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    Ohio BTA Rules SERP is a Pension, Not Subject to Municipal Income Tax

    The Ohio Board of Tax Appeals has ruled that a supplemental executive retirement plan (SERP) was a pension, proceeds from which were specifically exempted from income taxation under the municipal ordinance in question. MacDonald v. City of Shaker Heights, BTA No. 2008-K-1883 (December 28, 2012).

    : The taxpayer was a resident of the City of Shaker Heights until December 27, 2006. Effective December 31, 2006, he retired from employment and qualified for benefits under the employer’s non-contributory retirement plan and supplemental executive retirement plan. He elected to receive benefits in the form of a joint and survivor annuity.

    As required by federal law, the present value of the SERP was reported in Box 5 of the taxpayer’s 2006 form W-2; however, the taxpayer excluded that amount in computing his municipal income tax liability for the 2006 tax year. Upon review, the city included the present value of the SERP in the taxpayer’s income for the year and assessed a deficiency. The city’s municipal board of tax appeal upheld the assessment, and the taxpayer appealed to the BTA.

    R.C. 718.01(F) provides that a municipal corporation may not impose its income tax on compensation other than “qualifying wages.” “Qualifying wages” is defined in R.C. 718.03(A) and “wages” as defined in section 3121(a) of the Internal Revenue Code. R.C. 718.03(A)(2) also provides that nonqualifying deferred compensation plans are deducted to the extent they are excluded from taxation by resolution or ordinance. The city’s ordinance did not exclude deferred compensation plans generally but did exclude payments from pensions from taxable compensation. However, neither the ordinance, nor the tax administrator by regulation, defined the term “pension.” Thus, the issue became whether the SERP was a pension.

    The SERP in question was a noncontributory, unfunded defined benefit plan. Evidence indicated it was designed to provide certain highly compensated executives a target income replacement upon retirement from employment, with allowances made for payments received due to pensions, other qualified and nonqualified plans, and social security. In fact, the stated purpose of the SERP was to provide for the payment of pension benefits to participants.

    The city argued that notwithstanding the nature of the plan, the proceeds were taxable because they were “qualifying wages.” Because the ordinance specifically included compensation from nonqualified deferred income plans as subject to the tax, and the SERP was a nonqualified deferred compensation plan, it claimed that it should have been the end of any inquiry. Since the income in question had not yet been paid, but merely had been reported in Box 5, the city asserted that the exclusion for pension payments did not apply.

    BTA Decision: Without a specific definition of the term “pension,” the BTA considered other sources for the ordinary meaning of the term. It noted that Treas. Reg. 31.3121(v)(c) described one type of SERP as a pension. It also noted that the general meaning ascribed to the term by various other sources referred to a payment given after separation from service, typically due to retirement or disability.

    Comments: By law, cities in Ohio may only provide tax compensation that constitutes “qualifying wages,” or wages as defined in IRC Section 3121(a). Thus, wages are typically taxed when they appear in Box 5 of the form W-2. For many nonqualified deferred compensation plans, this may occur when the benefits vest to the plan participant. When that happens, as in the MacDonald case, the liability can be significant.

    In this case, two key elements contributed heavily to the BTA’s decision. The first was the failure of the city to define, either by ordinance or regulation, the term “pension.” Thus, the BTA was compelled to look to the general meaning of the term. Had the city defined the term appropriately, the decision in the case may have been different.

    Second, the language and structure of the SERP were also important. Had the SERP permitted voluntary contributions by participants; had it been a defined contribution SERP; or had the benefits been funded, perhaps through a grantor trust, the result may also have been different. However, as noted by the BTA, the features in this case (i.e., noncontributory, defined benefit, unfunded) made it relatively easy for the BTA to conclude the SERP was indeed a pension.

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