I have heard that changes are being proposed to the way businesses are taxed in Ohio. Is this true, and if so, will you explain?
Indeed, the latest budget proposal from the Ohio House of Representatives included an increase of $1.2 billion in business taxes. While the overall proposal cuts income taxes across the board by 6.6%, it will retroactively increase taxes on pass-through-entity (PTE) business owners back to January 1, 2019. This will have a significant impact on many of our readers if eventually approved by the Ohio Senate and signed into law by Governor DeWine.
As an example, if a small business owner is operating a PTE that generates $200,000 this year in business income, and he or she doesn’t have any other income or deductions to claim, they will pay $2,774 in new tax under the current proposal, where previously they didn’t pay any personal income tax on this income.
What does this mean for the Ohio Business Income Deduction?
A little background: Effective for tax year 2013, Ohio enacted what is now called The Ohio Business Income Deduction (BID) for PTE owners. In tax year 2016, the BID enabled a business owner who files single or married filing jointly to deduct 100% of business income up to $250,000 from the adjusted gross income they report on their Ohio personal income tax return. Married filing separate filers can deduct 100% of business income up to $125,000. Any remaining business income above these thresholds is taxed at a flat 3% rate. This legislation was designed to increase jobs and mitigate Ohio’s broad municipal income tax system, as well as to help level the taxation playing field between PTE businesses and C Corporations. While PTE businesses and C Corps both pay the Commercial Activity Tax, PTE owners must also pay personal income tax on that same business income, while C corporations do not pay Ohio income tax.
With the latest budget proposal from the House, this deduction will be cut by 60%, lowering the maximum deduction to $100,000 (or $50,000 per spouse). This could increase the taxes of a small business owner by $4,500 . The flat 3% rate for qualified income above the threshold is completely eliminated, and may increase to as much as 4.667%. Also of concern: these proposed changes include an effective date back to Jan. 1, 2019, meaning business owners may have made 2019 capital investments and hired new employees based on tax savings they will not realize and will have new tax obligations they didn’t budget for.
In combination with Ohio’s average municipal tax rate, this increase could make the state’s combined state and local tax rate for businesses one of the highest in the region.
Who is eligible for the Ohio Business Income Deduction?
Owners of and investors in businesses structured as sole proprietorships and PTEs qualify for this tax deduction. PTEs include: partnerships, Subchapter S corporations (S-corps) and Limited Liability Companies (LLCs). Income generated by the business and passed through to the owners/investors is subject to personal income tax. The deduction, originally Ohio’s small business investor income deduction, was first effective for Ohio-sourced business income earned in taxable year 2013 and claimed on income tax returns filed in 2014. Beginning in tax year 2015, the deduction was expanded to include eligible business income from all sources regardless of where the income was earned.
What do these changes mean for Ohio business owners?
While state personal income tax rates are proposed to decrease by 6.6% across the board and be eliminated for all making $22,250 or less with the current proposal, the budgetary burden is essentially shifting to PTE business owners and also applying what could be a significant, retroactive increase in their state taxes. Depending on the size of your business, if they become law, the changes could have big implications for how you are taxed this year and into the future.
If you are an Ohio business owner, it is important to understand how these proposed changes could impact you. We only touched on a few of the proposed changes—there are many others that might affect you or your business moving forward. Speak with a tax professional now about what this could mean for you, and consider contacting your state legislators with questions or concerns.
Tom Cooney and Crystal Faulkner are partners with MCM CPAs & Advisors, a CPA and advisory firm offering expert guidance and beyond the bottom line thinking for today’s public and private businesses large and small, not-for-profits, governmental entities and individuals. For additional information, call 513-768-6796 or visit us online at www.mcmcpa.com. You can listen to Tom and Crystal daily on WMKV and WLHS on BusinessWise, a morning and afternoon radio show that profiles highly successful people, companies, organizations and issues throughout our region. Crystal is also the incoming President-elect for the Ohio Society of CPAs.