Ohio Tax Department’s Position On Small Business Deduction Baffling

The Ohio Tax Department has a taken a position with respect to the Ohio small business deduction that is difficult to explain or understand.

ORC section 5733.40(a)(7) permits a 20% (or more) owner of a qualifying pass-thru entity (“QPE”) to add back guaranteed payments and W-2 compensation paid by the QPE (“Compensation Payments”) to the owner to the business income allocated to the owner for purposes of calculating the Ohio small business deduction.

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The Ohio Tax Department has taken the position that an owner of a QPE that engaged a professional employer organization (“PEO”) to handle the payroll and benefit functions for the QPE is not entitled to add back the Compensation Payments to the business income allocated to the owner for purposes of calculating the Ohio small business deduction.  The Ohio Tax Department’s rationale is that the Compensation Payments made by the QPE to the owner do not go directly from the QPE to the owner.  Rather the Compensation Payments go from the QPE to the PEO and then to the owner.

The Ohio Tax Department has been conducting audits and issuing proposed income tax assessments against small business owners who were compensated thru a PEO arrangement and included such compensation in the calculation of the small business deduction amount.

Legislators have been working behind the scenes to fix this mess.  Rep. Gary Scherer, R-Circleville recently introduced House Bill 334 to amend ORC section 5733.40(A)(7) to provide that payments made by a PEO to a small business owner would be considered business income for purposes of calculating the small business deduction.  This House Bill would be effective retroactive to years beginning on or after January 1, 2013.   Hopefully this corrective legislation is enacted in short order.

It is believed that the Ohio Tax Department will suspend further audits while the legislation is pending.  But if a taxpayer has already received a notice of proposed assessment, the taxpayer should consider filing a petition for reassessment.

If you have any questions about this legislation or the small business deduction please call or email me at 937-223-1130 or Jsenney@pselaw.com.

AUTHOR: Jeff Senney
jsenney@pselaw.com