Today (June 24, 2022), Ohio Governor Mike DeWine signed Substitute House Bill 515 (“H.B. 515”), providing a needed clarification of the definition of “business income” in Ohio’s personal income tax law. We appreciate the efforts of the sponsors of the companion bills, Representatives Hoops and Riedel and Senators Lang and Roegner. H.B. 515 was supported by a lobbying effort of the BID Coalition created by ZHF, as well as by the Ohio Society of CPAs and NFIB-Ohio. ZHF is proud to have assisted the bill’s sponsors with drafting the language of the bill, a bill that passed unanimously in both houses of the General Assembly. The bill will become effective 90 days after today, which is September 22.
“Business Income” Definition
“Business income” is defined at Revised Code (“R.C.”) 5747.01(B) and serves several functions under Ohio income tax law. With its opposite, “nonbusiness income,” it is used to determine whether a certain source of income is apportionable among states or must be allocated to a taxpayer’s state of domicile. Income that qualifies as business income is apportioned while nonbusiness income, “all income other than business income” per R.C. 5747.02(C), is allocated. This distinction is contained in the income tax laws of most of the 50 states—although generally in the corporate income tax law—to serve the same general purpose. Ohio, in addition, uses the “business income” concept to determine whether a source of income qualifies for the Business Income Deduction of up to $250,000 and flat 3% tax rate imposed on qualifying income in place of the progressive tax rates imposed on nonbusiness income. The deduction and 3% rate are commonly referred to collectively as “the BID.”
Clarification of the law became necessary when it became apparent that different readings of the “business income” definition were leading to disputes between the Audit Division of the Ohio Department of Taxation (“ODT”) and many taxpayers whose income included a gain from the sale of a business. The debate over this issue was discussed in an earlier SALT Buzz, Unraveling the Ohio Taxation of a Sale of a Business Interest Under Current and Future Law. In short, ODT considered most gains from the sale of a business to be nonbusiness income, for which the ODT argued that the BID does not apply, while many taxpayers and their advisors disagreed.
H.B. 515 does not change the concepts used to define “business income,” contained in the first sentence of R.C. 5747.01(B) and derived, with some modification, from the Uniform Division of Income for Tax Purposes Act, a model statute dating from 1957. However, Ohio’s definition includes a second sentence, which ensures that “business income” includes income “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.” To that inclusion clause, H.B. 515 adds the wording, “or the sale of an equity or ownership interest in a business.” The language added by the bill clarifies that the legislature does not view the sentence’s liquidation language as limiting the applicability of the “business income” definition, when applied to business sales, to those structured as a sale of assets (this was ODT’s reading), but rather as inclusive of both asset and equity sales under the right circumstances.
Those circumstances are specified with a sub-definition of the phrase “sale of an equity or ownership interest in a business.” The sub-definition makes it clear that, not only is a contractual asset sale included, but so is a deemed asset sale under federal tax law, as happens, for instance, when an I.R.C. 338(h)(10) election is made.
The sub-definition also makes it clear that a qualifying equity sale also includes any sale in which the seller materially participated in the business during the taxable year that includes the sale or any of the five taxable years preceding the sale. The requirement of material participation, defined by reference to 26 C.F.R. 1.469-5T, for an equity sale, limits the concept’s applicability to those business owners who were deeply involved with the business being sold, as opposed to those who were merely investors in the business. A mere investor’s gain on the sale of his or her interest in a business is nonbusiness income under H.B. 515’s clarification.
The inclusion of equity sales in the “business income” concept not only means that the BID applies to many business sales by owners residing in Ohio. Under the other function of the “business income” concept—defining what sources of income are subject to multistate apportionment—the inclusion means that out-of-state sellers of businesses with Ohio operations are subject to Ohio income tax on a portion of their sale-related gains.
Section 3 of the bill provides that the bill’s amendment of the “business income” definition “is a remedial measure intended to clarify existing law” and will apply to any open petitions, refund applications, audits, or appeals as of or after the bill’s effective date. As noted above, many taxpayers had disagreed with ODT’s interpretation of the law, leading to administrative disputes. Although dependent on individual facts and circumstances, we expect that the clarification provided by H.B. 515 will resolve many of those disputes in favor of the taxpayers. Still, the timing and impact on existing audits and appeals is not entirely predictable. Unless already part of the record, ODT will likely require proof that a transaction was treated as an asset sale for federal purposes or that the selling owner met the material participation requirement. A hearing or informal meeting with ODT may be necessary, and some fact patterns may not fall within the legislative language.
Sports Gaming Tax
Sports gaming – gambling on the results of professional sports – will be legal in Ohio beginning January 1, 2023 and subject to regulation by the Ohio Casino Control Commission. The gaming receipts of sports gaming proprietors will also be subject to a 10% tax. The initial legislation, Amended House Bill 29, followed the casino operators’ tax in requiring sports proprietors to file an electronic return on a daily basis. H.B. 515 changes the rules for sports gaming proprietors so that they will file the electronic return monthly rather than daily. Since receipts and payouts often occur on different days, and the tax is imposed on receipts net of payouts, this lengthened reporting period should help level out the taxes paid by sports gaming proprietors, easing the compliance burden.
For advice on BID matters or sports gaming tax issues, contact any ZHF professional at 614-326-1120.