Not a one-size-fits-all specialty tax savings tool
Over the last few years, states have implemented new options for taxpayers to try and bypass the federal state and local tax deduction cap. This is the provision that currently limits an individual taxpayer from deducting more than $10,000 in state and local taxes on the itemized deductions schedule of their federal tax return, the 1040. The idea behind many of these options is that by allowing pass-through entities, like partnerships and S-corporations, the option to become the state taxpayer the taxes paid become entity taxes, not personal taxes. Essentially, the entity elect to not be a pass-through for that particular state’s taxation. Since the cap on state and local tax deductions is at the personal taxpayer level, this election effectively bypasses that cap – or at least that is how it’s supposed to work.
In mid-June, Ohio Governor DeWine signed SB 246 into law and Ohio joined the ranks of around 30 other states with similar legislation. The legislation will become effective in September 2022 and applies to the 2022 tax year and forward. The Ohio Society of CPA’s article provides additional insights into the new provision. While this provision could be a great savings opportunity for taxpayers, many tax advisors including Rea & Associates are urging caution – this is not a tool that will help out everyone. Of particular note, is how the Ohio Department of Taxation will implement the legislation. Similar programs in other states have found success or end up being extremely unfriendly to taxpayers depending on how certain decisions are made by the state tax department.
Here is what we know – if your business is a partnership or an S Corp, owned by Ohio residents, and all of its income is sourced to Ohio, then chances are this new law could provide some nice federal tax savings for you. You are still early too, the election cannot be made until 2023, though you could verify it’s a good idea or not between now and then. For now, the list of things we don’t know is pretty long. Below are some highlights where we expect to get more information from the Department of Taxation after the law’s effective date in mid-September:
- Who makes the election is unclear. It appears it is whoever is empowered to make tax decisions for the entity, which could be just one person. What if there are disagreements or the election will hurt some owners and favor others?
- Thought leaders believe that the law as written will disallow the credit for taxes paid to other states to owners on their Ohio return. This might destroy any federal benefit that might result from the election.
- If there are C corporations in the ownership chain, the entity may end up overpaying Ohio tax with no way to recover it (C corporations do not pay Ohio income tax, but an electing pass-through entity would have to pay that tax on behalf of all owners).
- The federal rule allowing this bypass of the SALT cap has not been tested against Ohio’s new legislation. It is possible that the way in which Ohio has done this will not result in federal tax savings if owners are audited.
We continue to monitor the developments on this law for our clients, but for now are urging caution and careful consideration of your business’ facts before committing to the new election, as most of the answers are coming this fall or later. Reach out to your Rea tax advisor for more information.
By Joseph Popp, JD, LLM (Dublin Office)