On Sept. 26, 2022, the Cuyahoga County Court of Common Pleas, Ohio, ruled that the City of Cleveland was required to refund municipal income tax collected from a nonresident employee who worked remotely from Pennsylvania during most of the 2020 tax year.1 The Court concluded that Ohio could not authorize its cities to engage in extraterritorial taxation under temporary emergency legislation permitting municipalities to tax the income of employees that worked in those cities prior to the COVID-19 pandemic but worked remotely from a different location for most of the 2020 tax year.
On March 27, 2020, Ohio enacted emergency legislation (H.B. 197) providing various tax relief measures in response to the COVID-19 pandemic.2 This law included temporary provisions that sourced compensation of teleworking employees to the employee’s principal work location for municipal income tax purposes, even if the employee was working remotely from a different location.3 This measure was implemented in part to ensure that Ohio cities would continue to maintain expected revenues by countering the adverse fiscal impact of remote work from a municipal income tax perspective. The temporary provisions were set to expire 30 days following the end of Governor Mike DeWine’s state of emergency declaration, first enacted in March 2020.4
While the temporary municipal income tax withholding rules were expected to expire in conjunction with the lifting of the governor’s state of emergency in July 2021, budget legislation enacted in June 2021 extended the temporary withholding rules through Dec. 31, 2021.5 Importantly, the legislation provided withholding relief for the 2021 tax year by allowing employees working remotely to claim refunds of tax paid to localities for days that the employee worked elsewhere during the year.6 However, the employee municipal tax refund provisions do not apply to the 2020 tax year.7
Prior to the pandemic, the taxpayer, a Pennsylvania resident employed by a biotechnology company based in Cleveland, worked in the company’s Cleveland office each week. The taxpayer commuted more than 400 miles and returned to her Pennsylvania home on the weekends. She regularly applied for and received a refund of municipal income tax for days worked outside Cleveland.
Beginning in March 2020, after the Governor declared a state of emergency and the state director of health issued a stay-at-home order in response to the pandemic, the taxpayer began working from her Pennsylvania home full-time and did not return to her Cleveland office for the remainder of 2020. Pursuant to H.B. 197, her employer continued to withhold municipal income tax as though she was still working in Cleveland. The City refused her request for a refund of tax paid from March 13 through Dec. 31, 2020.
The taxpayer filed a lawsuit in the Cuyahoga County Court of Common Pleas, arguing that H.B. 197 violates the Commerce Clause of the U.S. Constitution because it seeks to expand the taxing power of municipalities to Ohio nonresidents for work performed outside the state. She also alleged that the City lacks the jurisdiction to tax income earned by an Ohio nonresident for work done outside the state due to a lack of a “fiscal relation” with the City as required by the Due Process Clause of the U.S. Constitution. In Feb. 2022, Cleveland moved for summary judgment, arguing that the taxpayer must exhaust her administrative remedies before filing a lawsuit in state court, and that H.B. 197 does not violate the Due Process or Commerce Clauses of the U.S. Constitution.
Trial court decision
In its analysis, the Court reviewed several ongoing lawsuits filed by Ohio residents alleging similar issues. In Buckeye Institute v. Kilgore, an Ohio appellate court determined that H.B. 197 did not violate federal or state due process limitations placed on the city of Columbus’ jurisdiction to tax, and that the law was not an overreach of state legislative authority to administer municipal income taxes.8 In Schaad v. Alder, a different Ohio appellate court similarly ruled that the state legislature is authorized to create a uniform municipal taxation scheme, and that the law required Cincinnati to tax the income of an Ohio resident who worked outside the city during the pandemic.9 In particular, the appellate court determined that due process was satisfied in this case because the plaintiff was an Ohio resident.
In granting the taxpayer’s summary judgment motion, the Court first determined that she was not required to exhaust her administrative remedies because Cleveland “had no choice but to follow the dictates of the General Assembly” in H.B. 197. In essence, the City’s tax review board could not provide the relief sought by the taxpayer. Next, the Court found that H.B. 197 is not facially unconstitutional because it is not “clearly incompatible” with the authority of the state legislature to pass laws limiting the power of municipalities to levy taxes.
However, the Court ruled that H.B. 197 is unconstitutional as applied to the taxpayer’s specific factual situation. The Court distinguished the current case from the Kilgore and Schaad cases by noting that the taxpayers in those cases were Ohio residents, despite being taxed by a city in which they were not working. Despite the special circumstances of the pandemic, the Court noted that the Ohio legislature “cannot authorize cities to engage in extraterritorial taxation.” The Court found “no case law that suggests that the legislature can expand the taxing power of a municipality to non-Ohio residents on work performed outside the state.” Noting that the General Assembly has jurisdiction over Ohio residents and authority to address the exigencies of the pandemic, the Court concluded that the legislature “cannot create jurisdiction” to tax Ohio nonresidents for work performed outside the state.
