Ohio Tax
Workshop GG
Ohio Pass-Through Entity
Taxation … A Focus on
Audit Activity & Hot Issues
Wednesday, January 29, 2014
11:00 a.m. to 12:30 p.m.
Biographical Information
Jeffrey P. Sherman, J.D., CPA (inactive), Assistant Legal Counsel,
Regional Income Tax Agency
Worthington, Ohio
[email protected]
866-721-7482, Ext. 3586
A certified public accountant (inactive status) and admitted to the practice of law in New York and in Ohio,
Mr. Sherman is currently R.I.T.A.s assistant legal counsel. Previously, he was employed by the Ohio
Department of Taxation where for twenty-five years he was legal counsel for the Department’s Income
Tax Division. Prior to that time he was a senior manager for one of the Big Four accounting firms;
Earning his undergraduate degree from Miami University in Oxford, Ohio and receiving his law degree
with honors from The Ohio State University, he has published in national tax journals articles regarding
constitutional nexus, Ohio’s “bright line” domicile law, and Ohio’s passive investment company add-back
(“PIC add-back”) tax law. An instructor and editor for the Becker CPA Review Course, Mr. Sherman is a
frequent presenter at the yearly Ohio Tax Conference, at various state bar association conferences, and
at Ohio Society of Certified Public Accountants presentations. He has also taught undergraduate and
graduate business courses at The Ohio State University.
Stephen K. Hall, JD, LLM, Member, Zaino Hall & Farrin, LLC
41 South High Street, Suite 3600, Columbus, OH 43215
[email protected]
614-349-4812
Fax: 614-754-6368
Steve provides state and local tax services, legal business counsel, and lobbying services to clients in
multiple states and local jurisdictions. He leads the Firm's Real Estate Tax Practice Group, representing
real property owners in valuation matters and exemption matters. He has represented clients in all types
of state and local income tax, sales and use tax, excise tax, public utility tax, personal and real property
tax, and gross receipts tax matters.
Steve’s practice focuses on tax controversy and tax policy at the state and local level, including
representation of clients before County Boards of Revision, Local Income Tax Boards of Review, the Ohio
Board of Tax Appeals, Ohio state courts, and state and local tax agencies across the country. He also
frequently represents clients before Ohio’s General Assembly, the Ohio Department of Taxation, and
other state and local government agencies, both in tax controversy and lobbying matters.
Earlier in his career, he served as Assistant Counsel to the Ohio Tax Commissioner, where he was a
policy and technical advisor to the Tax Commissioner, the Ohio Governor’s Office, and the Ohio
Department of Development, while representing the Ohio Department of Taxation before the Ohio
General Assembly. He has spent significant time drafting tax legislation and lobbying for the
implementation of tax law changes both while in the Tax Commissioner’s office and on behalf of clients
while in private law practice
Steve is a frequent speaker on technical state and local tax matters, state and local tax policy, and
national tax policy matters addressing multistate taxation. He is actively involved in lobbying Ohio's
General Assembly and participates in various Ohio Bar Association committees addressing Ohio tax
policy and procedure. He is the chair of the Ohio State Bar Association subcommittee on municipal
income tax matters.
Biographical Information
Julie Corrigan, Associate, Plante & Moran
1111 Superior Ave., Suite 1250, Cleveland, Ohio 44114
[email protected]
216.274.6509
Fax 248.233.8853
Julie has more than twenty five years of experience in state and local taxation matters, including over
fifteen years in public accounting for the State and Local Tax Consulting practices of Plante & Moran,
PLLC and PricewaterhouseCoopers LLP. She also has twelve years of public service as a Tax Auditor
and Audit Supervisor for the Ohio Department of Taxation, Income/Franchise Tax Division. She has
served clients in the manufacturing, consumer products, and service industries and has assisted clients
with a broad range of state tax issues, including sales and use taxes, personal property taxation, income
and franchise taxes, gross receipt taxes and business credits and incentives.
Julie has written articles on state and local taxation topics and served on the Catalyst Editorial Advisory
Board for over 10 years. Julie has presented pertinent tax topics at the Ohio Tax Conference for several
years as well as presented other topics for outside organizations. Julie is a member of the American
Institute of CPAs, Ohio Society of CPAs, and the Tax Club of Cleveland.
Julie received her BBA in Accounting from the University of Cincinnati.
Raina M. Nahra, J.D., LL.M., Division Counsel, Personal Income & PTE Tax,
Office of Chief Counsel, Ohio Department of Taxation
4485 Northland Ridge Blvd., Columbus, OH 43229
[email protected]
614.387.1752
Fax 206.202.0747
Raina M. Nahra is currently serving as Division Counsel in the Office of Chief Counsel at the Ohio
Department of Taxation. Her practice focus areas include the personal income and pass-through entity
taxes. Raina has assisted in the analysis and writing of tax legislation and has written Tax Commissioner
Opinions and Information Releases. She also serves as the Department's Chief Disclosure Officer and
IRS Liaison. Prior to serving as Division Counsel, Raina was an administrative hearing officer with the
Department, addressing controversies involving the personal income, pass-through entity, and
corporation franchise taxes. Prior to her time at the Department, Raina was an associate in Lead Tax
Services at Deloitte Tax, LLP and a franchise business owner/operator. She earned a B.S., magna cum
laude, in Accounting from Case Western Reserve University, a J.D. from Cleveland State University,
Cleveland Marshall College of Law, and an LL.M. in Taxation from Capital University Law School. Raina
is admitted to practice law in Ohio, Washington, DC, and before several U.S. Courts, including the U.S.
Tax Court.
Paul Huckleberry, CPA, Audit Manager, Audit Division, Ohio Dept. of Taxation
4485 Northland Ridge Blvd., Columbus, OH 43229
[email protected]
(614) 387-2067 Fax: (614) 387-2071
He began his career with the Ohio Department of Taxation in April of 1986 as an accounting clerk,
appointed to the position of Tax Agent, specializing in Individual and Employer Withholding Tax in
February of 1990. In May of 1992, assigned to a joint IRS-Ohio Task Force, he pursued individuals and
businesses for failure to file federal and Ohio tax returns. In 1998, re-assigned to auditing S-corporations,
promoted to a Tax Auditor in October of 2001, he focused on auditing ESBTs and other Pass-Through
Entities. In August of 2005, promoted to Audit Manager in the South Central Region of the Audit Division,
he was instrumental in expanding and training the Audit Division’s staff of Pass-Through Entity auditors.
Paul received his undergraduate degree from the Ohio State University in 1984 majoring in accounting.
He is an active CPA and a member of the Ohio Society of CPAs.
Ohio Tax Conference
January 2014
Ohio Pass-Through Entity Taxation:
A Focus on Audit & Hot Issues
Julie Corrigan, Senior Manager, State & Local Tax
Plante & Moran PLLC, Cleveland
Stephen K. Hall, Member
Zaino Hall & Farrin LLC, Columbus
Raina M. Nahra, Division Counsel, Income & Pass-Through Entity Tax
Ohio Department of Taxation, Columbus
Paul Huckleberry, Audit Manager
Ohio Department of Taxation, Columbus
Jeffrey Sherman, Assistant Legal Counsel
Regional Income Tax Agency, Worthington
1
Hot Topics / Audit Issues







Legislative Updates
Business/Nonbusiness Income
ORC 5747.212 Gains
Unitary/Combined Filing Considerations
Related Member Adjustments
Compensation & Guaranteed Payments Add-back
Regional Income Tax Agency Legislative Update and
Audit Issues
2
Legislative Updates
3
Legislative Update – HB 59

New 50% Small Business Deduction
•
Effective taxable years beginning in 1/1/2013 and taken only by
individuals on IT1040 Schedule A
•
Deduction for 50% of TP’s OH small business investor income
(“OSBII”) of up to $250,000. OSBII = the portion of a tp’s AGI
that is business income reduced by business deductions and
apportioned to OH under ORC 5747.21.
•
Can’t exceed $62,500 for each spouse filing separately or
$125,000 for all other taxpayers
•
Does not impact school district income tax liability
4
Legislative Update – HB 59


Income Tax Rate Reductions
•
Reductions by 8.5% in taxable year 2013, an additional .5% to
total 9% in taxable year 2014, and an additional 1% to total
10% in taxable year 2015.
•
New withholding tables will be issued September 2013.
Ability of NR PTE Investors to File IT1040
•
NR PTE investors may now file an IT1040 whether or not they
have other Ohio-sourced income.
•
August 10, 2011 tax alert no longer effective.
5
Legislative Update – HB 59


Requests for Alternative Apportionment Modified
•
Effective 1/1/2013, requests must be submitted with a timely
filed return or amended return.
•
Makes technical change to ORC 5747.21 to include the term
“apportionment” with “allocation”.
Apportionment for NRs Clarified
•
Makes technical change in ORC 5747.05 statutory language.
Prior to this change, the term “allocable” was used, but not
“apportionable”.
6
Legislative Update – HB 59

Job Retention Tax Credit Modified
•

Extended to businesses whose principal place of business is
not located in same political subdivision as the capital
investment if maintains 4,200 employees at project site.
Technology Investment Tax Credit Eliminated
•
Effective 1/1/2013, credit no longer available. Taxpayers may
continue to carry forward excess credit amounts (15 year carry
forward period).
7
Business/Nonbusiness
Income
8
Business/Nonbusiness Income
What is Business Income?
Ohio Revised Code 5747.01(B): “Business Income”
means income, including gain/loss…

Arising from transactions, activities, & sources in the regular course
of a trade or business, (“Transactional Test”).

From real, tangible, 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,
(“Functional Test”).

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.
9
Business/Nonbusiness Income
What is Nonbusiness Income?

Ohio Revised Code 5747.01(C): “Nonbusiness
income” is all income that is not business income.
Examples:






Compensation
Rents, royalties from real or tangible property
Capital gains
Interest
Dividends and distributions
Patent, copyright royalties
10
Business/Nonbusiness Income

Allocable vs. Apportionable Income
• Business Income is Apportioned.
- See Ohio Revised Code 5747.21(B)
• Non-Business Income is Allocated.
- See Ohio Revised Code 5747.20
11
Business/Nonbusiness Income

Nonresidents: Allocation of Nonbusiness Income
•
•
•
•
Compensation for personal services: allocated to Ohio if
the services were performed in Ohio.
Gains/losses/rents/royalties from real property: allocated
to Ohio if the property was in Ohio
Gains/losses from sale of tangible personal property:
allocated to Ohio if the property was in Ohio at time of sale
Rents/royalties: allocated to Ohio in proportion to the
property’s utilization in Ohio, based on # of days physically
located in Ohio versus everywhere during taxable year.
12
Business/Nonbusiness Income

Residual Income:
•
Any other item of income/deduction of a nonresident
which is not specifically allocated or apportioned in
Ohio Revised Code 5747.20 through Ohio Revised
Code 5747.23 shall not be allocated to Ohio unless
the taxpayer’s domicile was in Ohio at the time the
income was paid or accrued.
13
Business/Nonbusiness Income
Department’s Position
All income is presumed to be
business income.
14
Business/Nonbusiness Income

Documentation To Show Why Income is
Treated as “Nonbusiness Income”
•
•
•
•
A schedule indicating the type and amount for each
item of income.
A detailed statement explaining why the taxpayer
asserts that the income is not business income.
A list of the states for which the taxpayer treats the
income as business income.
A copy of the other states’ returns.
15
Business/Nonbusiness Income
Kemppel v. Zaino, 91 Ohio St.3d 420 (2001)
 The Ohio Supreme Court recognized, without
explicitly adopting, both the transactional test
and the functional test.
 However, the court held that a liquidation
followed by dissolution fits neither test. Hence,
the last sentence of Ohio Revised Code
5747.01(B) was subsequently added.
16
Business/Nonbusiness Income

Kemppel v. Zaino, cont’d
• Transactional Test: looks to the nature,
frequency, and regularity of the transaction.
• Functional Test: Was the property an integral
part of the business? Did the property
contribute to business income in the past?
17
Business/Nonbusiness Income

Individual Income Tax Return, IT 1040
• For multi-state PTE owners, the PTE’s
activities are reflected in either the resident
or nonresident credit.
• Remember: The IT 1040 begins with federal
adjusted gross income, which will include all
distributive and proportionate shares.
18
Business/Nonbusiness Income

Composite Income Tax Return, IT 4708
•
•
•
Filed by the PTE on behalf of one or more of the
entity’s investors other than C corp.
Composite return satisfies each investor’s required
OH tax filing with respect to the investor’s share of
the PTE’s income.
Tax base is the sum of the allocated and
apportioned distributive shares of income for those
investors included.
19
Business/Nonbusiness Income

Audit Division Activity
•
•
Alternative Apportionment Requests
Other Issues
20
Business/Nonbusiness Income

Currently Pending Cases
Conwood Holdings Inc., fka Asworth Corp. v.
Testa BTA No. 2011-A-1964



Final Determination Date: June 7, 2011
Assessment No. 14200824009277
Appealed to the BTA on 8/4/2011
Issue & Decision: Treble damages and post-judgment interest
from dispute over core business deemed to be apportionable
business income.
21
ORC 5747.212 Gains
22
ORC 5747.212

Addresses nonresidents’ gain on the
sale of closely-held stocks and bonds.


Applies only to nonresidents directly or indirectly owning at
any time during the 3-year period ending on the last day of
the taxable year at least 20% of the equity voting rights of a
“section 5747.212 entity.”
When computing the nonresident credit, these taxpayers must
apportion the gain or loss of the sale of the debt or equity
interest in that entity.
23
ORC 5747.212

Addresses nonresidents’ gain on the
sale of closely-held stocks and bonds.


Apportionment factor is the 3-year average of
the entity’s apportionment fraction.
Definition of “section 5747.212 entity.”
24
ORC 5747.212 - Example

S Corporation Manufacturer – SKH, Inc.

SKH, Inc. has operations in Ohio, Indiana, Michigan.

Steve owns 40%, Julie owns 30%, Raina owns 20%,
Paul owns 10% of SKH stock
25
ORC 5747.212 - Example
• Steve is domiciled in Florida (0% rate) and is a passive investor who
plays golf in Florida all 365 days of the year and never comes to Ohio,
ever (receives no salary).
• Julie is domiciled in Michigan (4.25% rate) and is a marketing person in
the Michigan office of company. Juile never comes to Ohio to work
(salaried employee).
• Paul is domiciled in Indiana (3.4% rate) and is the chief operating officer
(salaried employee). Paul comes to Ohio 30 days a year for work.
• Raina is domiciled in Ohio (highest rate was 5.925%) and works at the
Ohio facility (salaried employee).
• All four have K-1 income for the 2009, 2010 and 2011 years, and salary,
if any.
26
ORC 5747.212 - Example

S Corporation Manufacturer – SKH, Inc.
•
In 2009, 2010, and 2011, SKH Inc. filed IT-1140 and withheld
for Steve, Julie, and Paul on Ohio apportioned amounts.
•
•
Steve, Julie, and Paul also filed Ohio IT-1040’s and
claimed credits for tax withheld for the operational income
of SKH (and for wage income).
In 2012, the S Corp owners sell their shares to an unrelated
purchaser and generate $100 million of capital gain in total.
27
ORC 5747.212 - Example



2010 – apportionment was 25% Ohio, AF
2011 – apportionment was 17% Ohio, AF
2012 – apportionment was 4% Ohio, AF
•
•
Average of AF was 15.33%
Apportionment, if correctly computed, would have been:
•
2010 – 22%
•
2011 – 14%
•
2012 – 6%
•
Average as corrected is 14%.
28
ORC 5747.212 - Example

2012 tax year – ODT audits Steve’s non-resident credit
computation and assesses Steve for capital gain
income using Ohio Revised Code 5747.212
•
ODT contends that 40% times $100 million times 15.335% is Ohio
taxable income.
•
$6,134,000 of income taxable to Ohio times 5.925% tax rate =
$363,440 of alleged additional Ohio tax for Steve (simplified for hypo).
29
ORC 5747.212 - Example

Ohio Revised Code 5747.212- SKH S Corp Sold Is the
Ohio assessment constitutional and properly
computed?
•
•
•
Explore Steve’s facts and nexus with Ohio, if any.
Review apportionment and help ODT understand that AF was
incorrect – here, the tax would be reduced by approximately $31,800
(15.3% vs. 14%).
Does entity need to file amended 1140’s for earlier years to satisfy
ODT that apportionment incorrect?
•
Communication among ODT divisions may be necessary.
30
ORC 5747.212 - Example

Steve
•
•
•
•
Does the discovery of the wrong apportionment AF provide a
refund claim opportunity for earlier years for Steve or others?
Are there any valid arguments relating to when Steve acquired
40% of the stock?
Why is 3 years the right measure under .212?
•
Note that the year of the sale was only 6% Ohio
apportionment.
Is the history of SKH Inc.’s nexus with Ohio or Steve’s nexus, if
any, with Ohio relevant?
31
ORC 5747.212 - Example

Julie’s issues:
•
•
•
Julie should get a credit in Michigan if she pays Ohio, but watch
the statute of limitations for amending Michigan return if she
pays Ohio.
•
Doesn’t matter as much (5.925% v. 4.25%)
Does Julie have different facts for purposes of Ohio nexus over
her?
Does Julie have refund claim opportunities for earlier years?
32
ORC 5747.212 - Example

Paul’s issues:
•
•
•
•
Paul is not necessarily under 5747.212 (since he was 10% owner), but
he needs to see if he was 20% at any time in last three years. If so,
Paul IS under 5747.212.
•
Recall that Paul is running the Company and clearly has nexus
with Ohio because he comes to Ohio to work. Why should Paul
escape 5747.212?
Paul has same credit issue as Julie, and needs to watch Indiana’s
SOLim. for amending – tax rate difference is greater (5.925 v 3.4%).
Does Paul have different facts for purposes of Ohio nexus over him?
Does Paul have refund claim opportunities for earlier years?
33
ORC 5747.212 - Example

Raina’s issues:
•
Raina is an Ohio resident, so 5747.212 does not apply.
•
If non-Ohio investors receive refunds for earlier years (because wrong
apportionment), is she adversely affected?
34
Unitary/Combined
Filing Considerations
35
Unitary/Combined Filing
Considerations

IT-2023 instructions reference to unitary/combined
method examples have been removed.

