Santa Claus brings an extra SBD, with some fine print included

Ohio’s small business income tax deduction (SBD) is just one of the ways legislators have sought to further stimulate the state’s economy. As the New Year approaches and taxpayers look toward the 2014 tax year filing season, even more relief is on the way.

Smart Business spoke with Joe Popp, JD, LLM, tax manager, Rea & Associates, to find out about what changes are in store for the small business income tax deduction.

Who can claim a SBD?

In October, the Department of Taxation reported that only half the number of small business owners who were expected to claim the 2013 deduction actually did. Maybe the owners — and their CPAs — weren’t up-to-speed on what kind of things qualify for the deductions. Or maybe they weren’t even aware of the deduction at all.

The SBD is available to a wide range of individual taxpayers who have Ohio-sourced business income, which can come from many different sources such as a residential rental property or select owner wages. As a good rule of thumb, if a taxpayer received a K-1 from a company that has locations, property or payroll in Ohio, the taxpayer is eligible. The same is true if the taxpayer has an activity in Ohio reported on personal schedule C or F. Investment income in a trust or pass-through entity, where investing is the business activity of that entity, can also qualify for the SBD if the income is passed through to an individual taxpayer.

What can small business owners expect when they file their 2014 personal income tax returns?

The SBD already allows individual taxpayers with Ohio-sourced business income to claim a 50 percent deduction on the first $250,000 of Ohio-sourced business income that they have. For the 2014 tax year, however, taxpayers are eligible to claim an additional deduction on this income.

How much more? Where is the matter at the state government level?

Legislation authorized up to an additional 25 percent deduction for a total of 75 percent on the first $250,000.

But there was a set pool of money to fund that, the legislation didn’t mandate an additional 25 percent (it just set a cap not to exceed), and Ohio retains the ability after Jan. 1, 2015, to draw funds from that pool to pay for budget shortfalls in several other departments.

So it’s possible you might not know just how much additional deduction you could get for some time. For now, think of this deduction as 50 percent, plus a “mystery bonus” of up to 25 percent more.

Stay tuned for more guidance on this from Ohio.

How does this deduction affect business owners who want to retire or sell their businesses?

This deduction provides an interesting opportunity for more mature companies that are currently structured as C corporations. Generally speaking, it is easier to produce great tax outcomes on the sale of a pass-through entity than a C corporation.

The SBD is also denied to owners of C corporations on their wages and on the income coming from the C corporation.

The SBD can help ease the pain of a C to S partnership conversion by providing an annual cash savings as large as $6,000 to $10,000 per owner.

While this might not be a strong enough reason to do the conversion on its own, if a business owner has a mature company that is not retaining profits to grow, and is thinking about selling the company soon, this is a great time to do the C to S partnership conversion.

Who knows how long the SBD might be on the books? The savings opportunities now make this a great time to consider accelerating a move from a C corporation structure if that was in the plans down the road.

Insights Accounting is brought to you by Rea & Associates