On June 16, 2014 Governor John Kasich signed into law H.B. 483, a bill with several tax provisions. One provision of the bill increases Ohio’s new (2013 was the first year the deduction existed) small business investor income deduction from 50% of “business income” to 75% of “business income” for tax year 2014 only. Under current law the deduction is to revert back to 50% after 2014. The bill also increased the maximum deduction to $187,500 ($93,750 in the case of the married filing separately filing status) from $125,000 ($62,500 in the case of the married filing separately filing status) for 2014 only. Ohio’s highest income tax bracket for 2014 is 5.92%, therefore, the maximum income tax savings for an individual from the Ohio small business investor deduction will be $187,500 x 5.92% = $11,100 for 2014.
The Ohio Office of Budget and Management had previously estimated the tax cut to be worth about $530 million for fiscal year 2014 prior to the increase in the rate and the increase in the maximum amount deductible under H.B. 483. In 2012 total tax receipts for the state of Ohio were approximately $26 billion of which about $9 billion was generated by the individual income tax.
This deduction can represent a major income tax savings for individuals having an ownership interest in what are commonly called “pass-through entities” for tax purposes (generally, S Corporations and limited liability companies) which have sales, property, or payroll within the state of Ohio. Those conducting business in the form of a sole proprietorship are also eligible for the deduction. Note that those choosing to conduct business in the traditional corporate form do not benefit from this particular deduction. Although the deduction is labeled the small business investor income deduction, there is no limitation on the size of the business through a “phase-out” or similar provision.
“Business income” is defined broadly to include income, including gain or loss, arising from transactions, activities and sources in the regular course of a trade or business. Also includable in the deduction is compensation paid to an individual by an eligible business entity in which that individual holds a 20% or greater ownership interest.
Business income includes rental income that an individual receives “in the ordinary course of a trade or business.” Hence, income that an individual receives from renting out a single residential property is generally eligible for this deduction so long as the property is rented or available for rent on a regular, consistent basis. In contrast, income from an individual renting out his primary residence for six weeks each year would not be eligible for the deduction because that income is not considered income arising in the regular course of a trade or business. The issue of whether interest, dividends, capital gains, royalties, and rents sourced from an eligible business entity are includable in the deduction hinges on a “functional test” analysis adopted by the Ohio Supreme Court in Kemppel v. Zaino to determine whether this income represents “business income” under Ohio law.
As would be expected, there are a series of complications in computing the deduction, including adjustments related to health insurance payments, self-employment tax, depreciation and other items.
Due to the significance of the deduction, the Ohio Department of Taxation has made a number of resources available to taxpayers including a webinar and “frequently asked questions” page. This information can be accessed at:
Written by: Brian Spencer