Can the unitary/combined method be used on the
Composite Return (IT-4708) and the Pass-Through Entity
Withholding Tax Return
(IT-1140)?

Can the unitary/combined method apply to Ohio Revised
Code 5747.212?
36
Unitary/Combined Filing
Considerations
Does the Ohio tax commissioner have the
statutory authority to require a combination of
pass-through entities that are unitary?
37
Unitary/Combined Filing
Considerations
See the January 12, 1994 ODT inter-office
communication which discusses the tax
commissioner’s authority to combine passthrough entities.
38
Unitary/Combined Filing
Considerations
•
Query: does the post-1994 enactment of Ohio
Revised Code 5733.40(A)(3) and 5733.40(A)(4) -which disallow the deduction for PTE-incurred
expenses paid to related PTE’s – and Ohio Revised
Code 5733.40(A)(6) suggest that there is no
statutory authority for either ODT-required
combinations or T/P-requested combinations?
•
Prohibits combination under Ohio Revised Code
5733.052
39
Unitary/Combined Filing
Considerations

Ohio Revised Code 5733.40(A)(6) cont.
(A)(6) The sum shall be computed without regard to
section 5733.051 or division (D) of section 5733.052 of
the Revised Code.
40
Related Member Adjustments
Ohio Revised Code Sections
5733.40(A)(3) and 5733.40(A)(4)
41
Related Member Adjustments

Ohio Revised Code 5733.40(A)(3)
• “For the purposes of Chapters 5733. and 5747. . .
the profit or net income of the qualifying entity
shall be increased by disallowing all amounts
representing expenses, other than amounts
described in division (A)(7) of this section, that the
qualifying entity paid to or incurred with respect to
direct or indirect transactions with one or more
related members…”
42
Related Member Adjustments

These sections disallow most deductions for related
member expenses and related member losses
other than compensation expenses.

“Related member” definition for this purpose uses a
“40%” test rather than the “20%” test used for
division (A)(7) of this section.

Ohio Revised Code 5733.40(P) provides
reference/definition of “related member.”
43
Related Member Adjustments

Examples of common related member
adjustments can include:
• Management fees
• Interest expenses
• Intangible expenses (rent, royalties)
• Wages paid to family members
• Expense sharing arrangements
• Other
44
Related Member Adjustments
Department’s Position:
 Form IT 4708, Schedule II (Line 28) Add-back
for Expenses Paid to Related Members and to
Certain Investors’ Family Members.
• Example: PTE equity investor owns at least
40% of the PTE. Equity investor’s spouse
receives a wage salary. This salary expense
must be reported on line 28 as an add-back.
45
Compensation
and Guaranteed Payments
Add-back
Ohio Revised Code
Section 5733.40(A)(7)
46
Compensation and Guaranteed
Payments Add-back

Ohio Revised Code Section
5733.40(A)(7)
• “For purposes of Chapters 5733 and 5747…
guaranteed payments or compensation paid
to investors by a qualifying entity… shall be
considered a distributive share of income of
the qualifying entity.
47
Compensation and Guaranteed
Payments Add-back

Ohio Revised Code Section 5733.40(A)(7)
• . . . Division (A)(7) of this section applies only
to such payments or such compensation
paid to an investor who at any time during
the qualifying entity's taxable year holds at
least a twenty per cent direct or indirect
interest in the profits or capital of the
qualifying entity.”
48
Compensation and Guaranteed
Payments Add-back

Schedule II (Line 29) Guaranteed Payments
•
Match Schedule K to partner’s Schedule
K-1 and Form 1099
•
Include only amounts paid to partners directly or
indirectly owning at least twenty-percent of the entity
49
Compensation and Guaranteed
Payments Add-back

Schedule II (Line 29) Guaranteed Payments
•
Guaranteed payments reported on page 1 of the
1065 may not agree with the amount reported on
Schedule K if the guaranteed payments were
made to retired partners
50
Compensation and Guaranteed
Payments Add-back

Schedule II (Line 30) Investor
Compensation
•
This line applies to:
- S Corporations
- Payments made to investors directly or
indirectly owning at least 20% of the entity
51
Compensation and Guaranteed
Payments Add-back
Department’s Position:



This section controls for purposes of PTE, PIT, CFT,
and EWT.
Such wages, salaries, etc. are NOT considered to
be “non-Ohio” compensation but are distributive
shares of PTE profit apportioned within and without
Ohio.
For purposes of PTE tax these wages, salaries, etc.
must be added to the PTE’s adjusted qualifying
amount.
52
Compensation and Guaranteed
Payments Add-back
Department’s Position:

For purposes of computing the Ohio nonresident
credit on form IT-2023 and for purposes of
computing Ohio taxable income on form IT-4708,
these wages must be added to income and then
apportioned.
 If compensation is being treated as a distributive
share of income, how should the compensation be
treated for purposes of the payroll factor?
53
Compensation and Guaranteed
Payments Add-back
Department’s Position

W-2s, 1099s, and K-1s for 20% or more owners

Reciprocity agreements between Ohio and its
neighboring states do not apply to 20% owners

Investor’s IRS form 1040 to compare

Only include amounts paid to shareholders
participating in the filing of the Ohio Form IT 4708
54
Compensation and Guaranteed
Payments Add-back
Taxpayer’s Position:

Unfair re-characterization of wage income to
distributive share earnings

Unfair to the other owners who may pay tax
on “phantom income”

Consider the federal excessive
compensation standards
55
Compensation and Guaranteed
Payments Add-back
HBD Industries, Inc. v. Levin, BTA No. 2008M-1018 decided June 14, 2011


Compensation is not limited to W-2 wages.
The add-back for “compensation paid to
investors” also applies to board of director
fees paid by an S corporation to a director
who is an at-least-20% investor in the S
corporation.
56
Other Misc Adjustments
57
Other Misc Adjustments

Domestic Production Activity Deduction (DPAD)
under IRC section 199.
•
•

Treatment on composite income tax return since not
addressed.
Evidence for support of deduction.
State Tax Addback
•
Adds back to FTI the state and local income taxes
paid by the entity on behalf of the investors. Income
taxes paid for the entity are not added back.
58
Regional Income Tax
Agency Legislative Update
and Audit Issues
59
Legislative Updates – House Bill 5
•
•
Tax pass-through entities at the entity level
PTE is the filer


•
•
Nonresident does not need to file
Resident gets credit in home city for tax paid by
entity to any/all municipalities
NOL
Offset income against loss
60
S Corporation and Reasonable
Compensation
Only approximately five Regional Income Tax
Agency municipalities are allowed to tax 100% of
each resident’s distributive share of income from
an S corporation – even if the S corporation has no
property-payroll-sales in the residence
municipality.
•
See Ohio Revised Code 718.01(H)(9)(b).
61
S Corporation and Reasonable
Compensation
Only approximately twenty-eight Regional Income
Tax Agency municipalities are allowed to tax each
resident’s Ohio-apportioned and Ohio-allocated
distributive share of income from an S corporation
– even if the S corporation has no property-payrollsales in the residence municipality.
•
See Ohio Revised Code 718.01(H)(9)(c).
62
S Corporation and Reasonable
Compensation
All remaining Regional Income Tax Agency
municipalities (and most non-Regional Income Tax
Agency municipalities) are not allowed to tax any
resident’s distributive share of income from an S
corporation – even if the S corporation has 100%
of its property-payroll-sales in the residence
municipality.
•
See Ohio Revised Code 718.01(H)(9)(a)
63
S Corporation and Reasonable
Compensation
However, each Ohio municipality can tax
100% of each resident’s compensation
(“qualified wages”) – regardless of where the
resident earns that compensation and
regardless of the employer’s propertypayroll-sales ratio, if any, for the “residence
municipality.”
64
S Corporation and Reasonable
Compensation
Important concept: In cases where the
residence municipality is not allowed to tax
100% of a resident’s distributive share of
income from an S corporation, that income
is not automatically exempt from taxation by
the residence municipality
65
S Corporation and Reasonable
Compensation
Reason: If the municipality determines that
all or a portion of the distributive share of
income from an S corporation more
accurately represents wages earned by the
shareholder, the municipality can recharacterize as wages some or all of the
distributive share of income.
66
S Corporation and Reasonable
Compensation

The re-characterization is not bound by
the limitations on municipal income
taxation of distributive shares of S
corporation income.
 That is, the Ohio Revised Code
718.01(H)(9)(a) limitation does not apply
to a S corporation shareholder’s wages.
67
S Corporation and Reasonable
Compensation
See division (H)(9)(a) of Ohio Revised Code
718.01:
[A municipal corporation shall not tax,] Except as provided in
divisions (H)(9)(b) and (c) of this section, an S corporation
shareholder’s distributive share of net profits of the S corporation,
other than any part of the distributive share of net profits that
represents wages as defined in section 3121(a) of the Internal
Revenue Code or net earnings from self-employment as defined in
section1402(a) of the Internal Revenue Code.
68
S Corporation and Reasonable
Compensation
See materials in Appendix for detailed discussions of the
factors necessary for the taxing authority to re-characterize
successfully as wages all or some portion of the S
corporation profit reported as a distributive share of
income.
-
Services of shareholder(s)
Services of non-shareholder employees
Capital and equipment
Compensation which other employers pay to non-related
employees for similar services.
69
S Corporation and Reasonable
Compensation
Irony
 For Ohio state income tax purposes, compensation paid
by a PTE is often recharacterized as a distributive share
of income.

