If Ohio is adding record numbers of new businesses as a top official recently announced, where are the jobs?
Ohio Secretary of State Frank LaRose two weeks ago announced 11,920 new entities filed to do business in Ohio in October, allowing Ohio to reach 113,272 new businesses in the first 10 months of 2019. So far this year, 5,897 more new businesses have filed in the state of Ohio as compared to the same point last year. The 11,920 new businesses in October 2019 surpass last year’s October record of 10,876.
That sounds great, but where are the jobs? A state agency says there are fewer jobs.
Ohio’s unemployment rate was 4.2 percent in October 2019, unchanged from September, according to an announcement by the Ohio Department of Job and Family Services. Ohio’s nonagricultural wage and salary employment decreased 1,000 over the month, from a revised 5,593,100 in September to 5,592,100 in October 2019.
The number of workers unemployed in Ohio in October was 246,000, up 3,000 from 243,000 in September. The number of unemployed has decreased by 19,000 in the past 12 months from 265,000. The October unemployment rate for Ohio decreased from 4.6 percent in October 2018.
The U.S. unemployment rate for October was 3.6 percent, up from 3.5 percent in September, and down from 3.8 percent in October 2018.
So, with fewer jobs and an unemployment rate that’s higher than the national average, Ohio keeps adding new business entities.
Could part of the reason be the CAT tax?
The Ohio Department of Taxation says, “The commercial activity tax (CAT) is an annual tax imposed on the privilege of doing business in Ohio, measured by gross receipts from business activities in Ohio. Businesses with Ohio taxable gross receipts of $150,000 or more per calendar year must register for the CAT, file all the applicable returns, and make all corresponding payments.”
“Gross business income is the amount your business earns from selling goods or services before you subtract taxes and other expenses,” according to accounting software company Patriot Software. Gross income is calculated as revenue after the cost of goods sold (COGS).
So, the State of Ohio is taxing businesses based on the amount of money they bring in before paying for other taxes, utilities, wages and so forth.
The difficulty in running corporate income taxes has led to more interest by states in gross receipts taxes such as the CAT tax, according to the Tax Foundation. Such a tax creates multiple layers of taxes on the same good or service, however. The CAT is a 0.26 percent tax on business gross receipts above $1 million.
Gross receipts taxes have a simple structure, taxing all business sales with few or no deductions. Because they tax transactions, they are often compared to retail sales taxes. However, while well designed sales taxes apply only to final sales to consumers, gross receipts taxes tax all transactions, including intermediate business-to-business purchases of supplies, raw materials and equipment. As a result, gross receipts taxes create an extra layer of taxation at each stage of production that sales and other taxes do not—something economists call “tax pyramiding.”
The Tax Foundation also says the CAT tax of a 0.26 percent tax on business gross receipts above $1 million is a throwback to an earlier era of taxation, bringing back a tax type that had been in steady retreat for nearly a century.
Could the CAT tax be the reason so many business owners are creating new entities?
Jared Walczak, director of State Tax Policy for the Tax Foundation, spoke to The Ohio Star about the CAT tax. He said the CAT likely accounts for some but not all of the new filings.
Only 3-5 percent of pass-through entities are earning $1 million or more in gross receipts, he said. About 95 percent are smaller businesses and would have little liability.
However, companies that do pull in more than $1 million may find it handy to split into several entities to keep most or all of their income, Walczak said. They must have a “plausible separation” between those entities. Ohio law has provisions to address “entity isolation.”
“You can’t always do it,” Walczak said.
Ohio is unusual in that it created the CAT tax in modern times, while most states had abandoned it nearly a century ago, Walczak said. It was a trade-off to impose one tax instead of three taxes. Even if businesses are paying less, it is not a well-structured tax as it does not tax profitability, he said. It is disproportionate taxation on low-margin businesses.
Furthermore, the Tax Foundation has this to say in warning other states about adopting the CAT:
Where revenues are required, other options—like broadening the sales tax base or eliminating preferences in an existing corporate income tax—are far less economically destructive than modeling a tax provision based on the Ohio CAT. The resurgence of interest in gross receipts taxation is a throwback in the worst sense, the embrace of an inefficient and inequitable tax long since superseded by more modern revenue tools. Ohio’s experience, at most, offers a cautionary tale about capital stock and tangible personal property taxes, not a recommendation of gross receipts taxes. By learning the wrong lessons from the Buckeye State, other states risk embarking on a perilous course. Proponents hope the CAT has many lives—but for this CAT, even one life is one too many.
Corporate finance adviser Duff & Phelps says on its website there could be one advantage of one business owner forming multiple companies.
A company may elect to register as a consolidated elected taxpayer. A consolidated elected taxpayer will file on behalf of a group of entities under the common owner as a single taxpayer. After electing to act as a consolidated elected taxpayer, the business must file in this manner for the next eight quarters (or two years). There is a major benefit to electing to register as a group as taxable gross receives between each entity are not subject to the commercial activity tax.
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Jason M. Reynolds has more than 20 years’ experience as a journalist at outlets of all sizes.
