A surprising number of Ohio taxpayers are missing a golden opportunity to reduce their tax liability using a relatively straightforward deduction.
The Ohio Business Income Deduction allows taxpayers to deduct from their federal adjusted gross income the first $250,000 of business income earned by single taxpayers or married taxpayers who file jointly. For married taxpayers who file separately, the deduction applies to the first $125,000 of business income.
First introduced in Ohio in 2013, the deduction is relatively new. The exact provisions of the deduction have changed in those few short years, as has the filing process and even the name of the deduction. That might help explain why some taxpayers are unaware that the deduction exists or that they might qualify for it.
The deduction is available to any Ohio taxpayer who reports any amount of business income. Even taxpayers who do not live in Ohio but whose income is subject to Ohio tax can be eligible for the deduction.
The first step to understanding the deduction is to understand what constitutes business income under Ohio tax law.
- Ohio defines business income to include gains or losses on a number of events, including:
transactions or activities arising from the normal course of a trade or business;
- buying, selling or renting property, if it is integral to the normal course of a trade or business;
- the partial or complete liquidation of a business; or
- compensation or guaranteed payments paid by a pass-through business entity, like a partnership, a limited liability company, or an S corporation, to any owner who holds 20 percent or more interest in the entity.
Where a W-2 wage earner holds no interest in the business, compensation and guaranteed payments would not be considered business income. Rents or royalties on personal property, interest, dividends, capital gains, or prize winnings also are not regarded as business income.
Sometimes taxpayers are not aware they are eligible for the deduction, especially if they own less than a majority interest in a business. In fact, the deduction is available to any owner who holds any interest in a business. If he or she owns 20 percent or more, any W-2 wages or guaranteed payments from the business can also be included in the deduction.
Consider an example: Tom and Jane are married taxpayers filing jointly. Tom owns a 15-percent interest in an LLC, and owns a 25-percent interest in the same entity. Tom’s flow-through income from the LLC is $75,000, and Jane’s is $125,000. They each also earn $80,000 in W-2 income from the business.
Tom and Jane are eligible for the Ohio Business Income Deduction. Because Jane’s interest exceeds 20 percent, she can also deduct her wages. As such, they can claim the deduction not only against their combined $200,000 flow-through income, but also against Jane’s $80,000 in W-2 income. That means their combined business income for purposes of this deduction is $280,000.
By applying the Ohio Business Income Deduction, they can deduct $250,000 from their combined business income of $280,000. That would reduce their business income subject to Ohio income tax to only $30,000. That excess $30,000 is taxed at a flat 3 percent, which is sure to provide significant tax savings for Tom and Jane.
While the specific provisions of the deduction and the filing process have changed, the potential benefits of the deduction for Ohio taxpayers have not. Any taxpayer with Ohio business income should consider the potential benefits.
This article will also be published in the April 2019 issue of The Toledo Business Journal.