For Ohio city income tax purposes, a distribution from a
PTE is recharacterized as compensation
70
Thank you!
Q&A
71
Contact Information
Julie Corrigan, Plante & Moran, PLLC
(216) 274-6509, [email protected]
Stephen K. Hall, Zaino Hall & Farrin LLC, Columbus,
(614) 349-4812, [email protected]
Raina Nahra, Ohio Department of Taxation
(614) 387-1752, [email protected]
Paul Huckleberry, Ohio Department of Taxation
(614) 387-2067, [email protected]
Jeffrey Sherman, Assistant Legal Counsel, RITA
(866) 721-7482, ext. 3586, [email protected]
72
Joseph W. Testa, Tax Commissioner
Issued: July 31, 2013
Individual Income Tax / Pass-Through Entity Tax: HB 59 Modifications Impacting
Taxpayers Subject to Ohio Income Tax
On June 30, 2013, Amended Substitute House Bill 59 (HB 59) of the 130th General Assembly (also known
as the fiscal year 2014-2015 biennial budget bill) was signed into law. HB 59 contains the following
modifications and additions to the law that impact taxpayers subject to Ohio income tax:
Income Tax Rate Reductions
HB 59 reduces income tax base amounts and rates by 8.5% in taxable year 2013, an additional .5% to
total 9% in taxable year 2014, and an additional 1% to total 10% in taxable year 2015. See ORC 5747.02.
More information regarding corresponding changes to employer income tax withholding tables will be
forthcoming, as these changes will not occur until September 2013. Beginning September 2013,
taxpayers will see a reduction in the Ohio income tax withholding from their paychecks.
New 50% Small Business Income Deduction
For taxable years beginning on or after January 1, 2013, an individual taxpayer filing the IT1040 is
allowed a deduction amounting to 50% of the taxpayer’s Ohio small business income of up to $250,000.
The deduction cannot exceed $62,500 for each spouse filing separately or $125,000 for all other
taxpayers. Ohio small business investor income means the portion of a taxpayer's adjusted gross
income that is business income reduced by deductions from business income and apportioned or
allocated to Ohio under ORC 5747.21 and 5747.22 to the extent not otherwise deducted or excluded in
computing federal or Ohio Adjusted Gross Income for the taxable year. As such, net business income as
reported on the taxpayer’s federal 1040 Schedules C, E and F will be used in calculating the deduction.
The deduction will be available on Schedule A of the IT1040. Additional clarification regarding how this
deduction is calculated will be forthcoming. Note that the deduction will not impact the calculation of a
taxpayer’s school district income tax liability. Instead, it will be added back to Ohio Taxable Income for
school district income tax purposes. See ORC 5747.01(A)(31), 5747.21, 5747.22 and 5748.01(E)(1)(a).
Means Testing of $20 Personal Exemption Credit
For taxable years beginning on or after January 1, 2013, the $20 personal exemption credit is only
available to taxpayers with Ohio Taxable Income of less than $30,000 on either an individual or joint
return. Ohio Taxable Income is defined as Ohio Adjusted Gross Income less exemptions. The credit will
continue to be available to eligible taxpayers on line 9 of the IT1040. See ORC 5747.022.
Ability to Take Deduction for Same Dependent on Two Returns Eliminated
For taxable years beginning on or after January 1, 2014, taxpayers are prohibited from claiming either a
personal exemption or a $20 personal exemption credit on their returns if they are being claimed as a
dependent on the federal income tax return of another taxpayer. See ORC 5747.022 and 5747.025.
New Ohio Earned Income Tax Credit
For taxable years beginning on or after January 1, 2013, a non-business non-refundable earned income
tax credit is available for taxpayers who were eligible for the Federal Earned Income Credit (FEIC) on
their federal 1040 returns. The Ohio Earned Income Tax Credit (OEITC) is equal to 5% of the taxpayer’s
FEIC. However, if the taxpayer’s Ohio Taxable Income (Ohio Adjusted Gross Income less exemptions)
exceeds $20,000 on either an individual or joint return, then the credit is limited to 50% of the tax
otherwise due after deducting all other credits that precede the credit except for the joint filing credit.
For taxable years beginning on or after January 1, 2013, taxpayers must have earned income and Federal
Adjusted Gross Income (FAGI) of less than the following amounts to be eligible for the FEIC:
•
•
•
•
$46,227 ($51,567 married filing jointly) with three or more qualifying children
$43,038 ($48,378 married filing jointly) with two qualifying children
$37,870 ($43,210 married filing jointly) with one qualifying child
$14,340 ($19,680 married filing jointly) with no qualifying children
Concurrently, the maximum FEIC amounts that these taxpayers can be allowed to take on their federal
returns will be the following:
•
•
•
•
$6,044 with three or more qualifying children
$5,372 with two qualifying children
$3,250 with one qualifying child
$487 with no qualifying children
As such, the maximum OEITC amount allowable to taxpayers on their state returns in taxable year 2013
is $302 (5% of $6,044). The credit will be available to eligible taxpayers on the 2013 IT1040 Schedule B.
More guidance on how taxpayers can calculate this credit will be forthcoming. See new ORC 5747.71.
Military Retirement Pay Deduction Expanded
Beginning in taxable year 2014, taxpayers who receive retirement income related to uniformed service
in the Commissioned Corps of the National Oceanic and Atmospheric Administration (NOAA) and the
Commissioned Corps of the Public Health Service (PHS) are allowed a deduction for the entire amount of
such pay to the extent it is included in FAGI. This deduction can be taken on Schedule A, line 37b of the
IT1040. Prior to this change, the deduction was only available to former service members of the United
States Army, Navy, Air Force, Coast Guard, or Marine Corps receiving military retirement pay. See ORC
5747.01(A)(26).
Wagering Loss Deduction Repealed
The wagering loss deduction that was slated to be effective for taxable year 2013 is now repealed. The
item would have allowed taxpayers to deduct losses from wagering transactions included in FAGI that
were allowed as an itemized deduction for federal purposes under IRC 165 and that the taxpayer
deducted in computing federal taxable income. Due to HB 59’s repeal of the provision, no wagering loss
deduction will be available for taxpayers in 2013 or thereafter. See ORC 5747.01(A)(29).
Income Tax Apportionment for Non-Residents Clarified
Effective for taxable year 2013, HB 59 clarifies that non-resident taxpayers are allowed a credit equal to
the amount of tax otherwise due on the portion of adjusted gross income not apportionable to Ohio.
Prior to this change, the term “allocable” was used, but not “apportionable”. This change makes the
provision consistent with the income tax apportionment provisions in ORC 5747.20 to 5747.23. See
ORC 5747.05.
$1 Minimum for Tax Payments and Refunds
Effective September 29, 2013, the Tax Commissioner is excused from issuing any tax refund if the
amount of the refund is $1 or less. Concurrently, taxpayers are excused from paying a tax if the total
amount due with the taxpayer’s return is $1 or less. Currently, the $1 minimum applies only to income
tax, employer withholding, and pass-through entity income tax withholding. See ORC 5703.75, 5747.08,
5747.10, and 5747.11
Calculation of Interest on Refunds Upon Filings of Returns or Reports
With respect to income tax refunds upon filings of returns or reports, the law prior to HB 59 mandated
the accrual of refund interest only if the Tax Commissioner does not refund the overpayment within 90
days after the due date of the taxpayer's return or the date the return was actually filed, whichever is
later. If interest was allowed, it accrued from 90 days from the due date of the taxpayer's return or the
date the return was actually filed, whichever is later, until the refund payment date.
Effective September 29, 2013, HB 59 eliminates ORC 5747.11(C)(1), which is repetitive in part of (C)(2)
and makes other minor technical edits to ORC 5747.11. It continues to not require interest on refund
payments made by the Commissioner within the aforementioned 90 day period. However, if interest is
allowed, it now requires calculation of the interest to begin from the date of the overpayment until the
refund payment date. The bill does not, however, modify the calculation of interest on payments of
illegal or erroneous assessments. See ORC 5747.11.
Ability of Nonresident Pass-Through Entity Investors to File IT1040
For taxable years beginning on or after January 1, 2013, all nonresident investors in a pass-through
entity on whose behalf the entity files an Ohio composite return (IT4708) and pays tax may now file an
individual return (IT1040) and claim the refundable credit for taxes the entity paid on the investor’s
behalf. These include nonresident investors with no other Ohio-sourced income who currently are not
required or permitted to file an individual return if the entity files the composite. Note that in light of
this change, the Department will be retracting the Business Tax Division Alert issued on August 10, 2011,
which formerly precluded nonresident individual investors participating in a composite and having no
other Ohio-sourced income from filing an IT1040 return. See ORC 5747.08.
Modification of Requests for Alternative Apportionment of Income
For taxable years beginning on or after January 1, 2013, individuals and pass-through entities who
intend to submit requests for alternative apportionment are now required to submit such requests with
a timely filed return or amended return. Prior to this change, the request was not required to be
submitted by the return’s due date. Also, HB 59 makes a technical correction to clarify that taxpayers
may request the alternative to also effectuate equitable “apportionment” of business in Ohio and not
only equitable “allocation”. See ORC 5747.21.
Modification to the Job Creation Tax Credit
Continuing law authorizes the Tax Credit Authority (TCA) to grant job creation tax credits (JCTCs) against
the income tax. Currently, a taxpayer that has entered into an agreement with the TCA for a JCTC on the
basis of home-based employees must report to the development services agency the number of
employees and home-based employees employed by the taxpayer in Ohio. Beginning in 2014, the
reporting date is now modified from January 1 to March 1 of each year. The refundable JCTC is taken on
forms IT1040 or IT4708. See ORC 122.17 and 5747.058.
Modification to the Job Retention Tax Credit
Continuing law authorizes the TCA to grant job retention tax credits (JRTCs) against the income tax.
Qualifying businesses having a capital investment project and retaining a specified number of full-time
equivalent employees or maintaining a certain payroll threshold can be entitled to the JRTC. Effective
September 29, 2013, the JRTC is now extended to eligible businesses whose principal place of business is
not located in the same political subdivision as the capital investment, as long as the business maintains
a unit or division with at least 4,200 employees at the project site. Generally, JRTCs are nonrefundable.
However, between July 1, 2011, and December 31, 2013, the TCA may grant refundable JRTCs to eligible
businesses that meet certain additional criteria. The JRTC is taken on forms IT1040 or IT4708. See ORC
122.171 and 5747.058.
Technology Investment Tax Credit Eliminated
Effective September 29, 2013, the Technology Investment Tax Credit for Ohio taxpayers who invest in
certain research and development or technology-oriented businesses is no longer available. However,
taxpayers who are currently carrying forward an excess credit amount from prior years may continue to
do so until the amount is exhausted within the 15 year carry forward period allowed by law. See ORC
122.152 and 5747.33.
Calculation of Post-Assessment Interest Modified
Effective September 29, 2013, interest that is charged after an assessment has been issued will be
calculated based on the assessment tax liability only. The interest will no longer be calculated on the
penalty and pre-assessment interest amounts. Therefore, the requirement of calculating interest on
interest and penalties has now been removed until an assessment becomes certified to the Ohio
Attorney General for collection. Interest after certification will continue to be calculated on the entire
unpaid portion of the assessment. See ORC 5747.13.
Change in Electronic Notice or Order Delivery Requirement
Under current law, the Tax Commissioner may serve a tax notice or order upon a person through secure
electronic means with the recipient's consent. If the recipient does not access the notice within ten
business days after service, the Tax Commissioner is currently required to then serve it by certified mail,
personal service, or delivery service. Effective September 29, 2013, the Commissioner may deliver the
notice or order to the intended recipient by ordinary mail after a second attempt to deliver through
electronic means is unsuccessful. See ORC 5703.37(B)(2).
###
Should you have any questions concerning how HB 59 may affect your Ohio income tax liability or your
business, contact your designated tax professional or visit tax.ohio.gov. You may also submit a question
to the Ohio Department of Taxation using the “Contact Us” option on the website.
###
IT SBD
Rev. 11/13
Year 20____
IT SBD – Small Business Investor Income Deduction Schedule
Every taxpayer requesting a small business investor income deduction must complete a separate schedule for each pass-through entity in
which the taxpayer has an ownership interest.
Part I
A. Business Income Before Deductions
1. Self-employment income (federal Schedule C, C-EZ or F), guaranteed payments and/or compensation
received from each pass-through entity in which you have at least a 20% direct or indirect ownership
interest. Note: Reciprocity agreements do not apply (see line instructions) ............................................. 1.
00
2. Add-back for expenses paid to related members and to certain investors’ family members (see instructions).................................................................................................................................................. 2.
00
3. Ordinary income (loss) from trade or business activities (to the extent not shown on line 1).................... 3.
00
4. Net income (loss) from rental activities, net royalties, interest income and dividend income .................... 4.
00
5. Net capital gain (loss) and other gain (loss)............................................................................................... 5.
00
6. Add adjustments from I.R.C. section 168(k) and qualifying 179 expenses (see line instructions)............. 6.
00
7. Other items of income and gain separately stated on federal Schedule K-1 and miscellaneous federal
income tax adjustments, if any .................................................................................................................. 7.
00
8. Total of lines 1 through 7............................................................................................................................ 8.
00
B. Deductions From Business Income
00
9a. Keogh deduction, self-employment tax deduction and self-employed health insurance deduction......... 9a.
00
b. Deduct adjustments for the depreciation expenses added back in prior years (see line instructions)..... 9b.
c. Other items of deduction and loss separately stated on federal Schedule K-1 if such deductions are
allowable in computing federal adjusted gross income (individuals) or federal taxable income (estates) ... 9c.
00
d. Other business income deductibles (describe) and miscellaneous federal income tax adjustments, if
... 9d.
any
00
e. Total of lines 9a through 9d...................................................................................................................... 9e.
00
C. Net Business Income, Apportionment
00
10. Net business income (line 8 minus line 9e) ............................................................................................. 10.
11. Ohio apportionment ratio (Part II, line 4).................................................................................................. 11.
00
12. Total business income apportioned to Ohio (multiply line 10 by line 11) ................................................. 12.
00
D. Ohio Small Business Investor Income Deduction
(Complete a separate schedule for each pass-through entity or sole proprietorship)
00
13. Ohio small business investor income (line 12 from each separate schedule; see instructions) ............. 13.
00
14. Maximum Ohio small business investor income subject to deduction (see instructions)......................... 14.
15. Ohio small business investor income deduction; 50% of line 13 or 50% of line 14, whichever is less
(maximum deduction is $125,000 for married filing jointly or single/head of household/qualifying widow(er)
filers and $62,500 for married filing separately filers. Enter here and on Ohio form IT 1040, line 41 ......... 15.
00
Part II – Apportionment Formula for Business Income
(1)
Within Ohio
(2)
Total
Everywhere
(3)
(4)
Ratio
Weight
(5)
Weighted
Ratio
(carry to six
decimal places)
1. Property
(a) Owned (average cost) ...............
(b) Rented (annual rental x 8) .........
÷
(c) Total (lines 1a and 1b) ...............
x .20 =
=
2. Payroll (see Exclusions on page 4
=
of the instructions) ...........................
x .20 =
÷
3. Sales (see Exclusions on page 5
=
÷
of the instructions) ...........................
x .60 =
4. Ohio apportionment ratio. Add lines 1c, 2 and 3 (enter ratio here and on Part C, line 11) .................................
(carry to six
decimal places)
.
1c.
.
.
2.
.
3.
4.
.
.
.
Ohio Small
Business
Investor Income
Deduction
Instructions for
Apportioning
Business Income
Solely for Purposes
of Computing the
Small Business
Investor Income
Deduction
Rev. 1/14
hio
tax.
Department of
Taxation
hio.gov
IT SBD
Rev. 1/14
Ohio schedule IT SBD is solely for use in determining the
small business investor income deduction. See Ohio Revised
Code section (R.C.) 5747.01(A)(31).
Each factor is weighted: The property and payroll factors are
weighted at 20% each and the sales factor at 60%, for a total
of 100%. If any factor has a denominator (total everywhere
figure) of zero, the weight given to the other factors must be
proportionately increased so that the total weight given to
the combined factors is 100%. For example: If the business
entity has no payroll everywhere, then the property and
sales factors are weighted at 25% and 75%, respectively,
to total 100%.
Do not use this schedule to compute Ohio adjusted gross
income. The form and instructions apply to resident, part-year
resident and nonresident individuals who have business income from Ohio sources. If your only source of Ohio income
is wages paid by an unrelated employer, you are not eligible
to use this form.
R.C. 5747.22(B) and (C) Apportionment and Allocation
of Income and Deductions of Pass-Through Entities
Important: This form assumes that the taxpayer has business income that could include (i) a distributive share of
income/gain from only one pass-through entity or (ii) distributive shares of income/gain from more than one pass-through
entity that are unitary with each other (under Ohio law, passthrough entities include sole proprietorships).
Apportionment of Pass-Through Entity Business
Income
With respect to a pass-through entity where one or more of
the nonresident or part-year resident investors are subject
to the Ohio income tax, the business income and deductions
of the pass-through entity shall be apportioned to Ohio in the
hands of the pass-through entity according to the instructions
for apportioning business income, Such business income
and deductions thus apportioned to Ohio are then allocated
to the investors in proportion to their right to share in such
business income.
Pass-through entities and trusts should not use this form.
Definitions
Business Income and Nonbusiness Income
“Business income” means income, including gain or loss,
arising from transactions, activities and sources in the regular
course of a trade or business and includes income from real,
tangible 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.
Also, “business income” consists of 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 (R.C. 5747.01(B)).
Business Income
(Part I, Part A)
Line 1 – Compensation Received from a Pass-Through
Entity
Guaranteed payment or compensation paid by a passthrough entity (S corporation, partnership, limited liability
company treated as a partnership for income tax purposes,
etc.) having nexus with Ohio to an investor holding at least
a 20% direct or indirect interest in the entity is considered a
distributive share of income of the entity and treated as business income, which is subject to apportionment for purposes
of computing the individual’s small business investor income
deduction (R.C. 5733.40(A)(7)). The “reciprocity agreements”
between Ohio and neighboring states do not apply to full-year
nonresidents directly or indirectly owning at least 20% of the
stock or other equity of a pass-through entity.
In general, income, deductions, gains and losses recognized
by a sole proprietorship or a pass-through entity are items
of business income that the individual must apportion using
Part I, C of Ohio Schedule IT SBD.
“Nonbusiness income” means all income other than business
income and may include, but is not limited to, compensation,
rents and royalties from real or tangible personal property,
capital gains, interest, dividends, distributions, patent or
copyright royalties, and lottery winnings, prizes and awards
(R.C. 5747.01(C)). Nonbusiness income should be excluded
from the figures reported on this schedule.
Line 2 – Related Member Add-back
R.C. 5733.042(A)(6) and 5733.04(P) disallow expenses
and losses incurred in connection with all direct and indirect
transactions between each pass-through entity and its related members. As such, you must add back on Part I, line
2 your distributive/proportionate share of such expenses and
losses. However, do not add (i) amounts shown on line 1 or
(ii) expenses or losses incurred in connection with sales of
inventory to the extent that the cost of the inventory and the
loss incurred were calculated in accordance with Internal
Revenue Code sections (I.R.C.) 263A and 482.
R.C. 5747.21 and 5747.22
Apportionment of Business Income or Deductions
The amount of business income and deductions apportioned
to Ohio is determined by multiplying the net business income
by an Ohio apportionment ratio, which is the sum of the property, payroll and sales factors (please refer to the Part II apportionment formula for business income on Ohio Schedule
IT SBD). Please note that the net business income consists
only of those items of income and deduction that would be
included in Ohio adjusted gross income (Ohio form IT 1040,
line 3) if not for this deduction.
Line 3 – Ordinary Income or Loss
Include ordinary income or loss from business activities to
the extent not shown on line 1. Include only income that is
business income as defined by R.C. 5747.01(B).
-2-
IT SBD
Rev. 1/14
Line 6 – Depreciation Adjustments
For tax years 2012 and thereafter, add 2/3, 5/6 or 6/6 of the
I.R.C. 168(k) bonus depreciation claimed under the I.R.C.
Also add 2/3, 5/6 or 6/6 of the excess of the I.R.C. 179 depreciation expense claimed under the I.R.C. over the amount
of the I.R.C. 179 depreciation expense that would have been
allowed based upon I.R.C. 179 in effect on Dec. 31, 2002.
See R.C. 5747.01(A)(20) as amended by the 129th General
Assembly in HB 365 and information releases 2002-02 and
2002-01 regarding Ohio bonus depreciation adjustments
available on our Web site at tax.ohio.gov. These releases
were originally posted on July 31, 2002 and Nov. 7, 2002.
Affects Depreciation Deductions for Taxable Years Ending
2001 and Thereafter” by visiting tax.ohio.gov. The department posted this release on July 31, 2002, and revised the
release in July 2005 and June 2009.
Line 7 – Miscellaneous Federal Income Tax Adjustments
Because of a recent amendment to R.C. section 5701.11,
there are no miscellaneous federal tax adjustments on this
schedule. See Sub. House Bill 58, 129th General Assembly.
However, you must make all other required adjustments for
this line.
Deductions From Business Income (Part I, Part B) Line
9b – Depreciation Adjustments
Under I.R.C. 179, as that section existed on Dec. 31, 2002,
the maximum amount that could be expensed was $25,000,
and the phase-out began once the cost of purchases of
I.R.C. 179 property during the year exceeded $200,000. So,
under the prior law the taxpayer could not claim any I.R.C.
179 expense if the taxpayer’s purchases during the year
of I.R.C. 179 property, as defined on Dec. 31, 2002, were
$225,000 or more.
Deduct 1/2, 1/5 or 1/6th of the I.R.C. 168(k) and 179 depreciation adjustments you added back on each of your last two, five
or six years’ Ohio income tax returns. You can take this deduction even if you no longer directly or indirectly own the asset.
See R.C. 5747.01(A)(21) as amended by the 129th General
Assembly in HB 365 and information releases 2002-02 and
2002-01 regarding Ohio bonus depreciation adjustments
available on our Web site at tax.ohio.gov. These releases
were originally posted on July 31, 2002 and Nov. 7, 2002.
This “add-back and subsequent deduction” law also covers
(i) depreciable assets acquired by the taxpayer’s disregarded
entities and (ii) depreciable assets that are owned by passthrough entities in which the taxpayer directly or indirectly
owns at least 5% (R.C. 5747.01(A)(20)(a)).
Line 9d – Miscellaneous Federal Income Tax Adjustments
Because of a recent amendment to R.C. section 5701.11,
there are no miscellaneous federal tax adjustments on this
schedule. See Sub. House Bill 58, 129th General Assembly.
However, you must make all other required adjustments for
this line.
In addition, the pass-through entity can defer making all or
some of the add-back under the following circumstances:
(i) the pass-through equity is an equity investor in another
pass-through entity that has generated I.R.C. 168(k) bonus
depreciation and/or I.R.C. 179 depreciation; and
Net Business Income, Apportionment (Part I, C)
Line 11 – Ohio Apportionment Ratio (Part II, Line 4)
Note: When calculating the fraction used to compute the Ohio
small business investor income deduction, a taxpayer who
has invested in a partnership, an S corporation or a limited
liability company treated as a partnership for federal income
tax purposes must apply the “aggregate” (conduit) theory of
taxation. That is, the character of all income and deductions
(and adjustments to income and deductions) realized by a
pass-through entity in which the taxpayer has invested retains
that character when recognized by the taxpayer. Furthermore,
the taxpayer’s factors must include the proportionate share
of each lower-tiered pass-through entity’s property, payroll
and sales (R.C. 5733.057 and 5747.231).
(ii) because of either the federal passive activity loss limitation rules or the federal at-risk limitation rules, this investor
pass-through entity is unable to deduct fully a loss passing
through from the other pass-through entity to this investor
pass-through entity.
In such circumstances, to the extent that this investor passthrough entity does not deduct the loss passing through,
this investor pass-through entity can defer making the “2/3
or 5/6 add- back” until the taxable year or years for which
this investor pass-through entity does deduct the investee
pass-through entity’s loss and receives a federal tax benefit
from the bonus depreciation amount and/or the I.R.C. 179
amount generated by the investee pass-through entity. Of
course, this investor pass-through entity cannot begin claiming the related two- or five-subsequent years deduction until
the first taxable year immediately following the taxable year
for which this investor pass-through entity makes the 2/3 or
5/6 add-back.
Property Factor
The property factor is a fraction the numerator of which is
the average value of the sole proprietor’s or pass-through
entity’s includable real and tangible personal property owned
or rented, and used in the trade or business in this state
during the taxable year, and the denominator of which is the
average value of all the sole proprietor’s or pass-through
entity’s includable real and tangible personal property owned
or rented, and used in the trade or business everywhere
during such year.
For detailed information and examples regarding this adjustment, see R.C. 5747.01(A)(20) as amended by the 129th
General assembly in HB 365 and the department’s information release entitled “Recently Enacted Ohio Legislation
-3-
IT SBD
Rev. 1/14
Ohio law includes in the property factor real property and
tangible personal property that the sole proprietor or passthrough entity rents, subrents, leases or subleases to others
if the income or loss from such rentals, subrentals, leases or
subleases is business income. Ohio law specifically excludes
from the factor all property relating to, or used in connection
with, the production of nonbusiness income allocated under
R.C. 5733.051. Generally, all sole proprietorship and passthrough entity income and gain is business income.
Line 1(a), Column 2 – Property Owned – Total Everywhere
Enter the average value of all the sole proprietor’s or passthrough entity’s real property and tangible personal property,
including leasehold improvements, owned and used in the
trade or business everywhere during the taxable year.
Line 1(b) – Property Rented
Enter the value of the sole proprietor’s or pass-through
entity’s real property and tangible personal property rented
and used in the trade or business in Ohio (column 1) and
everywhere (column 2) during the taxable year. Property
rented by the sole proprietor or pass-through entity is valued
at eight times the annual rental rate (annual rental expense
less subrental receipts).
Property owned by the sole proprietor or pass-through entity
is valued at its original cost average value. Average value is
determined by adding the cost values at the beginning and
at the end of the taxable year and dividing the total by two.
The tax commissioner may require the use of monthly values
during the taxable year if such values more reasonably reflect
the average value of the sole proprietor’s or pass-through
entity’s property.
Line 1(c) – Property Total Within Ohio and Everywhere
Add lines 1(a) and 1(b) for column 1 (within Ohio) and column
2 (total everywhere).
Line 1(c), Column 3 – Property Ratio
Enter the ratio of property within Ohio to total everywhere by
dividing column 1 by column 2.
Exclusions
Exclude from column 1 (within Ohio) and column 2 (total
everywhere) the following:
• Construction in progress.
• Property relating to, or used in connection with, the production of nonbusiness income. See R.C. 5733.05(B)(2)
as amended by Amended Substitute House Bill 95, 125th
General Assembly.
• The numerator and the denominator of the property factor
includes real property and tangible personal property that
the sole proprietor or pass-through entity rents, subrents,
leases or subleases to others if the income or loss from
such rentals, subrentals, leases or subleases is business income. See R.C. 5733.05(B)(2)(a) as amended by
Amended Substitute House Bill 95, 125th General Assembly. Property owned by the sole proprietor or pass-through
entity and leased to others is excluded from the property
factor only if the property generates nonbusiness income.
• The original cost of property within Ohio with respect to
the air pollution, noise pollution or industrial water pollution control certificates issued by the state of Ohio (R.C.
5733.05(B)(2)(a)).
• The original cost of real property and tangible property (or
in the case of property that the sole proprietor or passthrough entity is renting from others, eight times its net
annual rental rate) within Ohio that is used exclusively
during the taxable year for qualified research.
Line 1(c), Column 5 – Weighted Property Ratio
Multiply the property ratio on line 1(c), column 3 by the property factor weighting of 20%.
Payroll Factor
The payroll factor is a fraction, the numerator of which is
the total compensation paid in this state during the taxable
year by the sole proprietor or pass-through entity, and the
denominator of which is the total compensation paid both
within and without this state during the taxable year by the
sole proprietor or pass-through entity. As used below, the
term “compensation” means any form of remuneration paid
to an employee for personal services.
Exclusions
Exclude from column 1 (within Ohio) and column 2 (total
everywhere) the following:
• Guaranteed payments made to partners;
• Compensation that the S corporation paid to any shareholder if the shareholder directly or indirectly owned at
least 20% of the S corporation at any time during the year
(R.C. 5733.40(A)(7));
• Compensation paid in Ohio to employees who are primarily
engaged in qualified research; AND
• Compensation paid to employees to the extent that the
compensation relates to the production of nonbusiness
income allocable under R.C 5733.051 (R.C. 5733.05(B)
(2)).
Do not include in column 1 but do include in column 2 the
original cost of qualifying improvements to land or tangible
personal property in an enterprise zone for which the taxpayer
holds a Tax Incentive Qualification Certificate issued by the
Ohio Development Services Agency.
Do not include in column 1 but do include in column 2 compensation paid in Ohio to certain specified new employees
at an urban job and enterprise zone facility for which the
pass-through entity has received a Tax Incentive Qualification
Certificate issued by the Ohio Development Services Agency.
Line 1(a), Column 1 – Property Owned Within Ohio
Enter the average value of the sole proprietor’s or passthrough entity’s real property and tangible personal property,
including leasehold improvements, owned and used in the
trade or business in Ohio during the taxable year.
Line 2, Column 1 – Payroll Within Ohio
Enter the total amount of the sole proprietor’s or pass-through
-4-
IT SBD
Rev. 1/14
entity’s compensation paid in Ohio during the taxable year.
Compensation is paid in Ohio if any of the following apply:
• The recipient’s service is performed entirely within Ohio;
or
• The recipient’s service is performed both within and outside
Ohio, but the service performed outside Ohio is incidental
to the recipient’s service within Ohio; OR
• Some of the recipient’s service is performed within Ohio
and either the recipient’s base of operations, or if there is
no base of operations, the place from which the recipient’s
service is directed or controlled is within Ohio, or the base
of operations or the place from which the service is directed
or controlled is not in any state in which some part of the
service is performed, but the recipient’s residence is in
Ohio.
as amended by Substitute House Bill 127, 125th General
Assembly):
• Interest or similar amounts received for the use of, or for
the forbearance of the use of, money;
• Dividends;
• Receipts and any related gains or losses from the sale or
other disposal of intangible property other than trademarks,
trade names, patents, copyrights and similar intellectual
property;
• Receipts and any related gains and losses from the sale
or other disposal of tangible personal property or real
property where that property is a capital asset or an asset
described in I.R.C. 1231. For purposes of this provision
the determination of whether or not an asset is a capital
asset or a 1231 asset is made without regard to the holding
period specified in the I.R.C.; AND
• Receipts from sales to (a) an at-least-80%-owned public
utility other than an electric company, combined electric
company, or telephone company, (b) an at-least-80%owned insurance company, or (c) an at-least-25%-owned
financial institution.
Compensation is paid in Ohio to any employee of a common or contract motor carrier corporation who performs his
regularly assigned duties on a motor vehicle in more than
one state in the same ratio by which the mileage traveled
by such employee within Ohio bears to the total mileage
traveled by such employee everywhere during the taxable
year. The statutorily required mileage ratio applies only to
contract or common carriers. Thus, without approval by the
tax commissioner a manufacturer or merchant who operates
its own fleet of delivery trucks cannot use the ratio of miles
traveled in Ohio to miles traveled everywhere to situs driver
payroll. See Cooper Tire and Rubber Co. v. Limbach (1994),
70 Ohio St. 3d 347.
Note: Income and gain from receipts excluded from the sales
factor is not presumed to be nonbusiness income. All income,
gain, loss and expense is presumed to be apportionable
business income – even if the related receipts are excluded
from the sales factor.
The law specifically includes in the sales factor the following
amounts when arising from transactions, activities and sources in the regular course of a trade or business: (i) receipts
from sales of tangible personal property, (ii) receipts from the
sale of real property inventory (such as lots developed and
sold by a real estate developer), (iii) rents and royalties from
tangible personal property, (iv) rents and royalties from real
property, (v) receipts from the sale, exchange, disposition or
other grant of the right to use trademarks, trade names, patents, copyrights and similar intellectual property, (vi) receipt
from the sale of services and other receipts not expressly
excluded from the factor. These amounts are situsable to
Ohio as set forth below.
Line 2, Column 2 – Payroll Total Everywhere
Enter the total amount of the sole proprietor’s or pass-through
entity’s compensation paid everywhere during the taxable
year.
Line 2, Column 3 – Payroll Ratio
Enter the ratio of payroll within Ohio to total everywhere by
dividing column 1 by column 2.
Line 2, Column 5 – Weighted Payroll Ratio
Multiply the property ratio on line 2, column 3 by the payroll
factor weighting of 20%.
Line 3, Column 1 – Sales Within Ohio
Enter the total of gross receipts from sales not excludable
from the numerator and the denominator of the sales factor,
to the extent the includable gross receipts reflect business
done in Ohio. Sales within Ohio include the following:
• Receipts from sales of tangible personal property, less
returns and allowances, received by the purchaser in Ohio.
In the case of delivery of tangible personal property by
common carrier or by other means of transportation, the
place at which such property is ultimately received after
all transportation has been completed is considered as the
place at which such property is received by the purchaser.
Direct delivery in Ohio, other than for purposes of transportation, to a person or firm designated by a purchaser
constitutes delivery to the purchaser in Ohio, and direct
delivery outside Ohio to a person or firm designated by a
purchaser does not constitute delivery to the purchaser in
Sales Factor
The sales factor is a fraction whose numerator is the sole
proprietor’s or pass-through entity’s includable business income receipts in Ohio during the taxable year and whose denominator is the sum of the sole proprietor’s or pass-through
entity’s within Ohio and without Ohio includable business
income receipts during the taxable year. The sales factor
specifically excludes receipts attributable to nonbusiness
income allocable under R.C. 5733.051 (see R.C. 5733.05(B)
(2) and the tax commissioner’s April 2004 information release
entitled “Sales Factor Situsing Revisions”).
Exclusions
The following receipts are not includable in either the numerator or the denominator of the sales factor even if the receipts
arise from transactions, activities and sources in the regular
course of a trade or business (see R.C. 5733.05(B)(2)(c)
-5-
IT SBD
Rev. 1/14
Ohio, regardless of where title passes or other conditions
of sale. Customer pick-up sales are situsable to the final
destination after all transportation (including customer
transportation) has been completed. See Dupps Co. v.
Lindley (1980), 62 Ohio St. 2d 305.
Line 3, Column 3 – Sales Ratio
Enter the ratio of sales within Ohio to total everywhere by
dividing column 1 by column 2.
Line 3, Column 5 – Weighted Sales Ratio
Multiply the sales ratio on line 3, column 3 by the sales factor
weighting of 60%.
Revenue from servicing, processing or modifying tangible
personal property is sitused to the destination state as a
sale of tangible personal property. See Custom Deco, Inc. v.
Limbach, BTA Case No. 86-C-1024, June 2, 1989.
• Receipts from sales of real property inventory in Ohio.
• Rents and royalties from tangible personal property to the
extent the property was used in Ohio.
• Rents and royalties from real property located in Ohio.
• Receipts from the sale, exchange, disposition or other
grant of the right to use trademarks, trade names, patents,
copyrights and similar intellectual property are sitused
to Ohio to the extent that the receipts are based on the
amount of use of that property in Ohio. If the receipts are
not based on the amount of use of that property, but rather
on the right to use the property and the payor has the right
to use the property in Ohio, then the receipts from the sale,
exchange, disposition or other grant of the right to use such
property are sitused to Ohio to the extent the receipts are
based on the right to use the property in Ohio.
• Receipts from the performance of services and receipts
from any other sales not excluded from the sales factor
and not otherwise sitused within or without Ohio under
