Ohio House Clarifies Income Tax Treatment of the Sale of a Business Interest
On March 30, 2022, the Ohio House passed House Bill 515 (HB 515), which would codify two situations in which the sale of an equity or ownership interest in a business would be considered business income.
Currently, there is much uncertainty about when the sale of an equity or ownership interest is considered nonbusiness income or business income. This is important because for Ohio income tax purposes the state tax impact significantly differs depending on whether the seller of the equity or business interest is an Ohio resident or nonresident.
For Ohio residents, nonbusiness income is currently taxed at a graduated rate under Ohio Revised Code (O.R.C.) Section 5747.02. For the 2021 tax year, this rate can be as high as 3.99%, compared to the flat business income tax rate of 3%.1 For prior years, the rate differential is more.
Conversely, nonresidents pay no Ohio income tax on nonbusiness income because tax is allocated to the seller’s domicile.2 Note, however, that under a special statute, nonresidents may be subject to business income tax on a portion of their gain from the sale of interests in a closely held business or pass-through entity.3 This statute generally applies to owners with a 20% or more interest in a closely-held pass-through business with five or fewer owners. Gain from the sale of a business interest in these circumstances is considered business income and the nonresidents’ gain is apportioned based on the business’ activity in the state over the preceding three years.4 This differs from the apportionment of other business income, which is based on the taxpayer’s activity in the state over the taxable year.5 This special statute has been declared unconstitutional as applied to a taxpayer that was not active in the day-to-day activities of a business that was sold.6
HB 515 would codify two situations in which the sale of an equity or ownership interest is to be considered business income:
- When the sale is treated as a sale of assets for federal income tax purposes.
- When the seller “materially participates”7 in the activities of the business during the taxable year in which the interest was sold or during any of the five preceding taxable years.
In either of those two situations, income from the sale would be considered business income. With respect to nonresidents, this means a portion of the income will be taxable in Ohio depending on the proportion of the business’ activity that took place in Ohio — subject to constitutional considerations.8
Furthermore, Ohio residents and nonresidents would be subject to the lower 3% tax rate and eligible for the Ohio business income deduction. The business income deduction permits joint-filing taxpayers to deduct the first $250,000 — $125,000 for single filers or in the case of spouses filing separately — of business income with any income above this amount being subject to the flat 3% business income tax rate.9
Additionally, HB 515 is intended to be remedial and clarify existing law. Thus, changes should apply to any audits, refund applications, petitions for reassessments, and appeals pending on or after the bill’s 90-day effective date. It is worth noting that the deadline to file an amended return and refund claim in Ohio is four years from the date the return was filed or required to be filed, whichever is later.10
Taxpayers should consider filing protective refund claims to be certain the statute of limitations does not expire in the event the bill is made into law.
Taft will continue to monitor the development of HB 515 as it progresses through the Senate and potentially to the Governor for signature. If you have any questions about current law or the impacts of HB 515, please contact any of the authors or other attorneys in Taft’s Tax practice.
1O.R.C. §§ 5747.02(A)(3), 5747.02(A)(4)(a); see also, the Ohio income tax tables published here.
2 O.R.C. § 5747.20.
3 O.R.C. § 5747.212.
5 O.R.C. §§ 5747.21; 5733.05(B)(2).
6 See Corrigan v. Testa, 149 Ohio St.3d 18 (2016), holding that a nonresident’s income from the sale of an Ohio business was not taxable under O.R.C. § 5747.212 because the particular nonresident’s connection to Ohio was insufficient to establish nexus with Ohio under the Due Process Clause of the Fourteenth Amendment to the United States Constitution.
7 HB 515 references Treas. Reg. § 1.469-5T to determine “material participation,” which generally considers the number of hours a taxpayer spent participating in the operation of a business, among other factors in specific circumstances.
8 See Corrigan v. Testa, 149 Ohio St.3d 18 (2016).
9 O.R.C. §§ 5747.01(A)(28), 5747.02(A)(4).
10 O.R.C. § 5747.13(A).
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