On June 14, Ohio Governor Mike DeWine signed Senate Bill 246 into law, making Ohio the latest state to allow Pass-Through Entities (“PTEs”) to elect into an entity-level tax.
Ohio joins over 20 other states that have enacted this “SALT Cap workaround,” allowing PTEs to elect to be taxed at the entity level to avoid the $10,000 federal cap on deductions for state and local taxes.
SALT Cap Workarounds, Generally
States adopting a SALT Cap workaround have adopted a similar framework: because the pass-through entity elects to have the state tax paid by the business (i.e., at the entity level), the income that passes through to the individual owners from the business is lowered, reducing each owner’s federal adjusted gross income (“FAGI”) reported on his or her federal income tax return. This lowers the owner’s federal tax liability without the owner having to deduct state and local taxes as an itemized deduction on his or her return. Because the decrease to FAGI is not an itemized deduction, it is not impacted by the $10,000 cap on state and local tax deductions imposed by the Tax Cut and Jobs Act of 2017. The Internal Revenue Service validated these workaround methodologies pursuant to its guidance in IRS Notice 2020-75.
Ohio’s SALT Cap Workaround
Taking effect for tax years starting on and after January 1, 2022, a qualifying PTE can make an annual and irrevocable election by the due date for filing PTE tax withholding returns1, including as extended, to be taxed at the entity level in Ohio. Qualifying PTEs include S corporations, partnerships and limited liability companies taxed as partnerships.
The PTE tax will be imposed on the electing PTE’s qualifying taxable income2, and the tax liability is computed without regard to any deductions or credits that can be claimed by a PTE owner in computing the owner’s individual income tax liability. The PTE will pay tax on its Ohio income at a rate of 5% for tax year 2022, and 3% tax year thereafter.
The Ohio PTE election allows estimated taxes paid by the 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.
Electing PTEs are required to file estimated tax returns and make the following quarterly estimated tax payments:
- 1st-quarter payment of 22.5% of the PTE’s estimated tax liability for the tax year.
- 2nd-quarter payment of 45% of the PTE’s estimated tax liability for the tax year.
- 3rd-quarter payment of 67.5% of the PTE’s estimated tax liability for the tax year.
- 4th-quarter payment of 90% of the PTE’s estimated tax liability for the tax year.
Owners of electing PTEs are entitled to a refundable credit equal to their pro rata share of the Ohio PTE tax imposed on the electing PTE. The refundable credit offsets an owner’s Ohio income tax liability pursuant to the Ohio credit ordering rules specified in Ohio Rev. Code § 5747.98.
A nonresident individual or trust owner with Ohio adjusted gross income from only one or more electing PTEs is not required to file an Ohio nonresident income tax return. However, a return is required to claim the amount of the refund from the refundable Ohio PTE tax credit.
Ohio Department of Tax Releases Additional Guidance
On August 5, the Ohio Department of Tax released an alert titled “Ohio’s PTE SALT Cap Workaround for ’Electing Pass-Through Entities’ beginning in Tax Year 2022” to provide some clarification on the recently enacted elective PTE tax.
The guidance notes that the Department has recently begun to develop a new PTE tax form (IT 4738) for tax year 2022, along with instructions and FAQs.
The guidance additionally reiterates:
- The election is made by the entity and is bound on all owners of the entity.
- All owners’ qualifying taxable income is required to be included if the entity makes this election.
- A disregarded entity is ineligible from making the election.
- The election is made known to the Department by filing the IT 4738.
- No refundable or nonrefundable credits can be claimed on the IT 4738.
- Owners who file an Ohio individual income tax return, IT 1040, must add back the tax amounts paid on the IT 4738 to the extent not included in computing federal or Ohio adjusted gross income using the Ohio Schedule of Adjustments.
- A refundable credit for the proportionate share of the tax paid on the IT 4738 is available for owners who file an IT 1040 using the Ohio Schedule of Credits, Pass-Through entity credit line.
Additional guidance is expected to be coming in the near future as Ohio works to finalize the framework of the PTE election.
Our Thoughts On
Ohio becomes the latest state to adopt an elective PTE tax as a workaround to the SALT Cap. The Department has indicated more guidance is forthcoming, so PTEs and their owners subject to Ohio taxation should monitor the current and future guidance to evaluate whether making the Ohio PTE election would be beneficial.
The Schneider Downs State and Local Tax (SALT) practice is equipped to help you evaluate the benefits of PTE elections in Ohio and the other adopting states and to assist you in the mechanics of making the election. Please direct inquiries to Stephen Worth, State & Local Tax Practice Leader, at [email protected].
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1Under 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.
2Qualifying taxable income is defined as:
The electing PTE’s business income apportioned to Ohio after the adjustments required by Ohio Rev. Code Section 5733.40(A)(2) to (A)(7), plus
The electing PTE’s nonbusiness income allocated to Ohio
