Buckingham’s SALT Published in Crain’s Cleveland Business
This article was originally published in Crain’s Cleveland Business, available at: http://www.crainscleveland.com/article/20150322/SPONSORED_BUCKINGHAM/303209999/ohio-tax-incentives-savings-for-small-midsize-businesses-critical.
Ohio tax incentives, savings for small, midsize businesses: Critical planning opportunities
4:30 am, March 22, 2015
Exciting tax savings are immediately available to Ohio businesses and their owners without substantially changing operations. The difficulty, however, is recognizing those opportunities and taking the proper steps to qualify, especially when affirmative action is necessary to trigger the incentive or savings.
Many opportunities exist for Ohio businesses, including a few new programs implemented as part of Gov. John Kasich’s goal to lessen the tax burden on Ohio small businesses. This article summarizes some of the common Ohio tax planning opportunities available to small and mid-sized businesses, or their owners.
InvestOhio provides a 10% Ohio individual income tax credit for investment in a qualifying small business enterprise (SBE). Two transactions are necessary to qualify for the credit: first, the investor must make a cash investment in exchange for an equity interest in the SBE; then, within six months of the investment, the SBE must make qualifying expenditures (described below) at least equal to the investment. The investor claims the credit against his / her Ohio individual income taxes in the second year following the investment, provided the investor continues to hold the equity interest received for the investment, and the SBE retains the property purchased in the qualifying expenditure, for the two-year holding period. Since the credit is non-refundable and taken against Ohio individual income taxes, it is imperative that the investor have a sufficient Ohio income tax liability against which the credit can be claimed. However, the credit may be carried-forward up to seven years.
To be a qualifying SBE, the business must have less than $50 million in assets or $10 million in annual sales at the time of the investment. In addition, more than half of the SBE’s employees must work in Ohio, or the SBE must have 50 full-time equivalent Ohio employees. This requires the SBE to have at least one full-time equivalent Ohio employee at the time of the investment. Accordingly, for startup investments, it is critical the SBE have an employee on payroll and open the relevant withholding and worker’s compensation accounts, prior to the investment.
The SBE’s qualifying expenditures include property primarily used in Ohio business – real, personal, or intangible property – or compensation paid to new Ohio employees, excluding owners, officers, and managers. The options available to the SBE are very broad and often include expenditures the SBE would be making as part of its normal operations. Thus, when a small business is planning to make a significant purchase, the business owners should consider whether this 10% savings can be obtained through InvestOhio qualification.
The InvestOhio credit is limited to $1 million per investor, per fiscal biennium, or $2 million for spouses filing jointly. Certain administration compliance is required to qualify for this credit. Both the investor and SBE must register for InvestOhio through the Ohio Business Gateway. Further, proof of the qualifying investment and qualifying expenditures by the SBE must be submitted to the Ohio Development Services Agency (DSA), along with a progress and final report during and at the end of the holding period. The DSA uses this information to confirm the investor and SBE continue to qualify for the credit, and then issues the investor a small business investment certificate specifying the credit amount.
InvestOhio credits are available to the owners of any Ohio small and mid-sized business able to make a cash investment in the business. But critical steps must be taken prior to completing the underlying transaction to comply with the required structure and administrative compliance. InvestOhio is a powerful tool that can provide savings to Ohio business owners for purchases made in the normal course of their businesses.
Bright-Line Residency Safe Harbor
In the early 1990s, Ohio enacted a residency safe harbor where individuals with homes in Ohio and another state, and who spent less than a certain number of days (i.e., contact periods) in Ohio, are treated as nonresidents for tax purposes by simply filing an affidavit with the Tax Commissioner. Beginning with 2015, the permissible Ohio presence was increased to 212 contact periods. This means individuals can now be present in Ohio for seven months, yet still qualify to be taxed as a nonresident, regardless of their intent. In other words, the individual can be a nonresident for Ohio income tax purposes but still maintain Ohio as the person’s primary home, including operating a business, voting, and using doctors and other professionals in Ohio, as long as the person maintains a home outside Ohio and is in Ohio no more than 212 days.
This safe harbor can provide significant state tax savings on investment and business income. Intangible investment income, such as dividends, interest, and gains from the sale of stock, is generally only subject to Ohio tax when the person is an Ohio resident. Further, business income of a nonresident is apportioned to Ohio based upon the business’ Ohio property, payroll, and sales. Since the sales factor is the most heavily-weighted factor, an Ohio business owner whose business has significant sales or operations outside Ohio could avoid Ohio taxes on a substantial portion of income from the business by qualifying as a nonresident under the bright-line residency safe harbor.
This safe harbor can provide an especially beneficial planning opportunity when an Ohio resident anticipates selling his/her business or realizing a significant gain from the sale of intangible investments, perhaps even enough to justify purchasing or renting a condominium in Florida, for instance. To meet the bright-line residency safe harbor, the individual must: (1) maintain an abode outside Ohio for the entire year (even if it is rented); (2) have no more than 212 Ohio contact periods; and (3) file an Affidavit of Non-Ohio Residency/Domicile (Form IT DA) with the Ohio Tax Commissioner by April 15th of the following year (although this date can be extended). Both the husband and wife must file separate affidavits. If an individual fails to meet these requirements, he or she will be presumed to be an Ohio resident and must meet the more burdensome common-law test, which is focused on one’s subjective intent to remain outside Ohio indefinitely with no plans to permanently return to Ohio.