the above situsing provisions are situsable to Ohio in
proportion to the purchaser’s benefit, with respect to the
sale, in Ohio to the purchaser’s benefit, with respect to
the sale, everywhere. The physical location where the
purchaser ultimately uses or receives the benefit of what
was purchased is paramount in determining the proportion
of the benefit in Ohio to the benefit everywhere. Note: For
taxable years ending on or after Dec. 11, 2003, the “cost
of performance” provision is no longer the law.
Line 4, Column 5 – Total Weighted Apportionment Ratio
Add column (5), lines 1 (c), 2 and 3).
Ohio Small Business Investor Income Deduction
(Part 1, D)
Line 13 – Ohio Small Business Investor Income
Individuals shall complete one form IT SBD (lines 1-12) for
each pass-through entity in which the taxpayer has an ownership interest or sole proprietorship. Enter the sum of line
12 from each separate schedule.
Line 14 – Maximum Ohio Small Business Investor Income
If filing status is married filing jointly or single, head of household, enter $250,000 on this line. If filing status is married
filing separately, enter $125,000 on this line.
Line 15 – Ohio Small Business Investor Income Deduction
Enter on this line the lesser of 50% of line 13 or 50% of
line 14. R.C. 5747.01(A)(31) states, “deduct one-half of the
taxpayers Ohio Small Business investor income, the deduction not to exceed $62,500 for each spouse if spouses file
separate returns under R.C. 5747.08 or $125,000 for all other
taxpayers. No pass-through entity may claim a deduction
under this division.
For purposes of this division, “Ohio small business investor
income” means the portion of the taxpayer’s adjusted gross
income that is business income reduced by deductions from
business income and apportioned or allocated to this state
under R.C. 5747.21 and 5747.22, to the extent not otherwise
deducted or excluded in computing federal or Ohio adjusted
gross income for the taxable year.”
Line 3, Column 2 – Sales Everywhere
Enter the total of such includable gross receipts, less returns
and allowances, from sales everywhere.
Note: Generally, all sole proprietorship and pass-through
entity income and gain is business income.
Federal Privacy Act Notice
Because we require you to provide us with a Social Security number, the Federal Privacy Act of
1974 requires us to inform you that providing us with your Social Security number is mandatory.
Ohio Revised Code sections 5703.05, 5703.057 and 5747.08 authorize us to request this information. We need your Social Security number in order to administer this tax.
-6-
IT SBD
Rev. 1/14
Summary of Ohio Tax Treatment of Income and Deductions for
Purposes of the Small Business Investor Income Deduction
Note: Except for lottery prizes and awards, all income and gain is presumed to be business income/gain.
Type of Income and Deductions
Ohio Tax
1. Guaranteed payments and compensation
paid to an individual for services performed
If the individual directly or indirectly owns at least 20% of the business,
the individual must show the guaranteed payments and compensation
on Part I, A, line 1.
2. Gains or losses from the sale or transfer of
real property
Apportion if gain constitutes business income.
3. Gains or losses from the sale or transfer of
tangible personal property
Apportion if gain constitutes business income.
4. Gains or losses from the sale or transfer of
intangible personal property
Apportion if gain or loss constitutes business income.
5. Rents or royalties from real property
Apportion if gain constitutes business income.
6. Rents or royalties from tangible personal
property
Apportion if the rents or royalties constitute business income.
7. Patent and copyright royalties
Apportion if the rents or royalties constitute business income.
8. Depreciation expense add-back/deduction
If the depreciation relates to nonbusiness property, the 1/2, 5/6 or 6/6
add-back and corresponding 1/2, 1/5 or 1/6 deductions are not considered business income and deductions. However, if the depreciation
relates to business property, these depreciation adjustments are apportioned as items of business income and deduction using the Part I
business income worksheet.
-7-
[Cite as Kemppel v. Zaino, 91 Ohio St.3d 420, 2001-Ohio-92.]
KEMPPEL ET AL., APPELLANTS, v. ZAINO, TAX COMMR., APPELLEE.
[Cite as Kemppel v. Zaino (2001), 91 Ohio St.3d 420.]
Taxation — Income tax — Liquidation of assets of Ohio subchapter S corporation
followed by dissolution of the corporation — Income from the gain on the
sale of the intangible personal property not business income as defined in
R.C. 5747.01(B) — Tax Commissioner’s remitting of portion of the statutory
penalty is not an abuse of discretion.
(No. 00-358 — Submitted February 27, 2001 — Decided May 23, 2001.)
APPEAL from the Board of Tax Appeals, No. 98-K-698.
__________________
ALICE ROBIE RESNICK, J. In 1989 the assets of the Logan Machine Co.
(“Logan”), an Ohio subchapter S corporation located in Akron, were liquidated and
the corporation dissolved.
The net proceeds from the sale of the assets were
distributed to the shareholders, including appellants, Russell and Carrie Kemppel,1
who were residents of and domiciled in Florida at the time of the sale.
As
shareholders of Logan, each of the Kemppels received his or her pro rata share of the
net proceeds of the sale, including gain from the sale of intangible personal property,
which was attributed to goodwill.
To calculate the amount of their nonresident tax credit under R.C.
5745.05(A), the Kemppels calculated the ratio of their non-Ohio income to their total
income. In calculating this ratio, the Kemppels included as non-Ohio income all
income attributed to them from Logan, except that from ordinary business operations
prior to the sale. The Tax Commissioner audited the Kemppels’ return and treated all
of the income attributed to them from Logan as business income and therefore subject
to allocation to Ohio, including the gain from the sale of the intangible personal
1.
On February 5, 2001, a suggestion of death was filed for Carrie M. Kemppel. Russell E.
Kemppel as administrator of the estate of Carrie M. Kemppel has been substituted as a party.
SUPREME COURT OF OHIO
property (goodwill). As a result, the ratio of the Kemppels’ non-Ohio income to total
income was reduced, thereby reducing the amount of the Kemppels’ nonresident
credit and increasing their Ohio tax. The assessment issued by the commissioner
included the statutory double interest penalty.
The Kemppels filed for reassessment. After a hearing, the commissioner
affirmed his assessment; however, he reduced the statutory interest penalty by onehalf. The Kemppels appealed the commissioner’s decision to the Board of Tax
Appeals, which affirmed the assessment. This cause is now before the court upon an
appeal as of right.
The Kemppels present two issues: (1) Is the income attributed to the
Kemppels from the gain on the sale of intangible personal property, as a result of the
liquidation of Logan, business or nonbusiness income? and (2) Did the Tax
Commissioner abuse his discretion in not abating the entire statutory interest penalty?
Because the Kemppels are shareholders in a subchapter S corporation, the
character of the income attributed to them from Logan is determined as though they
had received it directly from the same source as Logan. Dupee v. Tracy (1999), 85
Ohio St.3d 350, 708 N.E.2d 698; Section 1366(b), Title 26, U.S.Code. Thus, if
income is business income to Logan, it is business income to the Kemppels; if
income is nonbusiness income to Logan, it is nonbusiness income to the Kemppels.
Former R.C. 5747.21 provided: “All items of business income * * * shall be
allocated to this state by [apportionment].” Sub.H.B. No. 250, 140 Ohio Laws, Part I,
2643. R.C. 5747.20(B)(2)(c) provides that the nonbusiness income of a nonresident
resulting from capital gains from the sale of intangible property is “allocable to this
state if the taxpayer’s domicile was in this state at the time of such sale or other
transfer.” Since the Kemppels were not domiciled in Ohio at the time of the sale,
none of their share of the income from the gain on the sale of the intangible personal
property can be allocated to Ohio unless the income is classified as business income.
R.C. 5747.01(B) and (C) define the terms “business income” and
“nonbusiness income”:
2
January Term, 2001
“(B) ‘Business income’ means income arising from transactions, activities,
and sources in the regular course of a trade or business and includes income from
tangible 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.
“(C) ‘Nonbusiness income’ means all income other than business income and
may include, but is not limited to, compensation, rents and royalties from real or
tangible personal property, capital gains, interest, dividends and distributions, patent
or copyright royalties, or lottery winnings, prizes, and awards.”
The definition of “business income” set forth in R.C. 5747.01(B) is a
modified version of the definition initially promulgated by the National Conference
of Commissioners on Uniform State Laws in 1957, as part of its Uniform Division of
Income for Tax Purposes Act (“UDITPA”).
The UDITPA definition was later
adopted by the Multistate Tax Commission.
The same definition or a slightly
modified version has been adopted by many states.
Courts in other states have split in applying tests for classifying income.
Some courts have applied the “transactional test,” and others have applied an
additional distinct test, the “functional test.” To facilitate discussion of these tests we
have separated R.C. 5747.01(B) into two parts:
Part I:
“ ‘Business income’ means income arising from transactions,
activities, and sources in the regular course of a trade or business”
and
Part II: “includes income from tangible and intangible personal property if
the acquisition, rental, management, and disposition of the property constitute
integral parts of the regular course of a trade or business operation.”
The transactional test, which the Kemppels urge us to adopt, considers the
statute as a whole and emphasizes Part I of the definition. It treats Part II as merely
giving examples of income within Part I. In this test the income is business or
nonbusiness depending on whether it arises from a transaction or activity that occurs
3
SUPREME COURT OF OHIO
in the regular course of the business in which the taxpayer engages. The nature,
frequency, and regularity of the transaction are relevant factors. W. Natural Gas Co.
v. McDonald (1968), 202 Kan. 98, 446 P.2d 781; Phillips Petroleum Co. v. Iowa
Dept. of Revenue & Fin. (Iowa 1993), 511 N.W.2d 608; In re Uniroyal Tire Co. v.
State Dept. of Revenue (Ala.2000), 779 So.2d 227. In addition, some courts also look
to see whether the proceeds of the transaction are used in the business or dispersed to
shareholders. Union Carbide Corp. v. Huddleston (Tenn.1993), 854 S.W.2d 87, 93.
The functional test, which the commissioner urges us to adopt, focuses on
Part II, treating it as independent of Part I. Under the functional test, business income
includes income from sale of personal property if use of the property constituted an
integral part of the regular course of a trade or business operation. The Pennsylvania
Supreme Court has stated, “Income meets the functional test if the gain arises from
the sale of an asset which produced business income while it was owned by the
taxpayer.” Laurel Pipe Line Co. v. Commonwealth, Bd. of Fin. & Revenue (1994),
537 Pa. 205, 210, 642 A.2d 472, 475. Under the functional test, the extraordinary
nature or infrequency of the transaction is irrelevant.
Nevertheless, some courts that have adopted the functional test have also
recognized that the sale of assets as part of the total or partial liquidation of a business
is different from the sale of assets by a continuing business. In Polaroid Corp. v.
Offerman (1998), 349 N.C. 290, 306, 507 S.E.2d 284, 296, although the North
Carolina Supreme Court recognized the functional test, it noted, in footnote six,
“[C]ases involving liquidation are in a category by themselves.
Indeed true
liquidation cases are inapplicable to these situations because the asset and transaction
at issue are not in furtherance of the unitary business, but rather a means of
cessation.” Likewise, in Laurel Pipe Line Co., the Pennsylvania Supreme Court,
while recognizing the functional test, held that the partial liquidation of a company’s
business by the sale of a pipeline that had been idle for over a year “was not disposed
of as an integral part” of the company’s regular trade or business and, therefore, was
not business income. Id., 537 Pa. at 211, 642 A.2d at 475.
4
January Term, 2001
After reviewing these authorities we find that we do not need to determine
which test is applicable to decide this case. The income received by Logan was not
business income under either the transactional test or the functional test. The income
in question resulted from a liquidation of assets followed by a dissolution of the
corporation; this was a one-time event that terminated the business. This was no sale
in the regular course of a trade or business. Therefore, the income from the gain on
the sale of the intangible personal property was not “business income” as defined in
R.C. 5747.01(B).
Next the Kemppels contend that the Tax Commissioner abused his discretion
by failing to abate the entire statutory penalty. The penalty was based on assessments
that the Kemppels no longer dispute, as well as on the assessment that we have
determined to be improper. Obviously the portion of the penalty related to the
improper assessment must be abated. The Kemppels seek abatement of the entire
penalty because their failure to pay the proper amount of tax was based on the advice
of a national accounting firm.
R.C. 5747.15(A)(2) provides that if a taxpayer fails to pay the amount of tax
required, “a penalty shall be imposed equal to twice the interest charged under
division (G) of section 5747.08 of the Revised Code for the delinquent payment.”
R.C. 5747.15(C) provides: “All or part of any penalty imposed under this section may
be abated by the commissioner if the taxpayer shows that the failure to comply with
the provisions of this chapter is due to reasonable cause and not willful neglect.” The
Tax Commissioner, here, has abated one-half the statutory penalty.
The Kemppels failed to present any evidence to substantiate their claim that
the Tax Commissioner abused his discretion as to the assessments that they no longer
dispute. In prior cases this court has held that its review of the commissioner’s
discretionary power to remit a penalty is limited to whether an abuse of discretion has
occurred. Jennings & Churella Constr. Co. v. Lindley (1984), 10 Ohio St.3d 67, 10
OBR 357, 461 N.E.2d 897. This matter is remanded to the Tax Commissioner to
5
SUPREME COURT OF OHIO
exercise his discretion to reassess the penalty related to the assessments the Kemppels
no longer dispute.
Decision affirmed in part,
reversed in part
and cause remanded.
MOYER, C.J., F.E. SWEENEY, PFEIFER, COOK and LUNDBERG STRATTON, JJ.,
concur.
DOUGLAS, J., dissents.
__________________
Witschey & Witschey Co., L.P.A., Jeffrey T. Witschey and Frank J. Witschey,
for appellants.
Betty D. Montgomery, Attorney General, and Robert C. Maier, Assistant
Attorney General, for appellee.
Jones, Day, Reavis & Pogue and Charles M. Steines, urging reversal for
amicus curiae Lewis W. Dickey.
Taft, Stettinius & Hollister, L.L.P., and Stephen M. Nechemias, urging
reversal for amici curiae David S. and Linda K. Paresky.
__________________
6
FINAL
DETERMINATION
Office of the Tax Commissioner
30 E. Broad St., 22nd Floor  Columbus, OH 43215
Date: June 7, 2011
Conwood Holdings, Inc. F/K/A Asworth Corporation
71 South Wacker Dr. Suite 4600
Chicago, IL 60606
Re:
Assessment No. 14200824009277
Pass-Through Entity Tax
Tax Years 2003, 2005, 2006
This is the final determination of the Tax Commissioner with regard to a petition for
reassessment pursuant to R.C. 5747.13 concerning the following pass-through entity tax
assessment:
Period
2003
2005
2006
Total
Tax
$1,486,503.00
$ 24,622.00
$ 95,729.00
$1,606,854.00
Interest
$408,829.00
$ 4,408.00
$ 10,833.00
$424,070.00
Penalty
$
0.00
$
0.00
$4,786.00
$4,786.00
Late Payment Penalty
$222,975.00
$
0.00
$
0.00
$222,975.00
Total
$2,118,307.00
$ 29,030.00
$ 111,348.00
$2,258,685.00
The petitioner contends that the Department erroneously made adjustments on audit of its
2003 pass-through entity tax return filed pursuant to R.C. 5747.08(D)(1)(a). This contention is
not well taken.
I. Background
The petitioner is a manufacturer of smokeless tobacco products operating as an S
Corporation. The petitioner sells its products in several states, including Ohio. In 2000, the
petitioner was involved in an anti-trust lawsuit with a competitor in the moist snuff tobacco
industry for unlawful monopolization. Upon conclusion of the ensuing jury trial in 2000, the
petitioner was awarded $350 million in compensatory damages. The petitioner classified this
amount as apportionable business income on its 2000 Ohio income tax return. In 2003, the
proceeds were increased to include reimbursed legal expenses of $16 million, treble damages of
$700 million, and post-judgment interest of $195 million. Pursuant to R.C. 5747.08(D)(1)(a),
the petitioner filed Ohio composite income tax returns for certain investors in a pass-through
entity for tax years 2003, 2005, and 2006.1 The petitioner classified its treble damages and postjudgment interest as nonbusiness income not allocable to Ohio on its 2003 filing.
On audit, the Department reclassified the 2003 treble damages and post-judgment interest as
1
On May 30, 2006, Asworth Corporation sold all its interests to Conwood Holdings, Inc., which resulted in
dissolution of Asworth Corporation.
-2business income apportionable to Ohio. Reclassifications for other items were likewise made for
years 2005 and 2006. These amounts were added to the petitioner’s taxable income, resulting in
increased tax liabilities and generation of the assessment. In particular, the petitioner now
challenges the 2003 audit adjustment and asserts that it should be reversed.
II. The Petitioner’s Treble Damages & Post-Judgment Interest Are Business Income
Apportionable to Ohio
First, the petitioner contends that the treble damages and post-judgment interest it received
in 2003 do not meet Ohio’s definition of apportionable business income.
A. Ohio Business and Nonbusiness Income Defined
A pass-through entity electing to file a composite income tax return under R.C.
5747.08(D)(1)(a) is required to calculate and include in the return the distributive shares of the
participating investors as calculated under R.C. 5747.20 through R.C. 5747.231. Pursuant to
R.C. 5747.21(B), a non-resident taxpayer having business activity in Ohio must apportion all
items of business income or deduction to the state. Nonetheless, a non-resident taxpayer is not
required to allocate certain nonbusiness income or deductions to Ohio per R.C. 5747.20(B). R.C.
5747.01 classifies business and nonbusiness income by providing:
(B) “Business income” means income, including gain or loss, arising from transactions,
activities, and sources in the regular course of a trade or business and 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.
(C) “Nonbusiness income” means all income other than business income and may
include, but is not limited to, compensation, rents and royalties from real or tangible
personal property, capital gains, interest, dividends and distributions, patent or
copyright royalties, or lottery winnings, prizes, and awards.
Because nonbusiness income is defined as income not meeting the definition of business
income, the petitioner’s treble damages and post-judgment interest must be presumed to be
business income under R.C. 5747.01(B) unless the petitioner rebuts this presumption. Here, the
petitioner’s explanation is insufficient to overcome this presumption.
The Ohio Supreme Court and Board of Tax Appeals have examined the use of the
“transactional” and “functional” tests to assess the validity of an income classification. These
tests were considered in cases where pass-through entities having non-resident shareholders
earned Ohio-sourced income. Kemppel v. Zaino (2001), 91 Ohio St. 3d 420, Francis Special
-3Risk, Inc. v. Zaino (Aug. 3, 2001), BTA No. 00-T-74, unreported. Therefore, the income of an S
corporation having non-resident shareholders is business income apportionable to Ohio if it
meets the parameters of either test.
B. Treble Damages & Post-Judgment Interest Are Business Income under the Transactional Test
Since the proceeds received from the petitioner’s lawsuit satisfy the transactional test, they
are classified as business income under R.C. 5747.01(B). The transactional test considers
whether the income arises from a transaction or activity that occurs in the ordinary course of the
taxpayer’s business. Income satisfies this test if it arises from a transaction or activity that
occurs frequently and regularly in the operations of the taxpayer’s business. The taxpayer’s
subsequent use of the income is a relevant factor as well.2 Thus, the test may also be met if the
funds are used to foster the taxpayer’s business operations. Kemppel, supra.
In this case, the petitioner’s treble damages and post-judgment interest resulted from
activities involving the sale of smokeless tobacco products that occurred in the ordinary course
of the petitioner’s business. The petitioner’s primary business activity is the sale of moist snuff
tobacco. As of 2006, the petitioner was the second largest smokeless tobacco manufacturer in
the US. 2006 Form 10K Annual Report, page 3. Moist snuff accounted for 75% of the
petitioner’s revenue and was “the key driver” to the petitioner’s “overall growth and profitability
within the U.S. smokeless tobacco market.” Id at 8. Hence, the petitioner frequently and
regularly sold moist snuff tobacco products in its interstate business during the period leading up
to receipt of its award and beyond.
The source of the petitioner’s treble damages and post-judgment interest was a court
judgment resulting from an antitrust dispute concerning the petitioner’s primary business
activity. The dispute arose over the unlawful sale of moist snuff tobacco by the petitioner’s
competitor. Even without unfair practices, competition in the smokeless tobacco industry was
already “significant.” Id. As acknowledged by the petitioner, it initiated the lawsuit to prevent
the loss of its moist snuff tobacco market share and to protect the crux of its business. Petition
for Reassessment p. 2. The petitioner concedes that the compensatory damages were properly
included in the petitioner’s business income and subject to apportionment since they were, “a
substitution for lost profits.” Petition for Reassessment p. 1. Nevertheless, the petitioner asserts
that the treble damages (and resulting interest) are not apportionable business income because
they were issued by the jury to deter anticompetitive behavior and did not compensate the
petitioner for a loss in market share. Id at 2. Hence, it contends that the punitive nature of the
treble damages deems them (and the resulting interest) unrelated to the petitioner’s primary
business activities.
2
The Ohio Supreme Court acknowledged that some courts also consider under the transactional test whether the
proceeds of the transaction are used in the taxpayer’s business or dispersed to shareholders. Kemppel, supra (citing
Union Carbide Corp. v. Huddleston (Tenn. 1993), 854 S.W.2d 87, 93).
-4However, the jury’s purpose or intent in granting the award is irrelevant to the discussion of
its source, which is at the heart of the transactional test. Instead, this case hinges upon whether
the treble damages and interest “arose” from transactions or activities occurring frequently and
regularly in the petitioner’s business. If the petitioner’s primary business was not the sale of
moist snuff tobacco, it would likely not have initiated the action or been awarded the treble
damages and interest. But for the anti-trust violation, the interstate sales of the petitioner’s
competitor would have been the interstate sales of the petitioner and the treble damages would
not have been issued to the petitioner. Thus, the damages arose from the same transactions and
sources as the compensatory damages, and the true source of these funds was the petitioner’s
primary business activities. Consistent with this analysis is the manner in which the
compensatory and treble damages were actually calculated. Compensatory damages are defined
as damages “sufficient in amount to indemnify the injured person for the loss suffered.” Black’s
Law Dictionary, (7 Rev.Ed. 1999) 394. Treble Damages are typically calculated using a multiple
of the amount of compensatory damages. Id at 397. Here, the petitioner was awarded treble
damages as a result of the loss it sustained. This loss was calculable only by examining the
actual moist snuff tobacco sales of the petitioner and its competitor. The $350 million
compensatory award is an estimate of the dollar amount of “lost profits” that the petitioner would
have generated through its primary business activities but for the antitrust violation. The
petitioner’s treble damages of $700 million (and resulting post-judgment interest of $195
million) were numerically derived from the compensatory damages using a multiple of two.3
These facts confirm that the disputed income arose both factually and numerically from
transactions (snuff tobacco sales) occurring frequently and regularly in the petitioner’s business.
Therefore, characterizing the treble damages and interest as business income was proper.
Likewise, the frequency of the petitioner’s involvement in law suits arguably makes
litigation itself an activity that is ordinary in the course of the petitioner’s business. On February
2, 2007, 1,271 tobacco-related cases were pending in the U.S. against the petitioner’s parent
company or its parent’s affiliates or indemnitees. 2006 Form 10K Annual Report, page 27. As
of February 2, 2007, 6 of these cases involved antitrust litigation like the one at issue. Id at 28.
On February 2, 2007, the petitioner itself was a defendant in 9 actions brought by individual
plaintiffs in West Virginia and Florida courts in connection with the petitioner’s smokeless
tobacco products. Id at 58. These plaintiffs sought damages for the negative health affects they
experienced allegedly as a result of using the petitioner’s products. Id. Such statistics reveal that
litigation is a customary and unavoidable component of the petitioner’s business. In fact, the
petitioner and its parent company anticipate that these actions will be a normal part of their
business as a going concern. According to the petitioner’s annual report, “It is likely that similar
legal actions, proceedings and claims … will continue to be filed against [the petitioner’s parent
company] or its affiliates and indemnitees and other tobacco companies for the foreseeable
future.” Id at 12. Specifically, it foresees being, “subject to substantial liabilities from tobaccorelated antitrust lawsuits.” Id at 15. In the petitioner’s line of business, litigation is an industry
norm. Since the damages and interest at issue were awarded as a result of litigious activity,
3
$350 Million multiplied by 2 amounts to $700 Million.
-5which occurs frequently and regularly in the petitioner’s business, the transactional test has been
satisfied.
In further satisfaction of the transactional test, the petitioner may have utilized the treble
damages and post-judgment interest income to support its business operations. The petitioner
has provided no evidence as to how the income was actually utilized. Nothing in the petitioner’s
argument suggests that the petitioner did not use at least a portion of the funds to operate its
interstate business, of which Ohio is a significant part. Therefore, the petitioner has failed to
show that its treble damages and post-judgment interest are nonbusiness income allocated
outside Ohio.
III. Ohio Properly Excluded The Treble Damages & Post Judgment Interest From The
Petitioner’s Sales Factor
The petitioner contends that to the extent the treble damages and post judgment interest are
included as business income in the petitioner’s 2003 apportionable base, they should also be
included in the denominator of the petitioner’s sales factor.
A. Business Income Classification Is Not Determinative of Sales Factor Inclusion
Pursuant to R.C. 5747.21(B), all items of business income and deduction generated by a
pass-through entity are apportioned to Ohio by multiplying adjusted gross income by the fraction
calculated under R.C. 5733.05(B)(2) and R.C. 5733.057 as if the taxpayer’s business were a
corporation subject to the franchise tax. The numerator of this fraction is determined using a
three factor formula consisting of property, payroll, and sales factors. The sales factor is a
fraction computed in accordance with R.C. 5733.05(B)(2)(c). The numerator of the fraction is
the total sales by the corporation in Ohio, and the denominator of the fraction is the total sales by
the corporation everywhere during the taxable year. R.C. 5733.05(B)(2) states that the sales
factor does not include the portion of sales otherwise includible in the factor “to the extent that
the portion relates to, or is used in connection with, the production of nonbusiness income
allocated...” However, the portion of sales related to or used in connection with the production
of apportionable business income may or may not be included in the sales factor. R.C.
5733.05(B)(2)(c) specifically excludes certain types of “receipts” from the numerator and
denominator of the fraction. As noted by R.C. 5733.05(B)(2)(c)(iii), these items are not
presumed to be nonbusiness income solely by virtue of their exclusion from the fraction. These
items may in fact be apportionable business income, but are nonetheless eliminated from it.
Hence, a clear tenor of Ohio law is that the business income character of an item or its inclusion
in the apportionable base is not determinative of its inclusion in the sales factor.
B. The Treble Damages and Post-Judgment Interest are Not Includable in the Sales Factor
Nothing in Ohio law suggests that damages and post-judgment interest are includable in the
sales factor. In fact, Ohio law expressly excludes the petitioner’s post-judgment interest from the
sales factor. R.C. 5733.05(B)(2)(c) provides:
-6-
In computing the numerator and denominator of the fraction, the following shall
be eliminated from the fraction: receipts and any related gains or losses from the
sale or other disposal of excluded assets; dividends or distributions; and interest
or other similar amounts received for the use of, or for the forbearance of the use
of, money. [emphasis added]. See also Incom International, Inc. v. Limbach (Jan.
11, 1988), BTA No. 84-D-1149.
Furthermore, the petitioner asserts in its petition that the treble damage proceeds and post
judgment interest are intangibles. Petition for Reassessment p. 5. It contends that the lawsuit
that gave rise to the proceeds is also an intangible. Id. Assuming the treble damages and interest
were income analogous to receipts incurred upon sale of intangible property as the petitioner
implies, such income is also statutorily excluded under 5733.05(B)(2)(c) from the sales factor.
R.C. 5733.05(B)(2)(c) provides:
As used in this division, "excluded assets" means property that is either:
intangible property, other than trademarks, trade names, patents, copyrights, and
similar intellectual property; or tangible personal property or real property where
that property is a capital asset or an asset described in section 1231 of the Internal
Revenue Code, without regard to the holding period specified therein. [emphasis
added].
The petitioner’s characterization of the treble damages and interest as intangibles therefore
places them in the category of “excluded assets”, the receipts from which are eliminated from the
fraction under the foregoing statute.
Many states have likewise adopted the theme of excluding damages and post-judgment
interest from the sales factor or a slightly modified version of the same. As applicable to Article
IV of the Multistate Tax Compact and to the Uniform Division of Income for Tax Purposes Act
(‘UDITPA’), the Multistate Tax Commission4 promulgated allocation and apportionment
regulations in 1973. These regulations were developed with the intention of streamlining state
tax laws and were adopted by several states.5 Regulation IV.15.(a).(1) states that “…for the
purposes of the sales factor of the apportionment formula…the term ‘sales’ means all gross
receipts derived by the taxpayer…” “Gross receipts” are defined under Regulation IV.2.(a).(5)
as “gross amounts realized (the sum of money and the fair market value of other property or
services received) on the sale or exchange of property, the performance of services, or the use of
property or capital (including rents, royalties, interest and dividends) in a transaction…in
which…income or loss is recognized…under the Internal Revenue Code.” Regulation
IV.2.(a).(5)(4) also expressly states that “Gross receipts”, even if business income, do not include
“damages and other amounts received as the result of litigation.” Hence, both the plain language
4
“The Multistate Tax Commission is an intergovernmental state tax agency working on behalf of states and
taxpayers to administer, equitably and efficiently, tax laws that apply to multistate and multinational enterprises.”
http://www.mtc.gov/About.aspx?id=40.
5
Although Ohio has not adopted UDITPA, its law is similar in many respects to those found in the regulations.
-7of the Ohio statute and these provisions compel a finding against the inclusion of the treble
damages and post-judgment interest in the 2003 sales factor, even though they are deemed
business income.
C. The Petitioner is Not Entitled to Use of An Alternative Method of Apportionment
To the extent the treble damages and post judgment interest are included in the petitioner’s
apportionable income, the petitioner requests relief by use of an alternative apportionment
method under R.C. 5733.05(B)(2)(d), which provides:
If the allocation and apportionment provisions of division (B) of this section do
not fairly represent the extent of the taxpayer’s business activity in this state, the
taxpayer may request, which request must be in writing and must accompany the
report, a timely filed petition for reassessment, or a timely filed amended report,
or the tax commissioner may require, in respect to all or any part of the taxpayer’s
allocated or apportioned base, if reasonable, any one or more of the following: (i)
Separate accounting; (ii) The exclusion of any one or more of the factors; (iii) The
inclusion of one or more additional factors that will fairly represent the taxpayer’s
allocated or apportioned base in this state. An alternative method will be effective
only with approval by the tax commissioner. See Gatx Corp. v. Limbach, 21 Ohio
App. 3d 59, 21 Ohio B. 63, 486 N.E.2d 840 (1984).
The foregoing language expressly requires approval by the tax commissioner before an
alternative apportionment method is permitted. Given the nature of the petitioner’s awards and
their legally supported exclusion from the sales factor, the statutory apportionment formula
“fairly represents” the petitioner’s business activities in Ohio. Any deviation from the statutory
model would not be “reasonable.” Moreover, the petitioner has failed to submit information with
its petition that would suggest otherwise. Hence, the petitioner has not carried its burden of
showing that it is entitled to the requested relief.
IV. Ohio Constitutionally Apportioned the Treble Damages & Post-Judgment Interest
Next, the petitioner contends that Ohio has violated the Due Process and Commerce Clauses
of the United States Constitution by apportioning the treble damages and post-judgment interest
and not including them in the denominator of the petitioner’s sales factor. The Tax
Commissioner is without jurisdiction to decide these constitutional issues. See Cleveland Gear
Co. v. Limbach (1988), 35 Ohio St. 3d 229. Nonetheless, the laws of the State of Ohio are
presumed to be constitutional. See State, ex rel. Swetland v. Kinney (1982), 69 Ohio St.2d 567.
Therefore, the audit adjustments pursuant to R.C. 5747.21(B) and R.C. 5747.01(B) were proper.
V. Assessment Adjusted Due To IRS Audit
Subsequent to the Department’s audit, the petitioner’s 2005 ordinary income from trade or
business activities was adjusted as a result of an IRS audit. This change was reported to Ohio by
-8the IRS under authorization of Section 6103(d) of the Internal Revenue Code.6 The petitioner’s
2005 tax liability and interest are hereby adjusted to reflect this change.
Accordingly, the assessment is affirmed with respect to years 2003 and 2006 and is adjusted
with respect to year 2005 as follows:
Period
2003
2005
2006
Total
Tax
$1,486,503.00
$ 26,136.00
$ 95,729.00
$1,608,368.00
Interest
$408,829.00
$ 4,679.00
$ 10,833.00
$424,341.00
Penalty
$
0.00
$
0.00
$4,786.00
$4,786.00
Late Payment Penalty
$222,975.00
$
0.00
$
0.00
$222,975.00
Total
$2,118,307.00
$ 30,815.00
$ 111,348.00
$2,260,470.00
Current records indicate that a payment of $1,502.00 has been applied on this assessment as
paid with the petitioner’s 2005 amended filing, leaving a balance due of $2,258,968.00.
However, due to payment processing and posting time lags, payments may have been made that
are not reflected in this final determination. Any unpaid balance bears post-assessment
interest as provided by law, which is in addition to the above total. Payments shall be made
payable to “Ohio Treasurer Josh Mandel.” Any payment made within sixty days of the date of
this final determination should be forwarded to: Department of Taxation, Compliance Division,
P.O. Box 1090, Columbus, Ohio 43216-1090.
THIS IS THE TAX COMMISSIONER'S FINAL DETERMINATION WITH REGARD TO
THIS MATTER. UPON EXPIRATION OF THE SIXTY-DAY APPEAL PERIOD
PRESCRIBED BY R.C. 5717.02, THIS MATTER WILL BE CONCLUDED AND THE FILE
APPROPRIATELY CLOSED.
Joseph W. Testa
Tax Commissioner
6
There is no further pending action before the Internal Revenue Service pertaining to this taxpayer for this tax year.
The assessment by the Internal Revenue Service has been finally determined.
Ohio IT 2023
Instructions for Allocating
and Apportioning Income
Solely for Purposes of
Computing the Nonresident
Credit and the Part-Year
Resident Credit for
Individuals and Estates
Rev. 12/12
hio
tax.
Department of
Taxation
hio.gov
IT 2023
Rev. 12/12
Ohio form IT 2023 is solely for use in determining the numerator of the fraction used to calculate
the nonresident or part-year resident tax credit available for individuals and estates.
See Ohio Revised Code sections (R.C.) 5747.20 through 5747.231.
Do not use this form to compute Ohio adjusted gross income.
The form and instructions apply to nonresidents who have business
and/or nonbusiness income within and without Ohio. Use Ohio form
IT 2023 solely for determining the numerator of the fraction used to
calculate the nonresident tax credit. If your only source of Ohio
income is wages paid by an unrelated employer, you do not
have to use this form.
Ohio apportionment ratio, which is the sum of the property, payroll
and sales factors (please refer to the Part III business income
worksheet on page 2 of Ohio form IT 2023). Please note that the
net business income consists only of those items of income and
deduction included in Ohio adjusted gross income (Ohio form IT
1040, line 3) or Ohio taxable income (Ohio form IT 1041, line 3).
Each factor is weighted: The property and payroll factors are
weighted at 20% each and the sales factor at 60%, for a total of
100%. If any factor has a denominator (total everywhere figure) of
zero, the weight given to the other factors must be proportionately
increased so that the total weight given to the combined factors is
100%. For example: If the business entity has no payroll everywhere,
then the property and sales factors are weighted at 25% and 75%,
respectively, to total 100%.
If you are participating in the filing of Ohio form IT 4708 and
your only source of Ohio income/loss is from this entity, you
cannot file an Ohio form IT 1040 or an Ohio form IT 1041, and
you do not need to complete Ohio form IT 2023. See Ohio
Business Tax Division Alert dated Aug. 10, 2011. If you are an
investor in a pass-through entity that is a financial institution (as
defined in R.C. 5725.01), see “Special Rule for Investments in
Financial Institutions” on page 3.
Nonbusiness income and deductions, if any, are allocable only
as provided by R.C. 5747.20 and 5747.221. However, in general,
all pass-through entity income and gain is business income,
which, in accordance with R.C. 5747.21, is apportioned rather
than allocated.
Important: This form assumes that the taxpayer has either (i) a
distributive share of income/gain from only one pass-through entity
or (ii) distributive shares of income/gain from more than one passthrough entity that are unitary with each other (under Ohio law,
pass-through entites include sole proprietorships).
R.C. 5747.22(B) and (C)
Apportionment and Allocation of Income and
Deductions of Pass-Through Entities
Trusts should not use this form. Instead, trusts should complete Schedules F, G, H and I on Ohio form IT 1041.
Note: All net income shown on page 1 of the federal 1040 return
must be shown on the Ohio IT 2023 worksheet.
Apportionment of Pass-Through Entity Business
Income and Deductions for Purposes of the Nonresident
Credit and the Part-Year Resident Credit
With respect to a pass-through entity where one or more of the
nonresident or part-year resident investors are subject to the Ohio
