Ohio Tax Ohio Pass-Through Entities and Municipal Income Tax - - PDF document

26th Annual

Tuesday & Wednesday, January 24‐25, 2017

Hya Regency Columbus, Columbus, Ohio

Ohio Tax

Workshop LL

Ohio Pass-Through Entities and Municipal Income Tax Reform

Wednesday, January 25, 2017 2:00 p.m. to 3:00 p.m.

Biographical Information Julie Corrigan, Associate, Plante & Moran 1111 Superior Ave., Suite 1250, Cleveland, Ohio 44114 Julie.Corrigan@plantemoran.com 216.274.6509 Fax 248.233.8853 Julie is an Associate with Plante & Moran PLLC and serves as the State and Local Tax Ohio Practice Leader. She has more than thirty years of experience and specializes in multistate tax consulting services related to sales and use tax, income and franchise taxes, property taxes, gross receipts taxes, and business credit and

• incentives. She has served clients in the manufacturing, consumer products, and service industries with a

focus on solutions to minimize overall state taxes and to provide audit assistance & defense. Julie is a member of the Ohio Chamber of Commerce Tax Committee, American Institute of CPAs, Ohio Society of CPAs, and the Tax Club of Cleveland. Julie has written articles on state and local taxation topics and served on the Ohio CPA Voice Advisory Board for over 10 years. Julie has presented pertinent tax topics at the Ohio Tax Conference for several years as well as presented other topics for outside

• rganizations. Julie received her BBA in Accounting from the University of Cincinnati.

Jeffrey P. Sherman, Assistant Legal Counsel, Regional Income Tax Agency (R.I.T.A.) 760 Lakeview Drive, Suite 400, Worthington, OH 43085 866-721-7482, Ext. 3586 jsherman@ritatohio.com R.I.T.A. Assistant Legal Counsel Jeffrey Sherman is a certified public accountant (inactive status) and admitted to the practice of law in New York and in Ohio. Previously legal counsel for the Ohio Dept. of Taxation’s Income Tax Division and before that a senior tax manager with one of the Big Four accounting firms, he is also currently is an instructor for the Becker CPA Review Course. A frequent presenter at the yearly Ohio Tax Conference, at various state bar association conferences, and at Ohio Society of Certified Public Accountants presentations, he has also taught undergraduate and graduate business courses at The Ohio State University. Earning his undergraduate degree from Miami University in Oxford, Ohio, he received his law degree with honors from The Ohio State University. He has published in national tax journals articles regarding constitutional nexus, Ohio’s “bright line” domicile law, and Ohio’s anti-passive investment company (“anti -PIC”) tax law. Stephen K. Hall, JD, LLM, Member, Zaino Hall & Farrin, LLC 41 South High Street, Suite 3600, Columbus, OH 43215 shall@zhftaxlaw.com 614-349-4812 Fax: 614-754-6368 Steve provides state and local tax services, legal business counsel, and lobbying services to clients in multiple states and local jurisdictions. He leads the Firm's Real Estate Tax Practice Group, representing real property owners in valuation matters and exemption matters. He has represented clients in all types of state and local income tax, sales and use tax, excise tax, public utility tax, personal and real property tax, and gross receipts tax matters. Steve’s practice focuses on tax controversy and tax policy at the state and local level, including representation of clients before County Boards of Revision, Local Income Tax Boards of Review, the Ohio Board of Tax Appeals, Ohio state courts, and state and local tax agencies across the country. He also frequently represents clients before Ohio’s General Assembly, the Ohio Department of Taxation, and other state and local government agencies, both in tax controversy and lobbying matters. Earlier in his career, he served as Assistant Counsel to the Ohio Tax Commissioner, where he was a policy and technical advisor to the Tax Commissioner, the Ohio Governor’s Office, and the Ohio Department of Development, while representing the Ohio Department of Taxation before the Ohio General Assembly. He has spent significant time drafting tax legislation and lobbying for the implementation of tax law changes both while in the Tax Commissioner’s office and on behalf of clients while in private law practice Steve is a frequent speaker on technical state and local tax matters, state and local tax policy, and national tax policy matters addressing multistate taxation. He is actively involved in lobbying Ohio's General Assembly and participates in various Ohio Bar Association committees addressing Ohio tax policy and

• procedure. He is the chair of the Ohio State Bar Association subcommittee on municipal income tax

matters.

