Municipalities taxing stay-at-home workers during pandemic was OK, court says

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Welcome back to Route Fifty’s Public Finance Update! Last week, the Ohio Supreme Court issued a long-awaited ruling upholding a state law that allowed cities during the COVID-19 pandemic to temporarily collect income tax from individuals working from home. The decision comes as a relief to municipalities in the state, as an opposite ruling could have cost city governments millions of dollars.

The case is notable because it sets an important precedent in Ohio and is likely the first post-pandemic remote work ruling by a state supreme court.

The Ohio case revolves around a law passed by the General Assembly shortly after the start of the pandemic and Ohio’s stay-at-home order in March 2020. The measure temporarily allowed employers to withhold municipal income tax irrespective of where their employees performed their work. It stated that each day an employee spent working from home or an offsite location “shall be deemed to be a day performing personal services at the employee’s principal place of work.” The idea was to allow local governments to maintain their municipal budgets during the public health emergency. 

But the plaintiff in the case, Josh Schaad, sued Cincinnati’s finance director and the Ohio attorney general, arguing that the temporary measure “fundamentally altered what had been the law for 70 years and required workers to pay income taxes to cities in which they neither lived nor worked, and in many cases, had not set foot in for months,” according to court documents.

Before the pandemic, Schaad maintained a hybrid schedule. He worked a few days out of his home in Blue Ash, a suburb of Cincinnati, and commuted to his office in the city the other days of the week. He paid Cincinnati’s 1.8% income tax for the days he worked in the city.

But like most Americans, Schaad worked full-time out of his home during the state’s stay-at-home orders. But when he requested a refund of his city taxes for the days he worked outside Cincinnati, the city denied his request. Cincinnati maintained that Schaad was ineligible for a refund because of the state law that had been enacted. 

Schaad claims that allowing Cincinnati to tax his income while he worked from home violated the U.S. and Ohio constitutions.

Last week, the Ohio Supreme Court disagreed and ruled in a 5-2 decision that "Ohio had a legitimate interest in ensuring that municipal revenues remained stable” during the pandemic when employees were ordered to work from home. The ruling further stated that the temporary state law “was a valid exercise of the General Assembly’s constitutional authority.”

Ruling Sets a Precedent

The state law has since expired, ending Dec. 31, 2021. That means it is back to business as usual in Ohio. 

Of the 926 municipalities in the state, 649 levy an income tax. So, if an Ohioan works two days in a city in the state that collects income taxes and three days in another Ohio city that levies such a tax, their employer must withhold the appropriate amount and remit it accordingly to the two municipalities.

But while the temporary measure is no longer in effect, the ruling “sets a precedent for maintaining the status quo” should there ever be another emergency situation like the pandemic, said Rasheda Hansard, administrator of the Columbus Division of Tax.

Hansard says the Ohio General Assembly did what it had to do given the unique circumstances of the pandemic. “The court held that the General Assembly had the authority to create a temporary law to maintain the status quo of taxation,” she said. “The money was used to maintain city services to keep people safe. It was a unique circumstance [the law] to meet a unique circumstance.”

The Ohio Municipal League released a statement applauding the majority decision, as Ohio’s cities and villages “rely on certainty and stability when it comes to their revenue streams,” Kent Scarrett, the group’s executive director, said. “While we consider this a victory for municipalities that affirms what they were directed to do by the state during the pandemic, we remain cautiously optimistic about all the implications of the ruling and will delve deeper into it over the coming weeks and months to gain a fuller understanding of its impacts.”

Long-term Impact?

Had the Ohio Supreme Court ruled differently, cities like Cincinnati and Columbus would have had to forfeit millions of dollars in refunds to Ohio residents.

Because of that risk, Columbus budgeted for an adverse ruling. “We had to assume different variables,” said Megan Kilgore, the Columbus city auditor. 

The case had other impacts, too. “Before the ruling,” Kilgore said, “we had never received calls from bondholders asking about a tax case. We had to do a lot of disclosure.” 

But now that things are back to business as usual, the focus is on how remote work will affect city revenues in Ohio.

“In Columbus, we are absolutely seeing revenue declines due to remote work,” Kilgore said. “But we are also seeing population growth—Columbus is the fastest growing city in the U.S.—offset that. We have more people, more jobs.”

With any revenue change, Kilgore added, “there is a period of phase-ins and understanding how this will affect us. Remote work is not different. Some places, some local governments stand to benefit, like bedroom communities that have great amenities. Some stand to lose.” 

Jim Landers, associate professor of practice at the John Glenn College of Public Affairs at Ohio State University, underscored Kilgore’s point. “The focus has been on big cities, but this could be a hit on cities that rely on one office park or one company or one headquarters.”

Landers noted that there's only a handful of states where municipalities impose local income taxes. "Nationally, there are only 15 or 16 states that authorize local governments to impose income taxes," he said. "The largest concentration of local governments imposing income taxes are contained in about five states, and they are all in the Midwest: Ohio, Indiana, Kentucky, Pennsylvania and Michigan. The important distinction for purposes of the impact of remote work on local income taxes is whether the tax is residence-based or source-based as in the case in Ohio. Remote work could have a direct impact on revenue from source-based taxes when an employee normally working in an office in one jurisdiction shifts to work from home in another jurisdiction."

Other Remote Tax Cases

The Ohio case is likely the first post-pandemic remote work ruling by a state supreme court. A separate case in New York is still winding its way through the courts. 

The issues being litigated are different. In that case, Edward Zelinsky, a law professor who works in New York but lives in Connecticut, is challenging the constitutionality of New York’s commuter tax. Specifically, he is seeking a refund of all taxes New York imposed on his income for most of 2020 when pandemic-era public health orders prevented him from accessing his classroom. A state tax judge ruled against him last December. He’s now appealing the determination, according to Bloomberg Tax.

Before the pandemic, New York levied a commuter tax on the earnings of New Jersey and Connecticut residents who traveled to the state to work. But during the pandemic, New York determined that the days a nonresident worked remotely counted as a day of work in New York. New York’s rule is still in effect today, and Zelinsky argues that it violates federal due process and commerce clause language that prohibits extraterritorial taxation.

Editors note: This story has been updated to clarify a quote from Dr. Jim Landers.