Many Ohio taxpayers each year fail to take advantage of the Ohio Small Business Deduction, which could save them thousands of dollars. Many are not aware of who qualifies for the Ohio Small Business Deduction. Some who are aware of it may think the filing requirements are too cumbersome (not realizing they have been simplified since the deduction was implemented). Still others may think that it seems too good to be real. While the deduction does seem remarkable, we assure you that it is not only real, but applies to many taxpayers who don't see themselves as owning a "small business," including individuals and owners of some larger businesses.
Who does qualify for the deduction? Anyone who reports income from a "pass-through" entity on their personal income tax returns. Pass-through entities include sole proprietorships, partnerships, limited liability companies (LLCs), and S corporations. Since pass-through entities constitute about 60% of American businesses, and a similar proportion of Ohio businesses, a large number of taxpayers are eligible for the Ohio Small Business Deduction, including many farm businesses.
What's more, a taxpayer need not be a sole or even majority owner of a business to claim the deduction. Any taxpayer who reports pass-through income on their income tax return may claim the deduction. If the taxpayer (either individually, or together with a spouse filing jointly) owns more than 20% of the business entity, he or she can also take the deduction against W-2 wages.
First available in 2013, the Ohio Small Business Deduction is currently equal to 75% of the first $250,000 of a taxpayer's apportioned net business income. How is business income defined?
According to Ohio Rev. Code Section 5747.01(B), it is
"income, including gain or loss, arising from transactions, activities, and sources in the regular course of a trade or business and . . . [that] includes income, gain, or loss from real property, tangible property, and intangible property if the acquisition, rental, management, and disposition of the property constitute integral parts of the regular course of a trade or business operation. "Business income" includes income, including gain or loss, from a partial or complete liquidation of a business, including, but not limited to, gain or loss from the sale or other disposition of goodwill."
Lottery winnings, prizes, and awards are excluded from the definition of business income, as, generally, are wages from work in a business.
However, recall that a 20% or greater owner of a pass-through business can include compensation (wages) as business income. An example: Tom owns a 15% interest in an LLC. His wife, Jane, owns a 10% interest. Tom's income from the LLC is $75,000. Jane's is $50,000. In addition, they each earn $80,000 in W-2 income from the business.
If Tom and Jane file taxes jointly, they have a greater than 20% interest in the business, so they can claim the Ohio Small Business Deduction against not only their business income but their W-2 wages. That would include $125,000 (Tom's business income plus Jane's business income) plus $160,000 (Tom's wages plus Jane's wages), for a total of $285,000. Furthermore, even if their ownership interest dipped below 20% at any point in the year, so long as it equaled or exceeded 20% at any point in the year, they can claim the deduction against compensation as well as business income.
But wait a moment: Tom and Jane can deduct 75% of the first $250,000, or $187,500. What happens to the $35,000 in income above and beyond that first $250,000? Amounts over the $250,000 are taxed at a flat 3% rate.
As noted above, many taxpayers may not even consider taking the Ohio Small Business Deduction because they believe that either they don't qualify for it, or because they believe the effort involved in claiming the deduction would not be worth it. Here are some reasons you might have given for not taking this deduction—and the reasons you really can (and should) claim it.
"I don't own a 20% interest in a business." If you've been reading carefully, you know this is not necessary to claim the deduction; the 20% ownership stake is a requirement for claiming the deduction against wages, but not against business income.
"I'm not an Ohio resident." Ohio residents can claim the Ohio Small Business Deduction on all of their business income. But even non-residents can take the deduction with respect to their Ohio business income that is subject to tax in Ohio.
"My business isn't a small business." Good news for business owners: the Ohio Small Business Deduction does not have a limit as to an entity's assets or gross receipts. If a pass-through entity issues a federal Schedule K-1 and reports income from a trade or business, its owner is eligible for the deduction. Likewise, an individual taxpayer can claim the deduction for any business activity included on a federal Schedule C, like driving for a service like Uber or Lyft.
"The paperwork and hassle required to claim the deduction isn't worth it." It is true that when the Ohio Small Business Deduction was first implemented in 2013, business income from separate sources had to be reported on separate Ohio Small Business Deduction forms, making the process cumbersome. At that time, the deduction was also smaller (50%) and taxpayers were required to supply information for which they may not have received breakdowns from the business entity or entities.
As of 2018, however, the deduction is increased and the filing process has been simplified, making the effort to claim the Ohio Small Business Deduction much more worthwhile. Even so, many seasonal tax preparers are not as familiar with the requirements and benefits of the deduction as they should be.
If you have questions about whether you qualify for the Ohio Small Business Deduction or how to claim it, we encourage you to contact an experienced Ohio tax preparation service for assistance. The expense of a qualified tax preparer's service is not a cost, but an investment; the amount you save by claiming this deduction could amount to hundreds or even thousands of dollars. Gudorf Tax Group is based in Dayton, OH, and ready to help you maximize your deductions.