Ohio Tax Conference

Workshop LL January 25, 2017 2 P.M. – 3 P. M.

Pass-Through Entities and The New Municipal Income Tax Law Including the Effects of IRC – Muni. Income Tax Law Differences

Julie Corrigan – Plante Moran Steve Hall – Zaino Hall & Farrin LLC Jeffrey P. Sherman – R.I.T.A.

DISCLAIMER!

• These slides were prepared by RITA.
• The slides and the examples contained in

the slides are the position of RITA and are not necessarily the position of the other presenters and/or other municipalities.

• We recommend that you do NOT take

action based on these slides without consulting your tax advisor and the law.

2

TODAY’S AGENDA

 Definitions  Summary of the provisions affecting

PTE owners

 Summary of the provisions affecting

PTE’s, themselves

 Resident credit on account of PTE tax

paid to other municipalities

 Examples  Your questions

3

PASS-THROUGH ENTITY

"Pass-through entity" means a partnership not treated as an association taxable as a C corporation for federal income tax purposes, a limited liability company not treated as an association taxable as a C corporation for federal income tax purposes, an S corporation, or any

• ther class of entity from which the income or

profits of the entity are given pass-through treatment for federal income tax purposes. "Pass- through entity" does not include a trust, estate, grantor of a grantor trust, or disregarded entity.

Division (N) of Ohio Revised Code section 718.01

4

DISREGARDED ENTITY

"Disregarded entity" means a single member limited liability company, a qualifying subchapter S subsidiary, or another entity if the company, subsidiary, or entity is a disregarded entity for federal income tax purposes.

Division (BB) of Ohio Revised Code section 718.01

5

Summary of the Provisions Affecting PTE Owners

6

Owners of PTE’s

• PTE income and losses never “flow

through” either to nonresidents or to

• ther PTE’s.
• PTE income and losses generally do

“flow through” to residents. See subsequent slides for exceptions.

7

Owners of PTE’s

• PTE income and losses some times “flow

through” to C corporation owners of the

• PTE. See subsequent slides for

discussion.

8

Owners of PTE’s

• Each owner of a publicly traded partnership

(“PTP”) shall exclude from the owner’s income the profit or loss of that PTP if . . . . . . The PTP is subject to tax in at least one Ohio municipality and . . . The PTP makes an election to be treated as a C corp. for municipal income tax purposes (yearly election).

9

Owners of PTE’s

• A “publicly traded partnership” means any

partnership, an interest in which is regularly traded on an established securities market.

See divisions (D)(4) and (VV) of Ohio Revised Code section 718.01 as amended by the recently enacted budget bill, Amended Substitute House Bill 64, 131st General Assembly.

10

Owners of S Corporations

• Limitations for owners of S corporations still

apply.

• Income and losses of S corporations do not “flow

through” to an owner unless the owner lives in a municipality that voted in 2003 or 2004 to permit taxation of S corporation owners.

• Two methods of taxing the S corp. owners:
• “Ohio-apportioned” (not “city-apportioned”)

income, or

• 100% of the income.

11

IMPORTANT: PTE Losses and the PTE Owner’s Qualifying Wages

• PTE losses (and all other “Schedule E”

losses and all “Schedules C & F” losses) never reduce qualifying wages.

• No change from previous law.

12

C Corporations Owning an Interest in a PTE

• Except as set forth in division (E)(3)(b) of section

718.06 of the Revised Code (discussed below), the C corporation must deduct any net profit, and add any net loss, of each PTE owned “directly or indirectly” by the C corporation.

• Source: 718.01(A)(1)(a); 718.01(B)(3);

718.01(D)(1); 718.01(E), first paragraph; and 718.01(E)(9) & (E)(10).

13

C Corporations Owning an Interest in a PTE

• Except as set forth in division (E)(3)(b) of section

718.06 of the Revised Code (discussed below), the C corporation must deduct any net profit, and add any net loss, of each PTE owned “directly or indirectly” by the C corporation.

• “Directly or indirectly” is not defined in chapter 718

(or in chapter 1 of Title 1,”Definitions”).

14

PTE’s Owning an Interest in another PTE

• Each PTE must deduct any net profit, and add any

net loss, of every other PTE owned “directly or indirectly” by the PTE (same rule as for C corporations owning an interest in a PTE).

