Key Takeaways

• Ohio cities are not required to refund withholding taxes remitted to the principal place of work of the employee when the employee was required to work outside the municipality for the period covered by the decision and instead worked in another Ohio location. See Am. Sub. H.B. 197, Section 29 (134th General Assembly), as amended by Am. Sub. H.B. 110, Section 610.115 (134th General Assembly).

• Nothing in this ruling would seem to support denying municipal income tax refunds to Ohio (or nonresident) employees working remotely for periods not covered by the decision.

• Non-Ohio residents assigned to an office in Ohio but working remotely from home outside Ohio should not be controlled by this decision.

• It will be interesting to observe whether the General Assembly will respond to the decision by enacting new laws to address the issues raised by remote workers.

The Ohio Supreme Court issued its long-awaited decision in Schaad v. Alder, Slip Opinion No. 2024-Ohio-525, decided on February 14, 2024. The decision is available here.

In a 5-2 decision, the court upheld an Ohio statute that provided a temporary municipal income tax rule requiring employers to assign payroll to employees’ principal place of work during COVID-19 even when the employees were required to work outside the city in which their principal office was located.

The decision could have profound effects on several areas of state and local taxation. The presentation below addresses some of the more immediate effects.

Facts

During the pandemic, when employees were being directed to not come into the office, the Ohio General Assembly provided a temporary law that each day that an employee spent working offsite was treated as personal service performed at the employee’s principal place of work. During the Pandemic, Josh Schaad worked for a Cincinnati employer, but Schaad worked principally from his home in Blue Ash, Ohio. Schaad sought a refund of Cincinnati municipal income taxes for the time period in which he worked outside Cincinnati. Karen Alder, the Finance Director of Cincinnati, denied the refund. The trial court dismissed Schaad’s appeal, and on further appeal, the Ohio First District Court of Appeals affirmed the trial court’s decision. The Ohio Supreme Court agreed to hear the appeal. The oral argument occurred almost a year before the decision, which is a longer period than normal between an argument and a decision.

Analysis

Schaad argued that Cincinnati attempting to tax the income earned by him while in Blue Ash violated the Due Process Clause of the Fourteenth Amendment. The majority opinion, written by Justice Patrick DeWine, applied the rational basis standard such that Schaad only needed to establish that the State lacked a rational basis to enact the law in order for the State to prevail.

The Court distinguished its prior cases holding that municipal taxes imposed on nonresidents violated federal due process because many of those cases involved tax imposed by municipal ordinances on individuals who did not live in Ohio. Here, the issue was the taxing powers granted to municipalities by state law. In the author’s view, this case should not control the outcome of an effort by a municipality to tax those employees working outside Ohio during the Pandemic or otherwise.

The majority found that the Home Rule Amendment of Article XVIII, Section 3, of the Ohio Constitution did not prevent the General Assembly from granting additional power to municipalities as it relates to Ohio residents. The temporary law authorized a municipality to tax work performed outside the municipality; the law likewise prevented an employee residence city from taxing the employee although that employee was actually working from that location. “Because the General Assembly has the power to grant a municipality additional authority, and because it has the power to limit a municipality’s authority to collect taxes, [the temporary law] is within the General Assembly’s authority to enact.” Slip Op. at ¶ 48.

The law in question was temporary and designed to address the extraordinary circumstances of the Pandemic and, thus, readily supported the finding of a rational basis for the action of the General Assembly. The law was intended to alleviate an acute but temporary issue. In the author’s view, while different issues could arise during periods not subject to the COVID Pandemic, the rational basis standard is understood to provide a low threshold for the State to rationalize legislation, and the State could well be able to establish a rational basis for assigning income of Ohio residents away from the location where the work is performed even during non-COVID periods. That issue appears to remain open for future legislation, if any.

Dissents

Chief Justice Sharon Kennedy dissented on the basis that Home Rule limits the taxing power of municipalities and does not permit a city to tax income earned outside the city’s boundaries. She also questioned the majority’s conclusion that federal due process does not protect intrastate extraterritorial taxation. She observed that the U.S. Supreme Court had never had an opportunity to address whether federal due process applies to extraterritorial municipal taxes.

Justice Pat Fisher, in a separate dissent, agreed with the Chief Justice. “When [Schaad] worked in Blue Ash, Schaad plainly derived no benefit from Cincinnati. Put simply: no link, no minimum connection existed between Cincinnati and Schaad during the relevant time frame.” Slip Op. at ¶ 86.

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