income tax, the business income and deductions of the pass-through
entity shall be apportioned to Ohio in the hands of the pass-through
entity according to the instructions for apportioning business income.
Such business income and deductions thus apportioned to Ohio are
then allocated to the investors in proportion to their right to share
in such business income.
Definitions
Business Income and Nonbusiness Income
“Business income” means income, including gain or loss, arising
from transactions, activities and sources in the regular course of
a trade or business and includes income from real, tangible, 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. Also, “business income” consists
of 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. R.C. 5747.01(B)
Allocation of Pass-Through Entity Nonbusiness Income and
Deductions for Purposes of the Nonresident Credit and the
Part-Year Resident Credit
With respect to a pass-through entity where one or more of the
nonresident or part-year resident investors are subject to the
Ohio income tax, the nonbusiness income and deductions of the
pass-through entity shall be allocated to the investors in proportion to their right to share in such nonbusiness income. Then
such pass-through entity shares of nonbusiness income shall be
allocated within and without this state in the hands of the investors
according to the instructions, below, for allocating nonbusiness
income by individuals.
In general, income, deductions, gains and losses recognized by a sole
proprietorship or a pass-through entity are items of business income
that the nonresident and part-year resident taxpayer must apportion
(rather than allocate) using Part II on page 2 of Ohio form IT 2023.
“Nonbusiness income” means all income other than business income and may include, but is not limited to, compensation, rents
and royalties from real or tangible personal property, capital gains,
interest, dividends, distributions, patent or copyright royalties, and
lottery winnings, prizes and awards, R.C. 5747.01(C). Show nonbusiness income, if any, in Part IV on page 3 of Ohio form IT 2023.
R.C. 5747.23(A) and (B)
Taxation of Trust Income Received by Beneficiaries
for Purposes of the Nonresident Credit
R.C. 5747.20, .21 and .221
Allocation of Nonbusiness Income or Deduction;
Apportionment of Business Income or Deductions;
and Items and Deductions Not to Be Allocated or
Apportioned for Purposes of the Nonresident Tax Credit
Apportionment of Trust Business Income and Deductions
With respect to each estate and each trust where one or more of
the beneficiaries are subject to the Ohio income tax, the trust’s
business income (net of deductions) received by such beneficiaries
shall be apportioned to Ohio in the hands of the trust according to
the above instructions for apportioning business income by indi-
The amount of business income and deductions apportioned to
Ohio is determined by multiplying the net business income by an
-1-
IT 2023
Rev. 12/12
viduals. Such trust business income and deductions shall then be
allocated to such beneficiaries in proportion to their right to share
in the business income of such trust to the extent of the distribution
made to such beneficiary.
For ease of administration, part-year resident taxpayers investing
in pass-through entities having no nexus with Ohio can, for the
portion of the taxable year during which the individual was not an
Ohio resident, apportion/allocate outside Ohio such items by using
a daily or monthly pro-rata factor. If the tax commissioner examines
the tax return and determines that an “actual, year-to-date” method
more accurately reflects the tax due and, if as a result of that
determination, the taxpayer owes more tax (and interest on the tax)
the tax commissioner will not impose any failure to pay penalty or
interest penalty with respect to that increased tax.
Allocation of Trust Nonbusiness Income and Deductions for
Purposes of the Nonresident Credit
With respect to each estate and each trust where one or more of
the nonresident or part-year resident beneficiaries are subject to
the Ohio income tax, the trust’s nonbusiness income (net of deductions) received by such beneficiaries shall be allocated to such
beneficiaries in proportion to their right to share in such income (net
of deductions) of the trust. Then the share of nonbusiness income
shall be allocated to Ohio in the hands of such beneficiary pursuant
to R.C. 5747.20. The beneficiary is subject to Ohio income tax for
the taxable year in which such beneficiary recognizes income with
respect to trust distributions.
The following example illustrates the application of this requirement:
A taxpayer is a resident of Ohio for only the last five months of the
taxable year. During the entire taxable year the taxpayer was an
equity investor in a pass-through entity having no nexus with Ohio.
The pass-through entity’s business operations result in a significant
portion of the profit being earned during November and December
of each year. The individual’s distributive share of profit from the
pass-through entity was $12,000 for the taxable year.
Part-year Residents
For the portion of the taxable year that the taxpayer was not a
resident of Ohio, the taxpayer should allocate entirely outside Ohio
the taxpayer’s non-Ohio wages paid either (i) by any unrelated party
or (ii) by a related party C corporation. For purposes of this form,
“non-Ohio wages” are those wages which the taxpayer earned and
received for services performed outside Ohio while a nonresident.
For ease of tax compliance, the taxpayer can compute the partyear credit by assuming that $7,000 of the taxpayer’s distributive
share of income was earned during the seven-month period prior
to the taxpayer becoming a resident of Ohio: 7/12 X $12,000. Upon
examination of the taxpayer’s tax return, the tax commissioner
ascertains that $9,600 of the taxpayer’s $12,000 distributive share
was earned on and after Aug. 1, the date on which the taxpayer
became a resident of Ohio. As such, the tax commissioner will
recompute and reduce the nonresident credit by allocating outside
Ohio only $2,400 (recall that the pass-through entity has no nexus
with Ohio). As a result, the taxpayer will owe additional Ohio income
tax and related interest, but the tax commissioner will not impose
any failure-to-pay penalty on that tax due or related interest penalty.
For the portion of the taxable year that the taxpayer was not a
resident of Ohio, the taxpayer should also allocate entirely outside
Ohio (i) items of nonbusiness income (defined below) not allocated
to Ohio and (ii) all items of income, gain, expenses and losses if
such items do not represent items of business income (defined at
right) which are apportioned in and out of Ohio.
Examples of nonbusiness income amounts entirely allocated outside
Ohio for the portion of the year during which the taxpayer was a
nonresident include the following: interest income, dividend income,
and gains (losses) from the sale, exchange, or other disposition of
assets not having an Ohio situs. Examples of nonbusiness income
that the individual must entirely allocate to Ohio – even for the
portion of the year during which the individual was not a resident of
Ohio – include the following: (i) gain (loss) from the sale, exchange
or other disposition of Ohio real estate and prizes and (ii) awards
that the individual receives from the Ohio Lottery Commission.
Business Income
(Part II, Part A)
Line 1 – Compensation Received from a Pass-Through Entity
With respect to the guaranteed payments and/or compensation
received by pass-through entities (S corporations, partnerships,
limited liability companies treated as partnerships for income tax
purposes, etc.) the “reciprocity agreements” between Ohio and
neighboring states do not apply to those nonresidents directly
or indirectly owning at least 20% of the stock or other equity
of the pass-through entity. That is, these nonresidents cannot
use the “reciprocity agreements” in order to deduct, as non-Ohio
income, any guaranteed payments or compensation received from
such pass-through entities. Rather, the guaranteed payments or
compensation are included in Ohio taxable income and are treated
as business income which is subject to apportionment for purposes
of computing the individual’s nonresident credit. R.C. 5733.40(A)(7)
Examples of business income amounts that a part-year resident
must apportion in and out of the state – even for the portion of the
year during which the individual was not a resident of Ohio – include
the following: (i) wages and guaranteed payments that the taxpayer
receives from a related member pass-through entity having nexus
with Ohio (see Ohio form IT 2023, page 2, Part II, A, line 1), (ii)
distributive shares of income from each pass-through entity having
nexus with Ohio, and (iii) the profit from a sole proprietorship having
nexus with Ohio.
Line 2 – Related Member Add-back
R.C. 5733.042(A)(6) and 5733.04(P) disallow expenses and losses
incurred in connection with all direct and indirect transactions between each pass-through entity and its related members. As such,
you must add back on Part II, line 1 your distributive/proportionate
share of such expenses and losses. However, do not add (i) amounts
shown on line 1 or (ii) expenses or losses incurred in connection
with sales of inventory to the extent that the cost of the inventory
and the loss incurred were calculated in accordance with Internal
Revenue Code sections (I.R.C.) 263A and 482.
Pro-rating Amounts Recognized by a Part-Year Resident
Part-year nonresidents and full-year nonresidents use the same
methods to apportion and allocate within and without Ohio the
following: (i) those items of nonbusiness income, gain, expenses,
and losses sitused to Ohio and (ii) those items of business income,
gain, expenses, and losses from pass-through entities having nexus
with Ohio (with respect to items not described above, the taxpayer
should apportion/allocate entirely outside Ohio those amounts
recognized or incurred during the year or during the portion of the
year that the taxpayer was a nonresident).
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IT 2023
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Line 6 – Depreciation Adjustments
For tax years 2012 and thereafter, add 2/3, 5/6, or 6/6 of the I.R.C.
168(k) bonus depreciation claimed under the I.R.C. Also add 2/3,
5/6, or 6/6 of the excess of the I.R.C. 179 depreciation expense
claimed under the I.R.C. over the amount of the I.R.C. 179 depreciation expense that would have been allowed based upon I.R.C. 179
in effect on Dec. 31, 2002. See ORC 5747.01(A)(20) as amended
by the 129th General Assembly in HB 365 and information releases
2002-02 and 2002-01 regarding Ohio bonus depreciation adjustments available on our Web site at tax.ohio.gov. These releases
were originally posted on July 31, 2002 and Nov. 7, 2002.
Deductions From Business Income (Part II, Part B)
Line 9b – Depreciation Adjustments
Deduct 1/2, 1/5 or 1/6th of the I.R.C. 168(k) and 179 depreciation
adjustments you added back on each of your last two, five or six
years’ Ohio income tax returns. You can take this deduction even
if you no longer directly or indirectly own the asset. See ORC
5747.01(A)(21) as amended by the 129th General Assembly in
HB 365 and information releases 2002-02 and 2002-01 regarding
Ohio bonus depreciation adjustments available on our Web site at
tax.ohio.gov. These releases were originally posted on July 31,
2002 and Nov. 7, 2002.
Under I.R.C. 179, as that section existed on Dec. 31, 2002, the
maximum amount that could be expensed was $25,000, and the
phase-out began once the cost of purchases of I.R.C. 179 property
during the year exceeded $200,000. So, under the prior law the
taxpayer could not claim any I.R.C. 179 expense if the taxpayer’s
purchases during the year of I.R.C. 179 property, as defined on
Dec. 31, 2002, were $225,000 or more.
Line 9d – Miscellaneous Federal Income Tax Adjustments
Because of a recent amendment to R.C. section 5701.11, there are
no miscellaneous federal tax adjustments on this return. See Sub.
House Bill 58, 129th General Assembly. However, you must make
all other required adjustments for this line.
Net Business Income, Apportionment (Part II, Part C)
This “add-back and subsequent deduction” law also covers (i)
depreciable assets acquired by the taxpayer’s disregarded entities
and (ii) depreciable assets that are owned by pass-through entities
in which the taxpayer directly or indirectly owns at least 5% (see
R.C. 5747.01(A)(20)(a)).
Line 11 – Gain Described in R.C. 5747.212
Each nonresident taxpayer who sells, exchanges or otherwise disposes of his/her direct or indirect interest in a closely held business
having property, payroll and/or sales in Ohio must situs to Ohio a
portion of the gain (loss) recognized from that sale, exchange or
other disposition. For additional information, see R.C. 5747.212.
In addition, the pass-through entity can defer making all or some of
the add-back under the following circumstances:
Apportionment Formula for Business Income (Part III)
Note: When calculating the fraction used to compute the nonresident credit, a taxpayer who has invested in a partnership, an
S corporation or a limited liability company treated as a partnership for federal income tax purposes must apply the “aggregate”
(conduit) theory of taxation. That is, the character of all income and
deductions (and adjustments to income and deductions) realized
by a pass-through entity in which the taxpayer has invested retains
that character when recognized by the taxpayer. Furthermore, the
taxpayer’s factors must include the proportionate share of each
lower-tiered pass-through entity’s property, payroll and sales. See
R.C. 5733.057 and 5747.231.
(i) the pass-through equity is an equity investor in another
pass-through entity that has generated I.R.C. 168(k) bonus
depreciation and/or I.R.C. 179 depreciation; and
(ii) because of either the federal passive activity loss limitation
rules or the federal at-risk limitation rules, this investor passthrough entity is unable to deduct fully a loss passing through
from the other pass-through entity to this investor pass-through
entity.
In such circumstances, to the extent that this investor passthrough entity does not deduct the loss passing through, this
investor pass-through entity can defer making the “2/3 or 5/6 addback” until the taxable year or years for which this investor passthrough entity does deduct the investee pass-through entity’s loss
and does receive a federal tax benefit from the bonus depreciation
amount and/or the I.R.C. 179 amount generated by the investee
pass-through entity. Of course, this investor pass-through entity
cannot begin claiming the related two- or five-subsequent years
deduction until the first taxable year immediately following the
taxable year for which this investor pass-through entity makes
the 2/3 or 5/6 add-back.
Special Rule for Investments in Financial Institutions
With respect to distributive shares of income and gain that the
nonresident taxpayer recognizes on account of the nonresident
taxpayer’s direct or indirect equity investment in a financial
institution, as defined in R.C. 5725.01, do not use the standard
apportionment formula to apportion such income/gain. Instead,
apportion such income/gain by using the apportionment schedule
set forth in the Ohio form FT 1120FI, Ohio Corporation Franchise
Report for Financial Institutions. This form is available on our Web
site at tax.ohio.gov.
For detailed information and examples regarding this adjustment,
see ORC 5747.01(A)(20) as amended by the 129th General
assembly in HB 365 and the department’s information release
entitled “Recently Enacted Ohio Legislation Affects Depreciation
Deductions for Taxable Years Ending 2001 and Thereafter” by
visiting tax.ohio.gov. The department posted this release on July
31, 2002, and revised the release in July 2005 and June 2009.
Property Factor
The property factor is a fraction the numerator of which is the
average value of the sole proprietor’s or pass-through entity’s
includable real and tangible personal property owned or rented,
and used in the trade or business in this state during the taxable
year, and the denominator of which is the average value of all
the sole proprietor’s or pass-through entity’s includable real and
tangible personal property owned or rented, and used in the trade
or business everywhere during such year.
Line 7 – Miscellaneous Federal Income Tax Adjustments
Because of a recent amendment to R.C. section 5701.11, there are
no miscellaneous federal tax adjustments on this return. See Sub.
House Bill 58, 129th General Assembly. However, you must make
all other required adjustments for this line.
Ohio law includes in the property factor real property and tangible
personal property that the sole proprietor or pass-through entity
rents, subrents, leases or subleases to others if the income
or loss from such rentals, subrentals, leases or subleases is
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Rev. 12/12
Line 1(c) – Property Total Within Ohio and Everywhere
Add lines 1(a) and 1(b) for column 1 (within Ohio) and column 2
(total everywhere).
business income. Ohio law specifically excludes from the factor
all property relating to, or used in connection with, the production
of nonbusiness income allocated under R.C. 5733.051. Generally,
all sole proprietorship and pass-through entity income and gain is
business income.
Line 1(c), Column 3 – Property Ratio
Enter the ratio of property within Ohio to total everywhere by dividing
column 1 by column 2.
Property owned by the sole proprietor or pass-through entity
is valued at its original cost average value. Average value is
determined by adding the cost values at the beginning and at
the end of the taxable year and dividing the total by two. The tax
commissioner may require the use of monthly values during the
taxable year if such values more reasonably reflect the average
value of the sole proprietor’s or pass-through entity’s property.
Line 1(c), Column 5 – Weighted Property Ratio
Multiply the property ratio on line 1(c), column 3 by the property
factor weighting of 20%.
Payroll Factor
The payroll factor is a fraction, the numerator of which is the total
compensation paid in this state during the taxable year by the sole
proprietor or pass-through entity, and the denominator of which is the
total compensation paid both within and without this state during the
taxable year by the sole proprietor or pass-through entity. As used
below, the term “compensation” means any form of remuneration
paid to an employee for personal services.
Exclusions
Exclude from column 1 (within Ohio) and column 2 (total everywhere)
the following:
• Construction in progress.
• Property relating to, or used in connection with, the production
of nonbusiness income. See R.C. 5733.05(B)(2) as amended by
Amended Substitute House Bill 95, 125th General Assembly.
Exclusions
Exclude from column 1 (within Ohio) and column 2 (total everywhere)
the following:
• The numerator and the denominator of the property factor
includes real property and tangible personal property that the
sole proprietor or pass-through entity rents, subrents, leases
or subleases to others if the income or loss from such rentals,
subrentals, leases or subleases is business income. See R.C.
5733.05(B)(2)(a) as amended by Amended Substitute House Bill
95, 125th General Assembly. Property owned by the sole proprietor
or pass-through entity and leased to others is excluded from the
property factor only if the property generates nonbusiness income.
• Guaranteed payments made to partners;
• Compensation that the S corporation paid to any shareholder if
the shareholder directly or indirectly owned at least 20% of the
S corporation at any time during the year. R.C. 5733.40(A)(7);
• Compensation paid in Ohio to employees who are primarily
engaged in qualified research; AND
• The original cost of property within Ohio with respect to the
air pollution, noise pollution or industrial water pollution control
certificates issued by the state of Ohio. See R.C. 5733.05(B)(2)(a).
• Compensation paid to employees to the extent that the
compensation relates to the production of nonbusiness income
allocable under R.C 5733.051 (see R.C. 5733.05(B)(2)).
• The original cost of real property and tangible property (or in the
case of property that the sole proprietor or pass-through entity is
renting from others, eight times its net annual rental rate) within
Ohio that is used exclusively during the taxable year for qualified
research.
Do not include in column 1 but do include in column 2 compensation
paid in Ohio to certain specified new employees at an urban job
and enterprise zone facility for which the pass-through entity has
received a Tax Incentive Qualification Certificate issued by the Ohio
Development Services Agency.
Do not include in column 1 but do include in column 2 the original
cost of qualifying improvements to land or tangible personal property
in an enterprise zone for which the taxpayer holds a Tax Incentive
Qualification Certificate issued by the Ohio Development Services
Agency.
Line 2, Column 1 – Payroll Within Ohio
Enter the total amount of the sole proprietor’s or pass-through
entity’s compensation paid in Ohio during the taxable year.
Compensation is paid in Ohio if any of the following apply:
Line 1(a), Column 1 – Property Owned Within Ohio
Enter the average value of the sole proprietor’s or pass-through
entity’s real property and tangible personal property, including
leasehold improvements, owned and used in the trade or business
in Ohio during the taxable year.
• The recipient’s service is performed both within and outside
Ohio, but the service performed outside Ohio is incidental to the
recipient’s service within Ohio; OR
• The recipient’s service is performed entirely within Ohio; or
Line 1(a), Column 2 – Property Owned – Total Everywhere
Enter the average value of all the sole proprietor’s or pass-through
entity’s real property and tangible personal property, including
leasehold improvements, owned and used in the trade or business
everywhere during the taxable year.
• Some of the recipient’s service is performed within Ohio and
either the recipient’s base of operations, or if there is no base of
operations, the place from which the recipient’s service is directed
or controlled is within Ohio, or the base of operations or the place
from which the service is directed or controlled is not in any state
in which some part of the service is performed, but the recipient’s
residence is in Ohio.
Line 1(b) – Property Rented
Enter the value of the sole proprietor’s or pass-through entity’s real
property and tangible personal property rented and used in the
trade or business in Ohio (column 1) and everywhere (column 2)
during the taxable year. Property rented by the sole proprietor or
pass-through entity is valued at eight times the annual rental rate
(annual rental expense less subrental receipts).
Compensation is paid in Ohio to any employee of a common or
contract motor carrier corporation who performs his regularly
assigned duties on a motor vehicle in more than one state in
the same ratio by which the mileage traveled by such employee
within Ohio bears to the total mileage traveled by such employee
everywhere during the taxable year. The statutorily required mileage
ratio applies only to contract or common carriers. Thus, without
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IT 2023
Rev. 12/12
approval by the tax commissioner a manufacturer or merchant
who operates its own fleet of delivery trucks cannot use the ratio of
miles traveled in Ohio to miles traveled everywhere to situs driver
payroll. See Cooper Tire and Rubber Co. v. Limbach (1994), 70
Ohio St. 3d 347.
or other grant of the right to use trademarks, trade names, patents,
copyrights and similar intellectual property, (vi) receipt from the sale
of services and other receipts not expressly excluded from the factor.
These amounts are situsable to Ohio as set forth below.
Line 3, Column 1 – Sales Within Ohio
Enter the total of gross receipts from sales not excludable from the
numerator and the denominator of the sales factor, to the extent
the includable gross receipts reflect business done in Ohio. Sales
within Ohio include the following:
Line 2, Column 2 – Payroll Total Everywhere
Enter the total amount of the sole proprietor’s or pass-through
entity’s compensation paid everywhere during the taxable year.
Line 2, Column 3 – Payroll Ratio
Enter the ratio of payroll within Ohio to total everywhere by dividing
column 1 by column 2.
• Receipts from sales of tangible personal property, less
returns and allowances, received by the purchaser in Ohio.
In the case of delivery of tangible personal property by common
carrier or by other means of transportation, the place at which
such property is ultimately received after all transportation has
been completed is considered as the place at which such property
is received by the purchaser. Direct delivery in Ohio, other than
for purposes of transportation, to a person or firm designated
by a purchaser constitutes delivery to the purchaser in Ohio,
and direct delivery outside Ohio to a person or firm designated
by a purchaser does not constitute delivery to the purchaser in
Ohio, regardless of where title passes or other conditions of sale.
Customer pick-up sales are situsable to the final destination after
all transportation (including customer transportation) has been
completed. See Dupps Co. v. Lindley (1980), 62 Ohio St. 2d 305.
Line 2, Column 5 – Weighted Payroll Ratio
Multiply the property ratio on line 2, column 3 by the payroll factor
weighting of 20%.
Sales Factor
The sales factor is a fraction whose numerator is the sole proprietor’s
or pass-through entity’s includable business income receipts in Ohio
during the taxable year and whose denominator is the sum of the
sole proprietor’s or pass-through entity’s within Ohio and without
Ohio includable business income receipts during the taxable year.
The sales factor specifically excludes receipts attributable to
nonbusiness income allocable under R.C. 5733.051 (see R.C.
5733.05(B)(2) and the tax commissioner’s April 2004 information
release entitled “Sales Factor Situsing Revisions”).
Revenue from servicing, processing, or modifying tangible
personal property is sitused to the destination state as a sale of
tangible personal property. See Custom Deco, Inc. v. Limbach,
BTA Case No. 86-C-1024, June 2, 1989.
Exclusions
The following receipts are not includable in either the numerator or
the denominator of the sales factor even if the receipts arise from
transactions, activities and sources in the regular course of a trade
or business (see R.C. 5733.05(B)(2)(c) as amended by Substitute
House Bill 127, 125th General Assembly):
• Receipts from sales of real property inventory in Ohio.
• Rents and royalties from tangible personal property to the extent
the property was used in Ohio.
• Rents and royalties from real property located in Ohio.
• Interest or similar amounts received for the use of, or for the
forbearance of the use of, money;
• Receipts from the sale, exchange, disposition or other grant of
the right to use trademarks, trade names, patents, copyrights, and
similar intellectual property are sitused to Ohio to the extent that
the receipts are based on the amount of use of that property in
Ohio. If the receipts are not based on the amount of use of that
property, but rather on the right to use the property and the payor
has the right to use the property in Ohio, then the receipts from
the sale, exchange, disposition, or other grant of the right to use
such property are sitused to Ohio to the extent the receipts are
based on the right to use the property in Ohio.
• Dividends;
• Receipts and any related gains or losses from the sale or other
disposal of intangible property other than trademarks, trade
names, patents, copyrights and similar intellectual property;
• Receipts and any related gains and losses from the sale or other
disposal of tangible personal property or real property where that
property is a capital asset or an asset described in I.R.C. 1231.
For purposes of this provision the determination of whether or
not an asset is a capital asset or a 1231 asset is made without
regard to the holding period specified in the I.R.C.; AND
• Receipts from the performance of services and receipts from any
other sales not excluded from the sales factor and not otherwise
sitused within or without Ohio under the above situsing provisions
are situsable to Ohio in proportion to the purchaser’s benefit,
with respect to the sale, in Ohio to the purchaser’s benefit, with
respect to the sale, everywhere. The physical location where
the purchaser ultimately uses or receives the benefit of what
was purchased is paramount in determining the proportion of
the benefit in Ohio to the benefit everywhere. Note: For taxable
years ending on or after Dec. 11, 2003, the “cost of performance”
provision is no longer the law.
• Receipts from sales to (a) an at-least-80%-owned public utility
other than an electric company, combined electric company,
or telephone company, (b) an at-least-80%-owned insurance
company, or (c) an at-least-25%-owned financial institution.
Note: Income and gain from receipts excluded from the sales factor
is not presumed to be nonbusiness income. All income, gain, loss,
and expense is presumed to be apportionable business income
– even if the related receipts are excluded from the sales factor.
The law specifically includes in the sales factor the following amounts
when arising from transactions, activities and sources in the regular
course of a trade or business: (i) receipts from sales of tangible
personal property, (ii) receipts from the sale of real property inventory
(such as lots developed and sold by a real estate developer), (iii) rents
and royalties from tangible personal property, (iv) rents and royalties
from real property, (v) receipts from the sale, exchange, disposition
Line 3, Column 2 – Sales Everywhere
Enter the total of such includable gross receipts, less returns and
allowances, from sales everywhere.
Line 3, Column 3 – Sales Ratio
Enter the ratio of sales within Ohio to total everywhere by dividing
column 1 by column 2.
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IT 2023
Rev. 12/12
Line 3, Column 5 – Weighted Sales Ratio
Multiply the sales ratio on line 3, column 3 by the sales factor
weighting of 60%.
and concepts set forth on page 2 of the instructions, Part II, Part
A, line 6.
With respect to miscellaneous federal tax adjustments relating to
nonbusiness income, if any, add back any that was not included in
federal adjusted gross income. Follow the principles and concepts
set forth on page 3, Part II, Part A, line 7.
Line 4, Column 5 – Total Weighted Apportionment Ratio (add
column (5), lines 1 (c), 2 and 3).
Nonbusiness Income and Deductions (Part IV)
Line 14
With respect to depreciation expenses relating to nonbusiness
income, if any, deduct 1/2, 1/5 or 1/6 of the nonbusiness depreciation
add-back made for each of the previous two, five or six taxable
years. Follow the principles and concepts set forth on page 3 of
the instructions, Part II, Part B, line 9b.
Note: Generally, all sole proprietorship and pass-through entity
income and gain is business income.
Line 6
Each nonresident taxpayer who sells, exchanges or otherwise
disposes of his/her direct or indirect interest in a closely held
business having property, payroll and/or sales in Ohio must situs to
Ohio a portion of the gain (loss) recognized from the sale, exchange
or other disposition. For additional information, see R.C. 5747.212.
Miscellaneous Federal Income Tax Adjustments
With respect to miscellaneous federal tax adjustments relating to
nonbusiness income, if any, deduct any that was included in federal
adjusted gross income. Follow the principles and concepts set forth
on page 3 of the instructions for Part II, Part B, line 9d.
Line 7
With respect to depreciation expenses relating to nonbusiness
income, if any, add back excess depreciation. Follow the principles
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IT 2023
Rev. 12/12
Summary of Ohio Tax Treatment of Income and Deductions
Note: Except for lottery prizes and awards, all income and gain is presumed to be business income/gain.
Type of Income and Deductions
Ohio Tax Treatment
1. Guaranteed payments and compensation paid to an individual for
services performed
Allocate to Ohio to the extent earned in Ohio. However, if the individual directly or indirectly
owns at least 20% of the business, the individual must show the guaranteed payments and
compensation on Part II, A, line 1.
2. Gains or losses from the sale or
transfer of real property
Apportion if gain constitutes business income; otherwise, allocate to Ohio if the property is
physically located in Ohio.
3. Gains or losses from the sale or
transfer of tangible personal property
Apportion if gain constitutes business income. Nonbusiness gains and losses are allocated to
Ohio if the property is physically located in Ohio.
4. Gains or losses from the sale or
transfer of intangible personal
property
Apportion if gain or loss constitutes business income. If the gain or loss is from the sale, exchange
or other disposition of a closely held business, special apportionment provisions apply. See
R.C. 5747.212. All other nonbusiness gains and losses are allocated to Ohio if the nonresident
was domiciled in Ohio at the time of sale or transfer.
5. Rents or royalties from real property
Apportion if gain constitutes business income; otherwise allocate to Ohio if the property is
physically located in Ohio.
6. Rents or royalties from tangible
personal property
Apportion if the rents or royalties constitute business income; otherwise, allocate to Ohio to the
extent the property is used in Ohio. Extent the property is used in Ohio =
Number of days of physical location of property in Ohio
during rental or royalty periods in the taxable year
Number of days of physical location of property everywhere
during all rental or royalty periods in the taxable year.
If the physical location of the property during the rental or royalty period is unknown or unascertainable by the nonresident, and if the rents and royalties do not constitute business income,
tangible personal property is used in the state in which the property was located at the time the
rental or royalty payor obtained possession.
Apportion if the rents or royalties constitute business income; otherwise, allocate to Ohio to the
extent used by the payor in Ohio.
7. Patent and copyright royalties
• A patent is used in Ohio to the extent it is employed in production, fabrication, manufacturing
or other processing in Ohio or to the extent that a patented product is produced in Ohio. If
the basis of receipts or accounting procedures do not reflect this, then the patent is used in
Ohio if the business has its commercial domicile in Ohio.
• A copyright is used in Ohio to the extent that printing or other publication originates in Ohio.
If the basis of receipts or accounting procedures do not reflect this, then the copyright is
used in Ohio if the business had its commercial domicile in Ohio.
8. Lottery prize awards
Allocate to Ohio if the award was paid by the Ohio State Lottery Commission.
9. Depreciation expense add-back/
deduction
If the depreciation relates to nonbusiness property, the 1/2, 5/6 or 6/6 add-back and corresponding 1/2, 1/5 or 1/6 deductions are allocated as items of nonbusiness income and deductions
using the Part IV nonbusiness income worksheet. Otherwise, these depreciation adjustments
are apportioned as items of business income and deduction using the Part II business income
worksheet.
Federal Privacy Act Notice
Because we require you to provide us with a social security account number, the Federal Privacy Act of 1974 requires us to
inform you that your providing us your Social Security number
is mandatory. Ohio Revised Code sections 5703.05, 5703.057
and 5747.08 authorize us to request this information. We need
your Social Security number in order to administer this tax.
-7-
Exhibit
100% of a resident S Corporation shareholder’s distributive share is subject to city
resident income tax for the following municipalities:
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Jefferson Village
North Kingsville
Highland Hills
Lindale
North Randall
Richmond Heights
Walton Hills
Burton
Yellow Springs
Indian Hills
Wyoming
Liberty Village Center
Fairport Harbor
Painesville
Perry
Seville
Riverside
Peninsula
Bowling Green
Perrysburg
Source: Ray Turk, CPA
Exhibit
The following municipalities received a majority vote in November of 2004 allowing
each municipality to tax a resident S Corporation shareholder’s distributive share of
income on an Ohio-apportioned basis:
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Ashtabula County – Geneva on the Lake Village, Orwell Village
Auglaize County – Minster Village, New Bremen Village, New
Knoxville Village, St. Mary’s City
Columbiana County – Columbiana City, East Liverpool City, East
Palestine City, Lisbon Village, Salem City
Cuyahoga County – Bedford City, Brook Park City, Brooklyn Heights
Village, Chagrin Falls Village, Cleveland City, Cleveland Heights City,
Cuyahoga Heights Village, Euclid City, Highland Heights City, Lakewood
City, Maple Heights City, Oakwood Village, Parma Heights City, Seven
Hills City, Solon City, South Euclid City, Valley View Village,
Warrensville Heights City, Woodmere Village
Delaware County – Powell City
Fairfield County – Pickerington City
Franklin County – Gahanna City
Gallia County – Gallipolis City
Geauga County – Chardon City
Hancock County – Findlay City
Huron County – Willard City
Lake County – Eastlake City, Grand River Village, Mentor City,
Wickliffe City, Willoughby City, Willoughby Hills City
Licking County – Heath City, Johnstown Village, Newark City
Lorain County – Amherst City, Avon City, Avon Lake City, Lorain City,
Sheffield Lake City, Sheffield Village
Lucas County – Holland Village, Maumee City, Oregon City, Sylvania
City, Whitehouse Village
Mahoning County – Campbell City, Canfield City, Sebring Village
Medina County – Brunswick City
Ottawa County – Port Clinton City, Streetsboro City
Richland County – Bellville Village, Butler Village, Lexington Village,
Mansfield City, Ontario City
Sandusky County – Fremont City
Seneca County – Fostoria City
Shelby County – Anna Village, Botkins Village, Jackson Center Village,
Fort Loramie Village, Russia Village
Stark County – Alliance City, Canton City, North Canton City
Summit County – Akron City, Barberton City, Boston Heights Village,
Cuyahoga Falls City, Fairlawn City, Green City, Lakemore Village,
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Macedonia City, Munroe Falls City, Northfield Village, Norton City,
Richfield Village, Stow City, Twinsburg City
Union County – Marysville City
Van Wert County – Van Wert City
Warren County – Mason City
Wayne County – Wooster City
Wood County – North Baltimore Village
Source: Ray Turk, CPA
URL: http://www.irs.gov/businesses/small/article/0,,id=203100,00.html
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S Corporation Compensation and Medical Insurance Issues
When computing compensation for employees and shareholders, S corporations may run into a variety
of issues. The information below may help to clarify some of these concerns.
Reasonable Compensation
S corporations must pay reasonable compensation to a shareholder-employee in return for services
that the employee provides to the corporation before non-wage distributions may be made to the
shareholder-employee. The amount of reasonable compensation will never exceed the amount
received by the shareholder either directly or indirectly.
Distributions and other payments by an S corporation to a corporate officer must be treated as wages
to the extent the amounts are reasonable compensation for the service rendered to the corporation.
The instructions to the Form 1120S, U.S. Income Tax Return for an S Corporation, state "Distributions
and other payments by an S corporation to a corporate officer must be treated as wages to the extent
the amounts are reasonable compensation for services rendered to the corporation."
Several court cases support the authority of the IRS to reclassify other forms of payments to a
shareholder-employee as a wage expense and subject to employment taxes.
Authority to Reclassify
Joly vs. Commissioner, 211 F.3d 1269 (6th Cir., 2000)
Reinforced Employment Status of
Shareholders
Veterinary Surgical Consultants, P.C. vs. Commissioner,
117 T.C. 141 (2001)
Joseph M. Grey Public Accountant, P.C. vs. Commissioner,
119 T.C. 121 (2002)
The key to establishing reasonable compensation is determining what the shareholder-employee did
for the S corporation. As such, we need to look to the source of the S corporation's gross receipts.
The three major sources are:
2.
1. Services of shareholder,
Services of non-shareholder employees, or
3. Capital and equipment.
If the gross receipts and profits come from items 2 and 3, then that should not be associated with the
shareholder-employees personal services and not be allocated as compensation.
On the other hand, if most of the gross receipts and profits are associated with the shareholders
personal services, then most of the profit distribution should be allocated as compensation.
In addition to the shareholder-employee direct generation of gross receipts, the shareholder-employee
should also be compensated for administrative work performed for the other income producing
employees or assets. For example, a manager may not directly produce gross receipts, but he assists
the other employees or assets which are producing the day-to-day gross receipts.
Some factors in determining reasonable compensation:

