Ohio updates: Tax credits, PTET deduction, clarification on business income, and more
Substitute Senate Bill 225 expands the Ohio historic rehabilitation and opportunity zone investment tax credits
Effective Sept. 12, 2022, Sub S.B. 225 has the dual effect of updating the Ohio historic rehabilitation and opportunity zone tax credits.
Ohio historic rehabilitation tax credit
The Ohio historic rehabilitation tax credit is a credit equal to 25% of qualified expenditures to rehabilitate a historic building according to certain preservation criteria. The credit is awarded through a competitive application process by the Ohio Department of Development. Sub. S.B. 225 makes the following changes to the historic rehabilitation tax credit:
- Increases the tax credits available in the state’s fiscal years (FY) 2023 and 2024 from $60 million to $120 million. FY 2023 runs from July 1, 2022 through June 30, 2023, while FY 2024 begins on July 1, 2023 and ends on June 30, 2024.
- The maximum annual credit for a single project increased from $5 to $10 million.
- The credit is refundable in excess of tax incurred up to the $10 million annual limit.
- The credit is 35% instead of 25% for projects located in a county, township, or municipal corporation with a population of less than 300,000.
An owner of a project that was previously approved for a credit after June 30, 2020, and before the effective date of the bill may reapply to receive the enhanced 35% tax credit as long as construction has not yet commenced. The bill also clarifies that that the rehabilitation tax credit certificate is effective on the date placed in service as specified by federal law.
Ohio opportunity zone investment tax credit
The Ohio opportunity zone investment tax credit is a 10% nonrefundable credit for projects in certain economically distressed regions known as opportunity zones. Opportunity zones are designated by the state under the auspices of federal law. Sub. S.B. 225 modifies the Ohio credit by:
- Expanding eligibility to allocate a credit to persons who don’t pay Ohio personal income tax.
- Transitioning the caps on tax credits awarded from a biennial to an annual basis, starting in FY 2024.
- Increasing the overall cap for FY 2022–23 ($50 to $75 million) and FY 2024 ($50 million). The cap is $25 million annually thereafter.
- Requiring two semiannual application windows covering six-month investment windows instead of one annual application window.
The opportunity zone credit must still be claimed by an individual subject to Ohio individual income tax. However, the expansion of the credit allocations may expand the projects available for the tax credit.
Amended Substitute Senate Bill 246: Pass-through entity tax election in response to the $10,000 state and local tax cap
Effective Sept. 12, 2022, and effective for the 2022 tax year, Am. Sub. S.B. 246 institutes an elective tax for pass-through entities (PTE). Under this new regime, a PTE may elect to file and pay Ohio income tax at the PTE level instead of at the individual level. It’s anticipated the election will be made on Form 4738. A draft of this form is currently being developed and isn’t available yet. A nonresident owner is relieved of its filing requirement, but not precluded from filing, if the nonresident’s only Ohio-sourced income is derived from a PTE making the election. Many states have enacted similar taxing regimes that allow the PTE to deduct the tax at the PTE level, avoiding the $10,000 limitation imposed by the Tax Cuts and Jobs Act. PTE owners can claim a refundable Ohio tax credit based on the owner’s proportionate share of tax paid by the PTE. Both residents and nonresidents are eligible to claim the credit.
Under this new regime, a PTE may elect to file and pay Ohio income tax at the PTE level instead of at the individual level.
When a business elects into this optional tax and the owner also files an individual income tax return, the owner is required to add back the proportionate share of tax levied on the PTE to their Ohio taxable income. Then, the owner claims the credit equal to the amount of taxes added back. Under continuing law, Ohio residents can’t claim credits for PTE taxes paid to other jurisdictions. Since all states are different in their PTE regimes, a multistate PTE must complete an analysis to determine the potential benefits and detriments to each PTE owner based on that PTE’s state footprint.
The PTE rate will be 5% in 2022 and 3% for each tax year thereafter. The tax rates were enacted under Am. Sub. S.B. 246 with different rates due to changes incorporated in Sub. S.B. 18 that similarly decreases the PTE tax withholding rate for the same tax years. Under continuing law, the business income tax rate is 3% with the initial $250,000 of business income being exempt from Ohio individual income tax. Effective Jan. 1, 2021, the Ohio individual income tax rate decreased to a maximum of 3.990% for nonbusiness income.
Substitute House Bill 515 clarifies the treatment of certain sales of a business as business income
Effective on Sept. 22, 2022, S.B. H.B. 515 clarifies the character of the income realized from the sale of an ownership interest in a business.
Since the business income deduction was enacted, there have been significant disputes on whether the sale of a business is properly characterized as business or nonbusiness income. In 2016, the Ohio Supreme Court held in Corrigan v. Testa that the sale of an LLC interest was nonbusiness income for a nonresident individual that didn’t materially participate in business operations of the LLC. Since that decision, the Ohio Department of Taxation has generally treated the sale of an ownership interest in a PTE as nonbusiness income. As nonbusiness income, the income is allocable to the individual’s state of domicile. For nonresident individuals, the income hasn’t been subject to Ohio individual income tax. For resident individuals, the income has been allocable to Ohio, and nonbusiness income has been subject to the nonbusiness income tax rates, which are higher than the business income tax rates of 3%.
Sub. H.B. 515 clarifies that that the sale of an ownership interest will be treated as business income in the following situations:
- The sale is treated as an asset sale for federal income tax purposes.
- The seller materially participated in the business during the taxable year in which the business was sold, or the five preceding tax years.
The definition of material participation is the same as provided under federal law. Currently, the documentation or information required to prove material participation in a business is unclear.
Section 3 of the uncodified portion of Sub. H.B. 515 indicates that the change is a “remedial measure” and will apply to any open audits, refund applications, petitions for reassessment, and appeals pending after the bill’s effective date. Since previous guidance issued by the Ohio Department of Taxation (ODT) characterized such gains as nonbusiness income, it isn’t clear how the ODT will enforce the remedial measure for prior tax years.
Ohio PTE withholding tax rate
As a reminder, new rates for Ohio’s PTE withholding tax are set to take effect starting in 2023. Sub. S.B. 18 updated the rates from fixed statutory rates to matching the Ohio business income tax rate, which is 3%. Previously, the rate was 5% for individual investors and 8.5% for nonindividual investors.
If you have questions on the expansion of the tax credits, enactment of the PTE deduction, the treatment of the sale of a business, or any other state and local tax matter, please contact your Plante Moran advisor or one of the authors to discuss your specific facts and circumstances.