Ohio Senate Bill 246 was enacted on June 14, 2022, and established Ohio’s pass-through entity tax (PTET) election as a workaround to the federal state and local tax (SALT) cap deduction. Although the SALT cap deduction recently increased, taxpayers may still benefit from making an Ohio PTET election. Since the law was originally enacted, several changes have been made to the PTET, which have been beneficial to taxpayers.
PTET election options and federal income tax deductibility
The PTET election is available for tax years beginning on or after Jan. 1, 2022, and is irrevocable once made for a tax year. The election is made by filing Form IT-4738 by April 15 or the extended due date of the return, which in most cases is September 15, after the end of the tax year. The election is also available by filing Form EPTE-ELEC, which may be filed at any time, including prior to the end of a tax year. The timing of making the election, along with when payments are made, can determine the period in which the tax is deductible for federal income tax purposes.
For federal income tax purposes, the timing of the deduction depends on various factors. For example, an accrual basis taxpayer needs to consider whether the all-events test has been satisfied. The all-events test is satisfied if a taxpayer has opted into paying the tax prior to year end since the PTET election is irrevocable for the year. If a taxpayer makes the election prior to year-end, the taxpayer receives a deduction for any PTET amounts paid during the taxable year. If the election isn’t made until after year end, the tax isn’t deductible for federal income tax purposes until the election is made. For cash basis taxpayers, the deduction is impacted by when payments are made. Thus, before an election is made for a taxable year, taxpayers should consider the timing of the federal tax deduction as there may be a greater benefit to make the election either during the tax year or after the tax year ended. Taxpayers may also consider the benefit of electing into the PTET for one tax year over another tax year since it’s an annual election, and there is no requirement to elect into the PTET every year.
Estimated taxes
Estimated PTET payments must be made in the year for which the election is made; otherwise, taxpayers may incur penalties and interest for the underpayment of estimated taxes. Payments can be applied from other Ohio pass-through entity taxes, such as composite or withholding. Starting with tax year 2026, the due dates for second- and third-quarter estimated payments will move up by one month, making the payments due June 15 and September 15, respectively. The first and fourth quarter estimated tax payment due dates remain the same at April 15 and January 15 (after the end of the tax year). The recent changes should align all estimated due dates to the federal estimated tax payment dates.
Tax base
The tax base subject to income tax includes all Ohio apportioned income and doesn’t authorize any member or shareholder to separately opt out of the PTET. Thus, all members or shareholders of a pass-through entity are required to be included in the Ohio PTET return if the election has been made by the entity even if those members or shareholders aren’t eligible to claim a credit for taxes paid on their behalf.
Historically, Ohio hasn’t granted refunds of composite, withholding, or PTET paid on behalf of nonqualifying investors. Instead, Ohio requires the pass-through entity to file an amended Form 4708 or 1140 to eliminate withholding on behalf of a non-qualifying investor. Nonqualifying investors include, but are not limited to:
- C corporations
- Pension plans
- Not-for-profit entities
- Publicly traded partnership
- Real estate investment trusts
- Real estate mortgage investment conduits
- Regulated investment companies
The PTET is different because the tax paid is on all apportioned income of the entity. If PTET is paid on behalf of a nonqualifying investor, it may not be claimed as a refund by a nonqualifying investor, nor is there a mechanism to exclude the nonqualifying investor. Although taxpayers may still receive a federal income tax deduction for PTET paid, if a taxpayer has a nonqualifying investor as a direct or indirect owner, it should consider the detriment of paying tax that is unable to be claimed as a credit for taxes paid.
Adjustments to income
Similar to composite Form 4708 and withholding Form 1140, taxpayers that opt into the PTET are subject to numerous adjustments, including, but not limited to:
- Amounts paid to related parties including management fees, interest expenses, rents and royalties, compensation paid to an individual owner’s family members or other entities, and expense sharing, or “common paymaster” arrangements to be added back to the tax base. In numerous cases, the addback causes a higher amount of PTET to be paid at the entity level which is refunded at the individual level.
- Guaranteed payments paid to a 20% or more direct or indirect owner of the entity.
- Compensation paid to a 20% or more direct or indirect owner of the entity.
- IRC Section 179 expense greater than $25,000 and bonus depreciation claimed is also required including the addback and subsequent subtraction. Entities that opt into the PTET are only eligible for an addition or subtraction of bonus depreciation if the entity filed a return in prior years. If an Ohio return wasn’t filed by an entity in prior years, no bonus depreciation adjustments should be claimed for that prior year.
Tiered structure changes
Effective for tax years beginning on or after Jan. 1, 2025, upper-tier PTEs can now directly claim credits for PTET paid by a lower-tier entity. This change in law eliminated the need for multiple levels of tax to be paid on the same income before being able to be claimed by the ultimate owner.
Individual income taxpayer benefit to filing a return
While a nonresident’s individual income tax filing requirement is satisfied if PTET is paid on behalf of a nonresident, an individual may still consider filing an individual income tax return. Generally, pass-through income reported by an individual is treated as business income. Ohio law exempts the first $250,000 of business income reported by an individual. However, the business income deduction is only available to be claimed on an individual income tax return. Thus, individuals may consider filing an individual income tax return separate from the PTET return to claim this exemption and be entitled to a refund of the tax paid on their behalf for the first $250,000 of business income. In addition, nonresidents should consider the impact an Ohio refund might have on the resident state’s credit for taxes paid to other states.
Looking ahead
Ohio’s PTET continues to evolve, offering valuable opportunities for PTEs and their owners. Recent legislative updates have helped streamline compliance, particularly for tiered structures, and adjusted estimated payment deadlines have now been aligned with several other Ohio tax types to help simplify compliance. As these changes take effect, careful planning year over year will help taxpayers maximize the benefits of Ohio’s PTET.
