Willacy v. Cleveland Bd. of Income Tax Review

• Decision Date: 04 February 2020
• Docket Number: No. 2018-0794,2018-0794
• Parties: WILLACY, Appellant, v. CLEVELAND BOARD OF INCOME TAX REVIEW et al., Appellees.
• Court: Ohio Supreme Court

159 Ohio St.3d 383

151 N.E.3d 561

2020 Ohio 314

WILLACY, Appellant,

v.CLEVELAND BOARD OF INCOME TAX REVIEW et al., Appellees.

No. 2018-0794

Supreme Court of Ohio.

Submitted July 9, 2019

Decided February 4, 2020

Aubrey B. Willacy, Cleveland, and Buckingham, Doolittle & Burroughs, L.L.C., and Steven A. Dimengo, Akron, for appellant.

Barbara A. Langhenry, Cleveland Director of Law, and Linda L. Bickerstaff, Assistant Director of Law, for appellees.

Per Curiam.

{¶ 1} Appellant, Hazel M. Willacy, was employed by the Sherwin-Williams Company in Cleveland from 1980 until she retired in 2009 and moved to Florida. During Willacy's employment, Sherwin-Williams compensated her, in part, with stock options. When she exercised some of those options in 2014 and 2015, Cleveland collected income tax on their value. Willacy appeals from the denial of her claim for refunds. This case presents the question whether Cleveland may tax the options as income when Willacy did not work or live in the city during the tax years at issue.

{¶ 2} Willacy primarily argues that Cleveland's imposition of the tax violated her rights to due process. She also raises nonconstitutional arguments. We conclude that Willacy's arguments lack merit and hold that Cleveland properly taxed the compensation she received in 2014 and 2015.

I. FACTS AND PROCEDURAL HISTORY

{¶ 3} In 2007, when Willacy was working in Cleveland, Sherwin-Williams granted her options to purchase 2,715 shares of Sherwin-Williams common stock at $63.44 a share. The terms of the grant created a nine-year window for Willacy to exercise the options: she could first exercise them after one year, and they would expire on the tenth anniversary of the grant date. In 2009, Willacy retired and became a Florida resident.

{¶ 4} In 2014, Willacy exercised the options by purchasing 315 shares at the option price and immediately selling them at a market price of $192.646 a share, generating proceeds of more than $40,000. As required under Cleveland Codified Ordinances 191.1302(a), Sherwin-Williams withheld Willacy's municipal income-tax obligation (2 percent of the proceeds) and paid it to Cleveland. In 2015, Willacy again exercised her options by purchasing 1,800 shares at the option price and immediately selling them at a market price of $275 a share, generating proceeds of more than $377,000. Sherwin-Williams again withheld Willacy's municipal income-tax obligation. There is no dispute that Willacy did not live or work in Cleveland in 2014 or 2015.

{¶ 5} Willacy sought refunds from Cleveland based on the fact that she had resided in Florida during tax years 2014 and 2015. Cleveland's income-tax administrator, appellee Nassim M. Lynch, denied the refund requests. Willacy appealed that decision to appellee Cleveland Board of Income Tax Review, which affirmed the denial of the refunds. She then appealed to the Board of Tax Appeals ("BTA"), which also affirmed the denial. Willacy appealed the BTA's decision to the Tenth District Court of Appeals, and we granted her petition to transfer the appeal to this court under former R.C. 5717.04, 2017 Am.Sub.H.B. No. 49. 153 Ohio St.3d 1485, 2018-Ohio-3867, 108 N.E.3d 83.

II. ANALYSIS

{¶ 6} Willacy raises three propositions of law. In her first proposition, she argues that Cleveland's tax laws, as applied to her, violate the Due Process Clause of the United States Constitution and the Due Course of Law Clause of the Ohio Constitution. Her second proposition of law reiterates some of those due-process arguments and also raises separate nonconstitutional arguments addressing why, in her view, Cleveland lacked authority to tax her 2014 and 2015 stock-option income. Willacy's third proposition of law asserts an additional nonconstitutional argument.

A. Standard of review

{¶ 7} We must determine whether the BTA's decision is reasonable and lawful. R.C. 5717.04. In doing so, we defer to the BTA's factual findings, so long as they are supported by reliable and probative evidence in the record. Am. Natl. Can Co. v. Tracy , 72 Ohio St.3d 150, 152, 648 N.E.2d 483 (1995). But we review legal issues de novo. Pi In The Sky, L.L.C. v. Testa, 155 Ohio St.3d 113, 2018-Ohio-4812, 119 N.E.3d 417, ¶ 11. Because Willacy is not challenging the BTA's factual findings, our review is de novo.

