I am the sole owner of an S corporation doing business in Ohio. I receive a W-2 from my company as well as income that is passed through and taxed on my Ohio personal return. The Ohio Department of Taxation recently audited my Ohio personal income tax return and disallowed a part of the Ohio Business Income Deduction (BID)? I have heard there may be a change coming to their position. Can you clarify?
Effective for tax year 2013 Ohio enacted what is now called The Ohio Business Income Deduction (BID). 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.
Virtually all business income that is reported on an owner’s return is eligible for a 100% tax deduction on the first $250,000 of business income. Compensation reported on a W-2 or as a guaranteed payment to a person owning 20% or more of a business is also included in the deduction.
Who is eligible for the Ohio Business Income Deduction?
Owners of and investors in businesses structured as sole proprietorships and pass-through entities (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 about wages paid to an individual from a “professional employer organization” (PEO)? Are they eligible for Ohio’s Business Income Deduction?
PEOs are companies that perform outsourced services such as HR responsibilities for businesses that contract with them. If an employer uses a PEO, the wages are paid in the name of the PEO.
Recently, the Ohio Department of Taxation (ODT) was taking the position that a PTE business owner who utilizes a PEO is not considered a “business owner” for the purposes of the business income deduction, since often, their W-2’s come directly from the PEO. ODT has been auditing hundreds of businesses who use the services of a PEO causing these companies to pay taxes for deductions taken in prior years.
Is anything being done to remedy this discrepancy?
On September 7, 2017, the ODT issued a statement that it was suspending audit activities for individuals who own 20% or more of a pass-through entity and who receive compensation through a PEO and claim the small business and/or business income deduction for that compensation. The announcement was in response to House Bill 334 and Senate Bill 186 that were recently introduced in the Ohio General Assembly. If enacted, House Bill 334 and Senate Bill 186 would retroactively clarify the existing law. The clarification would allow compensation and guaranteed payments paid by a PEO to a 20% or more owner of a pass-through entity using a PEO to constitute a distributive share of income eligible for the small business and/or business income deduction computation.
If you are an Ohio business owner that uses the services of a PEO and have been the subject of an Ohio audit related to this issue (or if you did not include compensation in the business income deduction when you filed your return), you should pay attention to the pending legislation and consider filing an amended return if it passes.
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.