SALT Deduction Limitation | Ohio Pass-Through Entity Tax

Update: State & Local Tax (SALT) deduction limitation, including the Ohio Pass-Through Entity Tax

Status of the federal limitation on state & local tax deductions
The Tax Cuts and Jobs Act (TJCA) of 2017 included a $10,000 limitation on the amount of the federal income tax deduction for state and local taxes, including income and property taxes. This limitation is set to expire in 2025, and as our recent blog Inflation Reduction Act of 2022: Impact on Taxation, outlined, the limitation is still in effect.

Since 2017, over 25 states have enacted special legislation to work around the limitation by providing for entity level taxes on income of pass-through entities - States with Enacted or Proposed Pass-Through Entity (PTE) Level Tax.

Pennsylvania has proposed PTE legislation, and three nearby states, Maryland, New Jersey, and New York, have enacted PTE legislation. We addressed the NJ legislation in these blogs: New Jersey Enacts SALT Work-Around Pass-Through Entity Tax and Improved NJ Business Alternative Income Tax, and the NY legislation in this article - New York Enacts a Pass-Through Entity Level Tax.

Ohio is the latest state near the Mid-Atlantic region to enact PTE legislation. The remainder of this article is an explanation and summary of the Ohio bill.

Ohio Pass-Through Entity Tax
Ohio Senate Bill 246, signed June 14, 2022, provide a workaround for the SALT deduction for qualifying entities. Qualifying PTEs, which consist of S Corporations, Partnerships, and Limited Liability companies that are taxed as Partnerships, will now be able to choose to have state tax paid at an entity level.

The Ohio PTE election will be available for tax years beginning on or after January 1, 2022.

Impact On Individual Owners in Qualifying PTEs
This bill allows for state tax to be paid at entity level. Tax is therefore deducted from the owner’s income, reducing the adjusted gross income they will report on their federal return. The advantage of structuring state and local taxes this way is that they are now deducted from the owner’s income without needing to be claimed as itemized deductions. As indicated above, the maximum itemized deduction for state and local taxes is $10,000. The cap on state and local tax deductions does not exist when the state income taxes are allocated to the entity.

Specific Considerations for 2022 – and Beyond
The following is a list of specifics relevant to the new PTE tax bill:

• Once the election is made by the entity, all the owners must participate. All their combined individual qualifying taxable income must be reported. To elect the new Ohio PTE tax, entities must file IT 4738 by April 15 after the fiscal year (for the 2022 taxable year, the deadline is April 18, 2023).
• The tax rate for the 2022 fiscal year is 5%, while in subsequent years it will be equal to the taxable business income rate imposed under RC 5747.01 (A)(4)(a), which currently sits at 3%
• A disregarded entity is not eligible for this election.
• Eligible entity owners who also file an IT 1040 (Ohio individual income tax return), will add back the tax amounts paid on the IT 4738 to the extent not included in computing federal or Ohio adjusted gross income using the Ohio Schedule of Adjustments, line 2.
• Form IT 4738 meets all the Ohio filing requirements for non-resident investors, assuming the entity encompasses the entirety of their Ohio-sourced income.
• Once the IT 4738 is filed, the election is irrevocable for the tax year.
• Estimated payments will be made on the same dates as the IT 1140 required. Currently, no estimated payment coupons exist for the 4738. When making estimated payments, PTE’s may continue using IT 1140 estimated payment coupons. When IT 4738 is filed, entities will be able to transfer all payments from IT 1140 to IT 4738.

Conclusion
This article provides a brief explanation and summary of the recently enacted Ohio PTE tax. Additional information, including Frequently Asked Questions regarding IT 4738 are available on the Ohio Department of Taxation website Ohio - Electing Pass-Through Entity: IT 4738. We will continue to monitor developments with this and other PTE legislation and any updates regarding the federal SALT limitation and will provide timely updates when appropriate.

For any additional information or pass-through entity tax questions, please contact your Herbein tax consultant through the form below.

Article prepared by Samuel Greenberg