Individual Income Tax Insights: Ohio’s Small Business Tax Deduction - Big Cost but Small Impact?

As the 2016 tax filing season comes to a head, taxpayers will need to understand how recent tax changes impact their state tax liability. One such change is an increase in Ohio’s small business tax deduction. For tax years beginning in 2016, Ohio taxpayers with business income from pass-through entities are eligible to deduct 100 percent of that business income up to $250,000.

The small business income tax deduction was initially passed in 2013 and was subsequently amended and extended permanently.  The deduction available for the 2013 tax year was equal to 50 percent of the taxpayer’s first $250,000 of small business income.  For the 2014 and 2015 tax years, taxpayers were permitted to deduct 75 percent of the first $250,000 of small business income.

The deduction has been underutilized by taxpayers in the state, according to The Columbus Dispatch. Despite estimates that approximately 700,000 taxpayers were eligible for the deduction, less than half of them claimed it for 2014. An article in The Tax Adviser suggests that this was a result of the complexity in determining the amount of the deduction. In an effort to simplify the tax deduction, Ohio made significant changes to it for 2015.  

Prior to the changes in 2015, taxpayers were required to report each source of apportioned business income as well as certain deductions separately. According to The Tax Adviser, this was a very “time-consuming” process and could have contributed to the lower than expected utilization of the deduction. As a result of the changes in 2015, taxpayers are not required to apportion business income because the deduction is based on all income, not just income apportioned to Ohio, making the calculation significantly less cumbersome.  

While the small business tax deduction may put a few dollars back in the pockets of Ohio taxpayers, the research institutes Policy Matters Ohio, argues that the tax deduction will do little to spur job creation on the state. According to their 2015 report on the deductions, the tax savings for most eligible taxpayers will have little to no impact on job creation. The tax savings range from just a few dollars to few hundred dollars for most taxpayers. The report indicates that a business with $250,000 in gross receipts would see a tax savings of $60.31. Similarly, The Columbus Dispatch’s article reported that the tax savings in previous years ranged from as little as a few dollars up to $800 for 80 percent of filers claiming the deduction.

Despite such small individual savings, the deduction is estimated to cost the state 700 million dollars annually. With the increase and simplification of the deduction, it will be interesting to see the impact that the deduction has on the state of Ohio in future years.

Continue the discussion on Bloomberg BNA's State Tax Group on LinkedIn: Will the small business tax deduction spur job creation and growth in the state? 

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