June 21, 2022
Ohio enacts elective pass-through entity tax
On June 14, 2022, Governor Mike DeWine signed Senate Bill 246 (SB 246), making Ohio the latest state to adopt an elective pass-through entity (PTE) tax. Effective for tax year 2022, the PTE tax will provide PTE owners with a state "work-around" tax that is not intended to be subject to the $10,000 cap on the federal income tax deduction for state and local taxes (SALT Cap).
SB 246 adds new Ohio Rev. Code Section 5747.38, which allows a qualifying PTE1 to elect to be subject to an entity-level tax that is intended to comply with Notice 2020-75 (see Tax Alert 2020-2690). In this notice, the IRS generally announced that it would issue proposed regulations upholding the ability of PTE owners to effectively deduct state PTE taxes without regard to the SALT Cap. A PTE can make an annual election, which is irrevocable, to be subject to the PTE tax by the due date for filing PTE tax withholding returns2 (i.e., Form IT 1140), as extended, on a form to be prescribed by the Ohio Tax Commissioner.
The PTE tax will be imposed on the electing PTE's qualifying taxable income, which is defined as:
The PTE's tax liability will be computed without regard to any deductions or credits that can be claimed by a PTE owner in computing the owner's own tax liability. The PTE tax rate is 5% for tax year 2022 and 3% for tax year 2023 and thereafter.
A new provision under Ohio Rev. Code Section 5747.39 allows an electing PTE owner to claim a refundable credit against his or her income tax liability under Ohio Rev. Code Section 5747.02 (i.e., the Ohio income tax on individuals, estates or trusts) equal to the PTE owner's proportionate share of the tax imposed on the electing PTE.
SB 246 also adds Ohio Rev. Code Section 5747.43(F), which allows estimated taxes paid by a PTE, including an electing PTE, to be applied to that PTE's tax liability for either its IT 1140 (Pass-Through Entity and Trust Withholding Tax) or the elective PTE tax.
Finally, Ohio Rev. Code Section 5747.38(F) requires that the Ohio Tax Commissioner adopt rules to administer the PTE tax, including a description of the required adjustments4 to individual, estate or trust income and how the PTE tax credit will apply to direct and indirect5 owners of an electing PTE based on various ownership structures.
Ohio becomes the latest state to adopt an elective PTE tax as a "workaround" for individual PTE owners to the federal SALT Cap. More guidance will likely be forthcoming from the Ohio Department of Taxation on the new PTE tax, particularly relating to how income adjustments and refundable credits will flow up to indirect owners of an electing PTE. PTEs and their owners subject to Ohio taxation should monitor and consider these changes and follow the necessary procedures for making PTE tax elections under Ohio's new law.
1 PTEs include partnerships, S corporations and limited liability companies that are not treated as corporations for federal income tax purposes.
2 Under Ohio Rev. Code Section 5747.42(A)(2), the due date is the 15th day of the fourth month following the end of the qualifying entity's tax year that ends in the preceding calendar year, subject to extension.
3 Defined in Ohio Rev. Code Section 5747.38(A)(3) as the sum of the PTE owners' distributive shares of income, gain, expense or loss of the PTE for the tax year as reported for federal income tax purposes.
4 Ohio Rev. Code Section 5747.01(A)(36) requires an individual, to the extent not otherwise included in computing federal adjusted gross income, to adjust his or her proportionate share of the PTE tax paid by the electing PTE. A similar adjustment is prescribed for trusts and estates in Ohio Rev. Code Section 5747.01(S)(15).
5 SB 246 does not address how the elective PTE tax would apply to PTEs in a tiered ownership structure. Ohio Rev. Code Section 5747.401(A)(1) provides that investors in an investment PTE (i.e., a PTE with at least 90% of its assets represented by intangible assets and 90% of its gross income from certain enumerated items relating to those intangible assets) shall be deemed to be the investor in any other PTE in which the investment PTE is a direct investor. The interplay between the investment PTE rules and the new elective PTE tax is unclear. The reference to "indirect owners" in Ohio Rev. Code Section 5747.38(F), however, suggests that the legislature may have intended that the income adjustments and credits referenced in Ohio Rev. Code Section 5747.38 may flow up through certain tiered ownership structures to individual, estate or trust investors in a lower-tiered PTE.