B. Nonconstitutional issues

1. Willacy's exercise of the stock options generated taxable "qualifying wages"—not nontaxable "intangible income"

{¶ 8} Cleveland imposes its income tax on "all qualifying wages, earned and/or received * * * by nonresidents of the City for work done or services performed or rendered within the City or attributable to the City." Cleveland Codified Ordinances 191.0501(b)(1). See also Cleveland Codified Ordinances 191.0101(a) (levying municipal income tax on "qualifying wages"). Under Cleveland Codified Ordinances 191.031501, qualifying wages include "compensation arising from the sale, exchange or other disposition of a stock option, the exercise of a stock option, or the sale, exchange or other disposition of stock purchased by the stock option." See also former R.C. 718.03(A)(2)(b)(ii), 2012 Am.Sub.H.B. No 386, eff.

June 11, 2012 (now R.C. 718.01(R)(2)(b) ) (defining "qualifying wages" to include compensation attributable to the exercise of employee stock options unless exempted by ordinance or resolution). Regulation 3:01(B)(8), promulgated by Cleveland's tax-administration authority, provides that when a stock option is exercised, "regardless of the treatment by the Internal Revenue Service, the employer is required to withhold on the difference between the fair market value upon sale, exchange, exercise or other disposition of the stock option and the amount paid by the employee to acquire the option. The entire difference shall be allocated to and taxable by the employment city."¹

{¶ 9} Willacy does not dispute that she received the stock options in 2007 as compensation for employment services she provided to Sherwin-Williams. Thus, under Cleveland law, Willacy's stock options were taxable qualifying wages when she exercised them in 2014 and 2015. And consistent with Cleveland law, Sherwin-Williams withheld and paid to Cleveland Willacy's tax obligation, calculated based on the difference between the option price and the exercise price.

{¶ 10} This is a settled approach to imposing income tax on stock options. In Commr. of Internal Revenue v. LoBue , 351 U.S. 243, 247, 76 S.Ct. 800, 100 L.Ed. 1142 (1956), the court concluded that when an employer transfers options to an employee based on the services the employee has provided, the transfer constitutes compensation. And in Rice v. Montgomery , 104 Ohio App.3d 776, 663 N.E.2d 389 (1st Dist.1995), a municipality had measured the value of stock options based on the difference between the option and market prices at the time the options were exercised. The First District Court of Appeals upheld that method of valuing the stock options, explaining:

Quantifying the value of a stock option at the time of its grant is a complex task, subject to the vagaries of market forecast and compounded by the fact that no ready market can exist for nontransferable stock options. The I.R.S. resolves the difficulty of valuing a nontransferable stock option by waiting until the option is exercised, at which time there is a recognition of income equal to the difference between the option price and the fair market value of the stock at the time of the exercise. At the moment that the income is recognized, a fair market value can be assigned to the stock option.

* * * We find nothing in the general law of Ohio or in the [municipality's] tax ordinance and regulations which precludes the city taxing authority from employing the same methodology of valuing a stock option as does the I.R.S.

Id. at 781. Other Ohio courts have followed the same approach. See Salibra v. Mayfield Hts. Mun. Bd. of Appeal , 2016-Ohio-276, 58 N.E.3d 452, ¶ 22-23 (10th Dist.) ; Wardrop v. Middletown Income Tax Rev. Bd. , 12th Dist. Butler No. CA2007-09-235, 2008-Ohio-5298, 2008 WL 4541996, ¶ 43-47 ; Hartman v. Cleveland Hts. , 8th Dist. Cuyahoga No. 66074, 1994 WL 422284, *4 (Aug. 11, 1994).

{¶ 11} Willacy nevertheless argues that her income does not constitute qualifying wages but rather is "intangible income" derived from the sale of intangible property. Intangible income, unlike qualifying wages, is exempt from income taxation under state law and Cleveland municipal law. See former R.C. 718.01(H)(3), 2013 Am.Sub.H.B. No. 51, eff. July 1, 2013 (now R.C. 718.01(C)(2) ) (generally prohibiting municipal taxation of "intangible income"); former R.C. 718.01(A)(5), 2013 Am.Sub.H.B. No. 51, eff. July 1, 2013 (now R.C. 718.01(S) ) (defining "intangible income" to include "income yield, interest, capital gains, dividends, or other income arising from the ownership, sale, exchange, or other disposition of intangible property"); Cleveland Codified Ordinances 191.0901(i) (exempting "[i]nterest, dividends, gains, and other revenue from intangible property described in [former] R.C. 718.01(A)(5)"); Cleveland Codified Ordinances 191.031001 (" ‘intangible income’ means that income specified in [former] R.C. 718.01(A)(5)").

{¶ 12} Willacy primarily relies on Hickey v. Toledo , 143 Ohio App.3d 781, 787, 758 N.E.2d 1228 (6th Dist.2001), in which the Sixth District Court of Appeals stated that a "stock option is intangible property." But she fails to acknowledge that the Hickey court, relying on Rice , went on to state that "when stock options are received by an employee as compensation, they may be properly taxed as compensation." Id. Because Willacy does not dispute that she earned the options as compensation, she has not shown that her proceeds should be classified as intangible income.

{¶ 13} Willacy also suggests that the profit from the options must be classified as intangible income based on her status as a nonresident retiree. But she provides no support for the proposition that the...