 Training and experience
 Duties and responsibilities
Time and effort devoted to the business
 Dividend history
 Payments to non-shareholder employees
 Timing and manner of paying bonuses to key people
 What comparable businesses pay for similar services
 Compensation agreements
 The use of a formula to determine compensation
Treating Medical Insurance Premiums as Wages
Heath and accident insurance premiums paid on behalf of the greater than two percent S corporation
shareholder-employee are deductible and reportable by the S corporation as wages for income tax
withholding purposes on the shareholder-employee’s Form W-2.
These benefits are not subject to Social Security or Medicare (FICA) or Unemployment (FUTA) taxes.
The additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement,
issued to the shareholder-employee, but would not be included in Boxes 3 and 5 of Form W-2.
A 2-percent shareholder-employee is eligible for an Adjusted Gross Income (AGI) deduction for
amounts paid during the year for medical care premiums if the medical care coverage is established by
the S corporation and the shareholder meets the other self-employed medical insurance deduction
requirements. If, however, the shareholder or the shareholder’s spouse is eligible to participate in any
subsidized health care plan then the shareholder is not entitled to the AGI deduction.
A medical plan can be considered established by the S corporation if the S corporation paid or
reimbursed the shareholder-employee for premiums and reported:

 The premium payment
Reimbursement as wages on the shareholder-employee’s W-2
Health Insurance Purchased in Name of Shareholder
The insurance laws in some states do not allow a corporation to purchase group health insurance when
the corporation only has one employee. Therefore, if the shareholder was the sole corporate employee,
the shareholder had to purchase his health insurance in his own name.
The IRS issued Notice 2008-1 which ruled that under certain situations the shareholder would be
allowed an above-the-line deduction even if the health insurance policy was purchased in the name of
the shareholder. Notice 2008-1 provided four examples, three of the examples had the shareholder
purchasing the health insurance and the other example had the S corporation purchasing the health
insurance.
The Notice held that if the shareholder purchased the health insurance in his own name and paid for it
with his own funds the shareholder would not be allowed an above-the-line deduction. On the other
hand, if the shareholder purchased the health insurance in his own name but the S corporation either
directly paid for the health insurance or reimbursed the shareholder for the health insurance and also
included the premium payment in the shareholder’s W-2, the shareholder would be allowed an above-
the-line deduction.
The bottom line is that in order for a shareholder to claim an above-the-line deduction, the health
insurance premiums had to be paid by the S corporation and had to be included in the shareholder’s
W-2.
References/Related Topics
 S Corporations
S Corporation Employees, Shareholders and Corporate Officers
 S Corporation Stock and Debt Basis
Special Rules for Health Insurance Costs of 2-Percent Shareholder-Employees (IRB 2008-2
Notice 2008-1)
 Other Business Structures


