Ohio income tax changes for business income may increase taxes for some taxpayers

*Please note that the information in this publication has been updated since the introduction of S.B. 208. For additional details regarding the changes, click here.

Much has been made about the income tax cut that is the centerpiece of the tax provisions contained in Am. Sub. H.B. 64, the budget bill for 2016-2017.  Behind all the noise, however, lurks a tax increase for the 2015 tax year for many taxpayers taking advantage of the so-called small business tax deduction.  The increase will not affect all small business, just those with a taxable income (after subtracting their small business deduction) less than about $40,000. This is because of the budget bill’s tax rate change. Those small businesses with a net income less than $40,000 will now be taxed at a flat three percent rate, while currently net income less than $40,000 is taxed at a lower graduated rate.

Under the budget bill, Ohio’s income tax is a graduated tax ranging from 0.495 percent for persons with taxable income of $5,000 or less, to 4.997 percent for persons with taxable income in excess of $200,000.  For taxable years beginning in 2014, taxpayers with “Ohio small business investor income” and filing joint returns were able to deduct three-fourths of the first $250,000.  “Ohio small business investor income” is business income of an individual (typically from a sole proprietor or from a pass-through entity) apportioned or allocated to Ohio.

For taxable years beginning in 2015, however, taxpayers may exclude three-fourths of the first $250,000 of their taxable business income, and the excess is taxed at a flat rate of three percent.  For taxable years beginning in 2016, taxpayers may exclude the entire first $250,000 of taxable business income from taxation.  Taxable business income in excess of $250,000 is subject to the flat three percent tax rate.

What appears to have been overlooked is that for taxable years beginning in 2015, some taxpayers with taxable business income in excess of the excluded amount will actually pay more income tax in 2015 than they would have had the law not been changed. That is caused by the graduated nature of Ohio’s income tax rate structure.  Taxpayers with nonbusiness taxable income below $40,000 are taxed at a top marginal rate of 2.969 percent.  However, taxpayers with business taxable income in excess of the excluded amount are taxed at the flat rate of three percent. Because that rate is higher than the graduated rates to which nonbusiness taxable income is subject, taxpayers with taxable business income will actually pay more income tax in 2015 than if the law had not been changed.

The following table illustrates the situation:

One can readily see that for taxpayers with taxable business income below $250,000, there will be a one-year increase in income tax due in 2015.

One other feature that seems to have escaped notice is that while taxpayers with Ohio business taxable income are not subject to tax on the first $250,000 of such income beginning in 2016, the first dollar of business income in excess of that amount will be subject to the three percent tax rate.  That means that taxpayers with more than $250,000 but less than $290,000 total Ohio business income will pay more income tax under the flat tax than they would if the excess income were taxed under the normal graduated rate system.  Overall, individuals with Ohio business income still see a sizeable reduction in their income tax as a result of the bill.  However, individuals who might fall into this range of business income need to be aware of this situation when making their estimated tax payments.