• Source: 718.01(A)(1)(a); 718.01(B)(3);

718.01(D)(1); 718.01(E), first paragraph; 718.01(E)(9) & (E)(10); and the first paragraph following (E)(10) of 718.01.

15

Division (E)(3)(b) of Section 718.06 of the Revised Code

• A corporate “affiliated group” each year can make the

718.06(E)(3)(b) election to include in the group’s income the “net profit” (loss) of one, some, or all of at-least- 80%-owned-by-the- group PTE’s (“owned or controlled, directly or indirectly, by an affiliated group . . .”).

• Also included is such PTE’s property, payroll, and sales

(receipts).

16

Question Regarding Division (E)(3)(b) of Section 718.06

• If, for example, the corporate affiliated group owns
• nly 80% of the PTE, does the group include in net

profit (and in property, payroll, and receipts) only 80% of the PTE’s net profit (and property, payroll, and receipts), OR

• Does the group include in net profit (and in

property, payroll, and receipts) 100% of the PTE’s net profit (and property, payroll, and receipts)?

17

Question Regarding Division (E)(3)(b) of Section 718.06

• Per (E)(3)(b) of 718.06: “[The group shall] include

the PTE’s net profit or loss in the . . . income of the . . . group and . . . include the property, payroll, and gross receipts of the PTE . . .”.

• Note that the law does not state that the group

shall include only the group’s distributive share of the PTE’s net profit or loss.

18

Question Regarding Division (E)(3)(b) of Section 718.06

• Note that for federal income tax purposes the group

pays federal income tax on the subsidiary’s entire profit – even if the group owns only 80% of the subsidiary.

• Does (E)(3)(b) of 718.06 provides likewise? “[The

group shall] include the PTE’s net profit or loss in the . . . income of the . . . group and . . . include the property, payroll, and gross receipts of the PTE . . .”.

19

Question Regarding Division (E)(3)(b) of Section 718.06

• Note that for federal income tax purposes, the subsidiary

included in the consolidated federal income tax return does not pay its own tax even if the group owns only 80% of the subsidiary.

• Note that for municipal income tax purposes the PTE

included in the consolidated municipal income tax return does not pay its own municipal income tax even if the group

• wns only 80% of the PTE. See division (E)(3)(b) of Ohio

Revised Code section 718.06.

20

Question Regarding Division (E)(3)(b) of Section 718.06

• Even if the corporate group must include 100% of

the PTE’s profit, property, payroll and gross receipts in those situations where the group owns less than 100% of the PTE, individuals, if any,

• wing the remaining %-age of the PTE are liable

for municipal income tax, too.

• In such situations more than 100% of the PTE

profit could be subject to tax.

21

Question Regarding Division (E)(3)(b) of Section 718.06

• Finally, note that the corporate group can

“cherry pick” which PTE(s) to include in the affiliated group’s corporate municipal income tax return.

• And the election only applies to the

municipalities for which the group so elects.

22

Summary of the Provisions Affecting PTE’s, Themselves

23

Most PTE's Remain Subject to Income Tax

• Exception: If a corporate “affiliated group”

makes the 718.06(E)(3)(b) election to include in the group’s income the net profit” (loss) of an at-least-80%-owned-by-the group PTE, then . . . . . . the PTE is not subject to municipal income

• tax. See 718.06(E)(3)(b).

24

Most PTE's Remain Subject to Income Tax

• 718.01(D)(1) defines “net profit” for “a person other

than an individual” as “adjusted federal taxable income” defined at 718.01(E).

• Just as under previous law, PTE’s must compute AFTI

“as if the taxpayer were a C corporation, except . . . [for certain PTE adjustments discussed on subsequent slides] . . .”. See the first paragraph after 718.01(E)(10).

• Recall that 718.01(E)(8) provides for a phased-in five

year NOL carryforward deduction for post-2016 NOL’s. So, PTE’s can deduct NOL cfd’s, too.

25

Most PTE's Remain Subject to Income Tax

• Recall that a C corp.’s adjusted federal taxable

income (“AFTI”) generally excludes net profit or loss from any PTE owned by the C corp. See 718.01(E)(9) & (E)(10), subject to 718.06(E)(3)(b).

• So, a PTE’s AFTI excludes net profit (loss)

from any other PTE.