Rate the Small Business and Self-Employed Web Site
Page Last Reviewed or Updated: December 15, 2010
Accessibility | Freedom of Information Act | Important Links | IRS Privacy Policy | USA.gov | U.S.
Treasury
URL: http://www.irs.gov/newsroom/article/0,,id=200293,00.html
Page Last Reviewed or Updated: October 05, 2011
Wage Compensation for S Corporation Officers
FS-2008-25, August 2008
Corporate officers are specifically included within the definition of employee for
FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax
Act) and federal income tax withholding under the Internal Revenue Code. When
corporate officers perform services for the corporation, and receive or are entitled to
receive payments, their compensation is generally considered wages. Subchapter S
corporations should treat payments for services to officers as wages and not as
distributions of cash and property or loans to shareholders.
S corporations are corporations that elect to pass corporate income, losses,
deductions, and credits through to their shareholders for federal tax purposes.
Shareholders of S corporations report the flow-through of income and losses on their
personal tax returns and are assessed tax at their individual income tax rates.
The Internal Revenue Code establishes that any officer of a corporation, including S
corporations, is an employee of the corporation for federal employment tax
purposes. S corporations should not attempt to avoid paying employment taxes by
having their officers treat their compensation as cash distributions, payments of
personal expenses, and/or loans rather than as wages.
This fact sheet clarifies information that small business taxpayers should understand
regarding the tax law for corporate officers who perform services.
Who’s an employee of the corporation?
Generally, an officer of a corporation is an employee of the corporation. The fact
that an officer is also a shareholder does not change the requirement that payments to
the corporate officer be treated as wages. Courts have consistently held that S
corporation officer/shareholders who provide more than minor services to their
corporation and receive or are entitled to receive payment are employees whose
compensation is subject to federal employment taxes.
The Treasury Regulations provide an exception for an officer of a corporation who
does not perform any services or performs only minor services and who neither
receives nor is entitled to receive, directly or indirectly, any remuneration. Such an
officer would not be considered an employee.
What's a Reasonable Salary?
The instructions to the Form 1120S, U.S. Income Tax Return for an S Corporation,
state "Distributions and other payments by an S corporation to a corporate officer
must be treated as wages to the extent the amounts are reasonable compensation for
services rendered to the corporation."
The amount of the compensation will never exceed the amount received by the
shareholder either directly or indirectly. However, if cash or property or the right to
receive cash and property did go the shareholder, a salary amount must be
determined and the level of salary must be reasonable and appropriate.
There are no specific guidelines for reasonable compensation in the Code or the
Regulations. The various courts that have ruled on this issue have based their
determinations on the facts and circumstances of each case.
Some factors considered by the courts in determining reasonable compensation:






