House Bill 515 opens door for more to qualify for Ohio business income deduction treatment

A House Bill recently signed by Ohio Governor Mike DeWine (R) sheds much needed light on certain situations under which the sale of an equity ownership interest in a business is considered business income. This will result in the Ohio Business Income Deduction (BID) and the 3% rate in continuing law coming into play for many taxpayers.

To be considered business income, the sale of an ownership must:

  • Be treated as a sale of assets for federal income tax purposes.
  • Involve the seller materially participating in the activities of the business during the taxable year in which the interest was sold or during any of the preceding taxable years. In this scenario, it is important to note that the IRS rules for material participation generally considers the number of hours the taxpayers spent participating in the business, either on their own or in relation to other business participants. Under prior law, a nonresident may have been required to pay Ohio tax on their sale if the nonresident materially participated in the business, but the circumstances in which that situation occurred appeared to be fact-dependent

If these conditions are met, income of the sales of the business would be eligible for preferential treatment under the BID and the 3% flat tax on business income. The law still stands that a taxpayer can deduct their first $250,000 of business income ($125,000 for spouses filing separate returns) under the personal income tax (PIT). Any business income above that amount is subject to a 3% flat tax. Both apply only to income classified as “business” income. Nonbusiness taxable income is taxed at graduated PIT rates, up to 3.99% in codified law. R.C. 5747.01(A)(28) and R.C. 5747.02(A)(4)

Reclassifying such capital gains as business income may have a secondary effect, in some cases, that could partially offset the revenue loss explained above. Such reclassification could, in some cases, make taxable by Ohio the capital gains received by nonresidents of the state, when they may not be taxable currently. Potential revenue gains from this provision are unpredictable due to uncertainty regarding the particular facts and circumstances of a taxpayer’s case that could make such income taxable.

The act states that the change related to the sale of ownership interests is a remedial measure intended to clarify existing law. These changes apply to any audits, refund applications, petitions for reassessment, and appeals pending on or after September 23, 2022, the act’s effective date.

This newly signed bill could open the door for taxpayers who took part in a sale of the business to attempt to file refund claims. It could also change the outcome of on-going controversial tax situations.

Holbrook & Manter will be taking all elements of the bill into consideration while working with clients regarding upcoming transactions that could now quality for BDI and the 3% flat tax rate. If you would like further information, please reach out to our team today.

You can also review more detailed information here: House Bill 515 | The Ohio Legislature