26

Most PTE's Remain Subject to Income Tax

• New law – similar to pre-2016 law –

expressly requires PTE’s to make three add-backs:

• Guaranteed payments – UNLESS

“such payments are in consideration for the use of capital and treated as payment of interest under IRC section 469.” [The “UNLESS” clause is not in pre-2016 law]

27

Most PTE's Remain Subject to Income Tax

• New law – similar to pre-2016 law –

expressly requires PTE’s to make three add-backs:

• Amounts paid/accrued to a qualified

self-employed retirement plan with respect to partners, former partners, shareholders, former shareholders, members, and former members.

28

Most PTE's Remain Subject to Income Tax

• New law – similar to pre-2016 law –

expressly requires PTE’s to make three add-backs:

• Amounts paid/accrued to or for life

insurance for partners, former partners, shareholders, former shareholders, members, and former members.

29

Most PTE's Remain Subject to Income Tax

• Recall that per the first paragraph after

718.01(E)(10), adjusted federal taxable income for PTE’s is computed “as if the taxpayer were a C corporation, except . . . [for three PTE adjustments discussed on the immediately preceding slides] . . .”.

• Let’s focus on the clause, set forth above,

“ . . . as if the taxpayer were a C corporation . . .”

30

Most PTE's Remain Subject to Income Tax

• On account of that clause (also in pre-

2016 law), the PTE must make many

• ther adjustments such as the following:
• PTE’s must pay tax on IRC section 291 income which

applies to “corporate” sales of “section 1250” property (section 291 does not apply to individuals, estates, and trusts).

• PTE’s much compute the charitable contribution limits

at the entity level.

• PTE’s can claim the DPAD deduction – even if the

partners cannot do so.

31

Most PTE's Remain Subject to Income Tax

• On account of that clause (also in pre-

2016 law), the PTE must make many

• ther adjustments such as the following:
• PTE’s must add back any additional depreciation

deduction not allowed to a C corporation per IRC section 362(e).

• PTE’s must add back any additional depreciation

deduction allowed (and deduct any depreciation expense not allowed) to the PTE on account IRC sections 743 and 754.

• PTE’s must add back any loss which is capital loss solely on

account of IRC section 724(c).

32

IRA’s, Keoghs, Pension Plan Trusts, Other Non-grantor Trusts, Bankruptcy Estates, and Decedent’s Estates

• Are these entities subject to municipal

income tax (for example, the entity has profitable real estate in a municipality imposing income tax)?

33

IRA’s, Keoghs, Pension Plan Trusts, Other Non-grantor Trusts, Bankruptcy Estates, and Decedent’s Estates

• “If the taxpayer is not a C corporation, . . . and

is not an individual, the taxpayer shall compute adjusted federal taxable income . . . as if the taxpayer were a C corporation, except [for three adjustments discussed earlier].”

See the first paragraph after division (E)(10) of Ohio Revised Code section 718.01.

34

IRA’s, Keoghs, Pension Plan Trusts, Other Non-grantor Trusts, Bankruptcy Estates, and Decedent’s Estates

• 718.01(L)(1):

(2)(a) A single member limited liability company that is a disregarded entity . . . [end of excerpt]

35

IRA’s, Keoghs, Pension Plan Trusts, Other Non-grantor Trusts, Bankruptcy Estates, and Decedent’s Estates

• 718.01(M):

36

IRA’s, Keoghs, Pension Plan Trusts, Other Non-grantor Trusts, Bankruptcy Estates, and Decedent’s Estates (to review)

• “If the taxpayer is not a C corporation, . . . and

is not an individual, the taxpayer shall compute adjusted federal taxable income . . . as if the taxpayer were a C corporation, except [for three adjustments discussed earlier].”

See the first paragraph after division (E)(10) of Ohio Revised Code section 718.01.

37 37

IRA’s, Keoghs, Pension Plan Trusts, Other Non-grantor Trusts, Bankruptcy Estates, and Decedent’s Estates

• Are these entities subject to municipal

income tax (for example, the entity has profitable real estate in a municipality imposing income tax)?

• Don’t forget that “intangible income” is

generally exempt income.

Divisions (S) and (C)(2) of Ohio Revised Code section 718.01.

38

Resident Credit on Account of PTE Tax Paid to Other Municipalities

39

Resident Credit on Account of PTE Tax Paid to Other Municipalities

If a municipality does not tax the resident on the resident’s share of S

• Corp. profit, then the municipality will

not allow a credit with respect to muni. tax which the S Corp. paid to one or more municipalities. NOTE: Consider “disguised wages” doctrine (previous law and current law).