Training and experience
Duties and responsibilities
Time and effort devoted to the business

Dividend history
Payments to non-shareholder employees
Timing and manner of paying bonuses to key people
What comparable businesses pay for similar services


Compensation agreements
The use of a formula to determine compensation
Medical Insurance Premiums treated as wages.
The health and accident insurance premiums paid on behalf of the greater than 2
percent S corporation shareholder-employee are deductible by the S corporation as
fringe benefits and are reportable as wages for income tax withholding purposes on
the shareholder-employee’s Form W-2. They are not subject to Social Security or
Medicare (FICA) or Unemployment (FUTA) taxes. Therefore, this additional
compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax
Statement, issued to the shareholder, but would not be included in Boxes 3 or 5 of
Form W-2.
A 2-percent shareholder-employee is eligible for an AGI deduction for amounts paid
during the year for medical care premiums if the medical care coverage is established
by the S corporation. Previously, “established by the S corporation” meant that the
medical care coverage had to be in the name of the S corporation.
In Notice 2008-1, the IRS stated that if the medical coverage plan is in the name of
the 2percent shareholder and not in the name of the S corporation, a medical care
plan can be considered to be established by the S corporation if: the S corporation
either paid or reimbursed the 2percent shareholder for the premiums and reported the
premium payment or reimbursement as wages on the 2percent shareholder’s Form
W-2.
Payments of the health and accident insurance premiums on behalf of the shareholder
may be further identified in Box 14 (Other) of the Form W-2.
Schedule K-1 (Form 1120S) and Form 1099 should not be used as an alternative to
the Form W-2 to report this additional compensation.
Page Last Reviewed or Updated: October 05, 2011
Reproduced with Permission of the AICPA
Reproduced with Permission of the AICPA
Reproduced with Permission of the AICPA