Finally, in contrast to the Kilgore and Schaad cases, the Court reasoned that due process was not satisfied in this case due to a lack of a sufficient “fiscal relation” necessary to establish Cleveland’s jurisdiction to tax the nonresident’s income. In the Court’s view, the requisite fiscal relation was lacking because the taxpayer was not physically present in the state to enjoy the protections, opportunities and benefits provided by Cleveland. For these reasons, the Court granted the taxpayer’s summary judgment motion and ordered a refund of municipal income tax collected.
The Court’s decision in Morsy makes clear that with respect to Ohio’s temporary emergency telework tax law, Ohio municipalities cannot tax the income of Ohio nonresidents for work performed outside the state. While declining to declare H.B. 197 unconstitutional on its face, the Court distinguished the Kilgore and Schaad cases, which dealt with the municipal taxation of Ohio residents that worked remotely outside the city associated with their principal work location during the 2020 tax year. The taxpayer’s out-of-state residency set this case apart from the other Ohio telework tax cases.
The different conclusions reached by Ohio courts over the constitutionality of H.B. 197 illustrate the fact-specific nature of these cases that can turn on where an employee resides. Given the outcome of these cases to date, the state legislature apparently is authorized to create a uniform municipal taxation scheme with respect to intrastate taxation, but it cannot authorize cities to engage in extraterritorial taxation. However, the Ohio Supreme Court in June accepted the Schaad case for review, meaning that the facial constitutionality of H.B. 197 remains a live issue.10 Indeed, it remains to be seen whether H.B. 197 will withstand constitutional scrutiny with respect to similar lawsuits brought by Ohio residents.
At first glance, the Ohio telework municipal tax cases may be thought to have relatively limited applicability in that they address the constitutionality of a temporary law that provides no refund mechanism for employees taxed by Ohio cities in which they were not physically present during 2020. However, the structure of the Ohio law mirrors that of other states that continue to employ the “convenience of the employer” rule, under which employee income is sourced to the state or locality if an employee works remotely for his or her own convenience rather than as a requirement of the employer that is located in the taxing state.11 As such, the due process arguments advanced in Morsy could potentially be used in support of future challenges to state convenience rules in the post-pandemic environment where employees often continue to work remotely across state borders.
In response to the Morsy decision, Cleveland filed a notice of appeal to the Eighth Appellate District of the Ohio Court of Appeals, along with a motion for a stay of the state trial court’s order until the appeal can be heard by the appellate court.12 On Nov. 2, 2022, the appellate court granted Cleveland’s motion to hold the appeal until the Ohio Supreme Court issues a decision in the pending Schaad case. Cleveland requested that the appellate court hold the appeal in abeyance under the reasoning that the decision could control the outcome of this case. This recent procedural activity illustrates the extent to which the Ohio telework taxes cases remain interrelated despite their factual differences.
- Morsy v. Dumas, Cuyahoga County Court of Common Pleas, Ohio, No. CV-21-946057, Sept. 26, 2022.
- Ohio H.B. 197, Laws 2020.
- H.B. 197, § 29.
- Executive Order 2020-01D, signed Mar. 9, 2020.
- H.B. 110, § 610.115, Laws 2021, amending H.B. 197, § 29. For further discussion, see GT SALT Alert: Ohio enacts biennial budget bill with tax changes.
- H.B. 110, § 757.40.
- H.B. 110, § 747.40(C).
- No. 21-AP-193, Ohio Court of Appeals, Tenth Appellate District, Nov. 30, 2021. For further discussion of this case, see GT SALT Alert: Ohio dismisses municipal income tax challenge.
- No. C-210349, Ohio Court of Appeals, First Appellate District, Feb. 7, 2022.
- Schaad v. Alder, Ohio Supreme Court, No. 2022-0316, filed Feb. 9, 2022.
- New York historically has interpreted the “convenience” rule most aggressively and continues to do so as the pandemic subsides, taking the position that for nonresidents with a primary office located in New York, days spent teleworking are considered days worked in the state unless the employer establishes a bona fide employer office at the teleworking location.
- Morsy v. Gentile, Ohio Court of Appeals, Eighth Appellate District, No. CA-22-112061, filed Oct. 19, 2022.
Ying Lee is a partner in Grant Thornton's State and Local Tax practice, and leads the Ohio State and Local Tax practice. Ying has extensive experience advising companies on multistate tax planning strategies aimed at minimizing state and local tax liabilities, resolving tax controversies, performing M%26A due diligence reviews, and assisting with complex compliance issues.
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Jamie C. Yesnowitz
Jamie Yesnowitz, principal serving as the State and Local Tax (SALT) leader within Grant Thornton's Washington National Tax Office, is a national technical resource for Grant Thornton's SALT practice. He has 22 years of broad-based SALT consulting experience at the national and practice office levels in large public accounting firms.
Washington DC, Washington DC
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