See division (C)(14)(a) of 718.01.

40

Resident Credit on Account of PTE Tax Paid to Other Municipalities

Most municipalities currently do not

• - and most likely under new law will

not -- allow PTE tax paid to any municipality to reduce the tax that an individual owes with respect to her/his qualifying wages.

41 41

Resident Credit on Account of PTE Tax Paid to Other Municipalities

Example

NOTE #1 REGARDING THE EXAMPLES:

• In all the examples the “residence”

municipality provides a nonrefundable credit equal to the product of . . . (i) the income taxed elsewhere and (ii) the lesser of the “elsewhere” tax rate or the residence municipality tax rate.

42

43

Resident Credit on Account of PTE Tax Paid to Other Municipalities

Example

NOTE #2 REGARDING THE EXAMPLES:

• “PTE” is shorthand for “partnership and includes

S Corp. but only if the resident shareholder(s) live(s) in a municipality which taxes the shareholder(s) on 100% of the S Corp. profit.”

Resident Credit on Account of PTE Tax Paid to Other Municipalities

Example

• Pat resides in municipality R (2% tax rate).
• Pat works in township T and earns

qualifying wages of $50,000 there.

• Pat has a -$50,000 distributive share
• f PTE loss (assume not a PAL).
• Pat has a $50,000 distributive share
• f PTE income from another PTE.
• The PTE paid $1,000 of muni. tax with

respect to that +$50K distributive share.

44 44

Resident Credit on Account of PTE Tax Paid to Other Municipalities

Example (continued)

• Pat’s municipal taxable income for R is

$50,000: $50K in qualifying wages - $50K PTE loss + $50K income from another PTE.

• Pat’s tax before credits is $1,000: 2% X $50K.
• Pat cannot claim as a credit the $1,000 of tax

paid by the PTE (with respect to Pat’s +$50K distributive share of income from that PTE).

• Reason: Credits on account of PTE tax paid

cannot reduce tax due on qualifying wages.

45

Another Example -- Credits

• Pat resides in Municipality R (2% tax rate).
• Pat’s only income is a $50,000 distributive

share of PTE income from PTE A doing business solely in Municipality A (2% tax rate).

• PTE A paid to A $1,000 with respect to

Pat’s $50,000 distributive share of income.

• Result: Pat will owe no tax to R.
• Reason: The $1,000 R tax before credits

is reduced by Pat’s $1,000 share of PTE A’s tax which PTE A paid to municipality A.

46

Still Another Example -- Credits

• Pat resides in Municipality R (2% tax rate).
• Pat has a $50,000 distributive share of PTE

income from PTE A doing business solely in Municipality A (2% tax rate).

• PTE A paid to A $1,000 with respect to Pat’s

$50K distributive share of PTE A profit.

• Pat has a $40,000 distributive share of PTE

income from PTE B. PTE B is not subject to any municipal income tax.

• Pat has a -$40,000 distributive share of PTE

loss from PTE C (the loss is not a PAL).

47 47

Still Another Example (continued)

• Pat’s municipal taxable income is $50,000:

+$50K from PTE A + $40K from PTA B - $40K from PTE C.

• Note that in the previous example Pat’s MTI

was also $50,000.

• Pat’s tax – before credits -- due to R is

$1,000: 2% X $50,000 municipal taxable income.

• Note that in the previous example Pat’s tax –

before credits -- due to R was also $1,000.

• Pat’s nonrefundable credit will be $556 -- not

$1,000.

48 48

Still Another Example (continued)

• Reason: Pat’s -$40,000 loss from PTE C must

be “apportioned” to (i) the income from PTE A and (ii) the income from PTE B.

• The amount of the PTE C’s loss apportioned

to PTE A’s $50,000 income is -$22,222: $50K from PTE A/[$50K from PTE A + $40K from PTE B] X -$40,000 loss from PTE C.

• So, the credit with respect to PTE A tax paid

will be $566: 2% tax rate in municipality A X [$50,000 PTE A’s profit - $22,222 PTE C’s loss apportioned to PTE A]. Recall that PTE B paid no tax.

49

50

Example 4 of 5 RE: Credits

Facts:

• Pat lives in municipality R, a 2.5% municipality

which allow a full credit for municipal income taxes paid elsewhere.

