How to claim up to a $125,000 deduction when filing Ohio state income taxes

The Small Business Investor Tax Deduction, new this tax season, allows individuals to save thousands of dollars in taxes on business income — if their tax preparer knows it’s available.

“Your CPA can help you with this deduction, but they may need to do some research since it’s new. The software used by many tax preparers is not yet fully functional in terms of this deduction, so it’s more dependent on what individual CPAs know,” says Joseph Popp, J.D., LLM, manager of tax at Rea & Associates.

Smart Business spoke with Popp about the purpose of the deduction and who can take advantage of it.

Why was the deduction established?

In Ohio, C corporations pay a commercial activities tax, and that’s it. There is no other income tax paid on earnings. But if you have a partnership, LLC, S corporation or some other pass-through entity, individuals also pay personal income tax on earnings. So for those entity types, there are two layers of tax.

One of the reasons for the small business deduction is to reduce that double layer of tax. This is in keeping with Gov. John Kasich’s other initiatives to make Ohio a better business environment.

What is the amount of the deduction and who can apply for it?

It’s a 50 percent deduction on up to $250,000 of Ohio source business income. It’s called a small business deduction, but that’s not really an accurate description. It’s really a small deduction for someone who has Ohio business source income.

As long as you have business income, the source doesn’t matter. It could come from a partnership, S corporation or a sole proprietorship. It could even come from an oil and gas well you hold interest in or a rental property, if they are business income sources for you.

The deduction isn’t tied to any types of business entities, or even owning a business. It’s more about the character of the income, whether it’s business income or nonbusiness income like capital gains on a stock sale, for example.

It was passed as part of Ohio’s budget last summer. It’s a permanent addition to the tax code; there’s no sunset date set. So the deduction will be available again next year unless the legislature decides to remove it.

Is it worth the effort required to file for the deduction?

Tax rates of individual investors vary, but Ohio’s rate is in the 5 percent range, so savings would be a little more than $6,000 if you get the maximum benefit. Most people would be happy with $6,000 more in their pocket.

But there are challenges to filing, one being that software companies haven’t fully implemented it yet, especially if you have more complex facts — there isn’t a button to push and get a calculation. Calculations have to be made manually, so it takes more time and costs the taxpayer more. In addition, some people might not have the data required to take the deduction or decide it’s too burdensome or impossible to get it.

The form itself is one page. If you have 10 or 20 K-1 partnerships that you’re using to get to that $250,000 of income, however, you have to fill out a separate form for each.

It’s also a challenge to fill the form out completely. If you’re a multistate business, Ohio uses an algebraic calculation (an apportionment) to determine the portion of income that should be taxed here. That formula is based on property, payroll and sales. When you add those together using the formula, the idea is that you get an accurate picture of how much Ohio should be able to tax. As an investor, you might not have this data from your business, but you need it for the form.  

If you’ve already filed your taxes or don’t have time to take this deduction before the April 15 filing deadline, you can always request a filing extension or amend your filed return. This could mean an extra few thousand dollars in cash, which would make it worth another visit to your CPA.

Joseph Popp, J.D., LLM, is a manager of Tax at Rea & Associates. Reach him at (614) 889-8725 or [email protected].

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