CAT – Sourcing Gross Receipts from Services
Ohio’s commercial activity tax (CAT) became effective in 2005 as essentially a low rate tax, currently .26%, on gross receipts sourced to Ohio. Although essentially taxing all gross receipts, the CAT implemented a significant shift in tax policy by sourcing receipts from services to the location where the purchaser received the benefit of the service, rather than the location where the services were performed (i.e., cost of performance). This is referred to as market-based sourcing.
Although the Tax Commissioner has promulgated an administrative rule describing 54 different types of services and how they are to be source, practical application has proven difficult in many cases since the CAT was enacted relatively recently and limited authority addressing these issues exists. Besides the Tax Commissioner’s administrative rule, there is a lack of guidance in determining the location where the benefit of services is received. This can be particularly troublesome when services are provided to business customers with locations in multiple states which benefit from the service. For instance, where is the benefit of the service received when consulting or business management services are provided to a large corporation when the service benefits the entire organization? Further, receipts from acting as a sales agent / representative should be sourced to where the principal is located, not necessarily where the sales agent completes the sale (i.e., where the service is performed). While taxpayers wait for more guidance on these issues through several cases currently pending with the Ohio Board of Tax Appeals, the Department of Taxation is also struggling, often resorting to “it’s taxable” at the audit level, forcing taxpayers to prove the receipts are properly sourced outside Ohio.
The Tax Commissioner’s administrative rule provides taxpayers with the ability to source receipts from certain services provided to multistate purchasers to the purchaser’s principal place of business. This election can provide significant CAT savings for businesses providing services when the location where the benefit is received is unclear, such as in the example above. Accordingly, Ohio businesses may benefit from significantly reducing their Ohio taxable receipts by implementing a reasonable, consistent, and uniform method for sourcing receipts from such services based upon the customer’s multistate locations or principal place of business.
Small Business Deduction
The small business investor deduction was first enacted in 2013. It applies to income from Ohio sole proprietorships and pass-through entities. Originally, business owners were entitled to deduct 50% of the first $250,000, or up $125,000, of Ohio small business investor income. The deduction was increased to 75%, or up to $187,500, for the 2014 tax year.
“Ohio small business investor income” means the taxpayer’s business income, reduced by deductions, apportioned or allocated to Ohio under R.C. 5747.21 and 5747.22. Therefore, the deduction is based upon net business income as reported on Schedules C, E, and F of the taxpayer’s federal income tax return to the extent sourced to Ohio. The taxpayer must complete Ohio Form IT SBD – Small Business Investor Income Deductions Schedule to receive the deduction on Schedule A of his / her Ohio individual income tax return (Form IT 1040).
The Ohio Tax Commissioner released a notice that an unexpectedly low amount of Ohio small business deductions were claimed for 2013, likely resulting from a lack of awareness. Thus, Ohio business owners who are not already taking advantage of this deduction should inform their tax preparer they may be entitled to these savings.
The Ohio tax climate for small and mid-sized businesses is very favorable. Although incentives and savings have always been available, Governor Kasich’s administration has made it a priority to significantly lower the Ohio tax burdens on small businesses and their owners. In fact, Governor Kasich’s recently-proposed budget would completely eliminate income tax on Ohio small businesses with less than $2 million in annual gross receipts.
It is often imperative that business owners be aware of and implement the proper steps prior to undertaking a transaction to qualify for the tax benefits. We have significant experience in identifying and ensuring our clients receive the tax incentives and savings currently available to Ohio businesses.
* About the Authors: Steve, Rich, and Casey each focus their practice on Ohio state tax planning and controversies, as well as multistate tax planning. They co-author the Ohio State Tax Blog (https://www.bdblaw.com/publications-events/ohio-state-tax-law/) where you can find other helpful commentary and resources concerning Ohio and multistate tax.
Steven A. Dimengo, JD, CPA, MTax is a partner at Buckingham, Doolittle & Burroughs, LLC in Akron, Ohio and serves as chair of the firm’s Taxation Practice Group. Steve has more than 30 years of experience in state and local tax matters, including regularly representing clients before the Ohio Supreme Court and Ohio Board of Tax Appeals. He is also an adjunct professor for The University of Akron’s Masters of Taxation program and the Co-Chair of the Ohio State Bar Association’s Sales and Use Tax Sub-Committee. Steve can be reached at 330-258-6460 or via email at [email protected].
Richard B. Fry III, JD, MTax is a partner at Buckingham, Doolittle & Burroughs, LLC in Akron, Ohio. Rich also has substantial experience in state and local tax planning matters and representing clients in Ohio tax audits and controversies. He is the Co-Chair of the Ohio State Bar Association’s Sales and Use Tax Sub-Committee with Steve. Rich can be reached at 330-258-6423 or via email at [email protected].
Casey J. Davis, JD is an associate at Buckingham, Doolittle & Burroughs, LLC in Akron, Ohio. He joined Buckingham’s state and local tax group shortly after passing the bar in 2014. Casey can be reached at 330-258-6463 or via email at [email protected].