• Pat has invested in PTE A which is located

solely in municipality A, a municipality imposing a 2.5% tax rate.

• Pat's share of the PTE A's profit is $10,000,

and Pat's share of the municipality A tax paid by PTE A is $250: $10,000 X 2.5%. Facts:

• Pat lives in municipality R, a 2.5% municipality

which allow a full credit for municipal income taxes paid elsewhere.

• Pat has invested in PTE A which is located

solely in municipality A, a municipality imposing a 2.5% tax rate.

• Pat's share of the PTE A's profit is $10,000,

and Pat's share of the municipality A tax paid by PTE A is $250: $10,000 X 2.5%.

51

Example 4 of 5 RE: Credits

Facts:

• On account of an IRC section 754 election to

deduct an additional $10,000, Pat's net share

• f PTE A profit reported on IRS Schedule E is
• 0-.
• Pat also has investment in PTE B which is not

located in any municipality imposing income tax.

• Pat's share of PTE B profit is $10,000 which

Pat properly reports on IRS Schedule E. Facts:

• On account of an IRC section 754 election to

deduct an additional $10,000, Pat's net share

• f PTE A profit reported on IRS Schedule E is
• 0-.
• Pat also has investment in PTE B which is not

located in any municipality imposing income tax.

• Pat's share of PTE B profit is $10,000 which

Pat properly reports on IRS Schedule E.

52

Example 4 of 5 RE: Credits

Facts:

• Pat's municipal taxable income ("MTI") for

municipality R is $10,000: + $10,000 from PTE A - $10,000 IRC section 754 adjustment + $10,000 from PTE B.

• Pat's municipality R tax before credits is

$250: $10,000 MTI X 2.5%.

• Pat can claim no credit with respect to the

$250 amount passing through from PTE A.

53

Example 4 of 5 RE: Credits

Reason:

• The municipality R tax on Pat's share of PTE

A's profit, after adjustment for the IRC section 754 election, is -0-.

• The $250 credit passing through from PTE A

to Pat can only be used to reduce the municipality R tax otherwise due on account of Pat's investment in PTE A.

• Because the municipality R tax otherwise due on account
• f Pat's investment in PTE A is -0-, no credit, with respect

to PTE A’s tax paid to municipality A, is available to Pat.

Reason:

• The municipality R tax on Pat's share of PTE

A's profit, after adjustment for the IRC section 754 election, is -0-.

• The $250 credit passing through from PTE A

to Pat can only be used to reduce the municipality R tax otherwise due on account of Pat's investment in PTE A.

• Because the municipality R tax otherwise due on account
• f Pat's investment in PTE A is -0-, no credit, with respect

to PTE A’s tax paid to municipality A, is available to Pat.

54

Example 5 of 5 RE: Credits

Facts:

• Pat lives in municipality R, a 2.5% municipality

which allow a full credit for municipal income taxes paid elsewhere.

• Pat has invested in PTE A which is located

solely in municipality A, a municipality imposing a 2% tax rate.

• Pat's share of the PTE A's profit is $10,000,

and Pat's share of the municipality A tax paid by PTE A is $200: $10,000 X 2%. Facts:

• Pat lives in municipality R, a 2.5% municipality

which allow a full credit for municipal income taxes paid elsewhere.

• Pat has invested in PTE A which is located

solely in municipality A, a municipality imposing a 2% tax rate.

• Pat's share of the PTE A's profit is $10,000,

and Pat's share of the municipality A tax paid by PTE A is $200: $10,000 X 2%.

Example 5 of 5 RE: Credits

Facts:

• On account of an IRC section 754 election to

deduct an additional $9,000, Pat's net share of PTE A profit reported on IRS Schedule E is $1,000.

• Pat's municipal taxable income ("MTI") for

municipality R is $1,000: + $10,000 from PTE A - $9,000 IRC section 754 adjustment.

• Pat's municipality R tax before credits is

$25: $1,000 MTI X 2.5%.

• Pat’s allowable credit will be $20, not $25.

Facts:

• On account of an IRC section 754 election to

deduct an additional $9,000, Pat's net share of PTE A profit reported on IRS Schedule E is $1,000.

• Pat's municipal taxable income ("MTI") for

municipality R is $1,000: + $10,000 from PTE A - $9,000 IRC section 754 adjustment.

• Pat's municipality R tax before credits is

$25: $1,000 MTI X 2.5%.

