($5,750 for Lakewood, $2,200 for Columbus)
Multiply the income listed on Line 12 by 2.5% to calculate the net profit City of Lakewood gross tax ($86.25 for Lakewood, $55.00 for Columbus respectively)

29. The Lakewood Table: Final Calculations
Confirm that taxes paid to other municipalities is correct relative to their own tax rate (Line 13)
Columbus’s tax rate is 2.5%, so $55.00 must be paid to Columbus in order to receive Lakewood’s tax credit
Multiply Line 11, Column 2 by 0.5% to calculate the credit for taxes paid to other municipalities ($11.00 on Line 14)
Subtract the credit on Line 14 from the net profit on Line 12, and record the results on Line 15 ($86.25 for Lakewood, $22.00 for Columbus)
Total tax due after adding all columns in Line 15: $ (Line 16)
It is this number that gets carried to Page 1, Line 10

30. Athens: Offsetting Only residents may offset
Non-residents cannot offset
e.g. If a non-resident taxpayer owns rental properties, the rentals must be filed in each municipality and in the taxpayer’s place of residence
Non-residents can no longer offset Schedule E and Schedule C income; this can only be done by a resident
e.g. Rental income for a non-resident can offset other Athens rental income—however, it cannot offset other types of Schedule income
A business loss cannot offset wage income

31. The Athens Table The giant bucket analogy
Imagine that all Schedule income and all Schedule loss is placed into a giant bucket, where it mixes together and offsets each other
After the losses and gains offset each other, any resulting net profit or loss is what gets reported on the return
Offsetting becomes confusing for residents when they must account for so much on their own
Business income for which credits were paid on the taxpayer’s behalf, different net operating losses to track, etc.
A new, straight-forward section specifically for offsetting was added to the back of the Athens individual form
The new section is based on similar sections which were already present on generic returns used by Athens preparers

32. The Athens Table Calculation
Using the same information as in the Lakewood Table:
Schedule C Income, Schedule E Income, and Schedule K-1 Income/Loss are all recorded in one column (Lines 1-3, Column A)
The tax credit allowed on $5,000 of the K-1 income is 1% (Line 3, Column D)
This represents the K-1 income earned in Columbus, for which taxes were paid to Columbus
The K-1 loss remaining is then subtracted from the Schedule C income (Line 5, Column A), while the credit is carried down (Line 5, Column D)
Because the taxpayers in question do not live in Athens, they cannot use the loss to offset any of the Schedule E income
They must carry the Schedule E gain instead to the front of the return and record it on Line 3b

33. Offset: Comparison

34. Net Operating Loss Carryforward (NOL) When it takes affect and what to expect 50% phase in
First year for the NOL is 2017
First year you can take a NOL is on the 2018 return filed in 2019
You will need to establish a NOL first in FYE 2017
No prior losses from 2016 and back will be available as a NOL, unless your municipality offered a NOL prior to the law change
There is a 5 year 50% phase in for the NOL
For the first 5 years (tax years 2017, 2018, 2019, 2020, and 2021), the NOL used cannot exceed 50% of the cumulative amount
e.g. If you have a $10,000 NOL carryforward from 2017 and 2018 on your 2019 return, you would only be allowed to use $5,000 as a loss offset—while the other $5,000 would be carried forward for future use

35. Questions? Comments?
Patricia Chittock Assistant Finance Director I City of Lakewood – Income Tax Division Detroit Ave., Suite 1 Lakewood, OH (216) Tina Timberman Income Tax Administrator City of Athens 8 E Washington St. Athens, OH (740) ext. 2