• Pat’s allowable credit will be $20, not $25.

56

Example 5 of 5 RE: Credits

Reason:

• On account of the IRC section 754 deduction,

Pat is paying to municipality R municipal income tax on only $1,000 of the PTE A distributive share (that tax, before credits, is $25).

• With respect to that $1,000 distributive share

amount, the municipal income tax paid by PTE A to municipality A was only $20: $1,000 X 2% tax rate in municipality A. Reason:

• On account of the IRC section 754 deduction,

Pat is paying to municipality R municipal income tax on only $1,000 of the PTE A distributive share (that tax, before credits, is $25).

• With respect to that $1,000 distributive share

amount, the municipal income tax paid by PTE A to municipality A was only $20: $1,000 X 2% tax rate in municipality A.

Example 5 of 5 RE: Credits

Reason:

• So, the credit available to Pat is only $20 --

the lesser of . . . . . . the $25 tax, before credits, owed to municipality R with respect to the net $1,000 PTE A profit Pat reported on IRS Schedule E,

• r

. . . the $20 municipal income tax paid by PTE A to municipality A with respect to that net $1,000 profit Pat reported on IRS Schedule E.

• So, Pat owes $5 income tax to municipality A.

Reason:

• So, the credit available to Pat is only $20 --

the lesser of . . . . . . the $25 tax, before credits, owed to municipality R with respect to the net $1,000 PTE A profit Pat reported on IRS Schedule E,

• r

. . . the $20 municipal income tax paid by PTE A to municipality A with respect to that net $1,000 profit Pat reported on IRS Schedule E.

• So, Pat owes $5 income tax to municipality A.

Example 5 of 5 RE: Credits

• So, Pat owes $5 income tax to municipality A.
• However, Pat does not have to pay any net

tax due which is . . . . . . “ten dollars or less” per division (G)(1) of Ohio Revised Code section 718.05

• r

. . . “less than ten dollars” per division (H)(1) of Ohio Revised Code section 718.05.

• So, Pat owes $5 income tax to municipality A.
• However, Pat does not have to pay any net

tax due which is . . . . . . “ten dollars or less” per division (G)(1) of Ohio Revised Code section 718.05

• r

. . . “less than ten dollars” per division (H)(1) of Ohio Revised Code section 718.05.

Example RE: NOL’s

• Pat lives in municipality A (2% tax rate).
• Lee lives in township T.
• Pat and Lee each own 50% of a PTE

doing business solely in municipality A.

• In year 2025 the PTE has a non-passive

activity loss of $50,000. In year 2026 the PTE has a profit of $50,000.

• In both years Pat and Lee own separate

rental properties in municipality A.

• For each year Pat and Lee each have

rental property profit of $25,000.

59

Example RE: NOL’s (continued)

Results:

• In 2025 the PTE owes no tax because the

PTE’s municipal taxable income for A is

• $50,000.
• In 2025 Pat owes no “residence” tax.
• Reason: the -$25,000 distributive share of

loss from the PTE offsets Pat’s $25,000 rental property profit.

• So, Pat’s year 2025 municipal taxable

income is -0-.

60 60

Example RE: NOL’s (continued)

Results (continued):

• In 2025 Lee will owe to A “nonresidence” tax
• n the $25,000 rental property profit.
• Reason: nonresidents must exclude from

nonresident municipal taxable income all income (loss) from PTE’s. (A)(1)(c), (B), (B)(2), & (D)(2) of 718.01.

• So, Lee’s municipal taxable income for A is

$25,000 attributable to the rental property in A.

• Recall that resident Pat owes no tax to A, but

nonresident Lee does owe tax to A. Same income; same sources; same location.

61 61

Example RE: NOL’s (continued)

Results (continued):

• In 2026 the PTE owes no tax because the

PTE’s municipal taxable income for A is

• 0-: current year profit of $50,000 minus

$50,000 NOL carryforward deduction.

• In 2026 Pat’s municipal taxable income for A

will be $50,000: $25,000 distributive share of profit from the PTE + $25,000 rental property profit.

• In 2026 Lee’s municipal taxable income for A

will be $25,000: $25,000 rental property profit. Nonresidents do not include PTE amounts.

Appendix 1 100% of a resident S Corporation shareholder’s distributive share is subject to city resident income tax for the following municipalities:  Jefferson Village  North Kingsville  Highland Hills  Lindale  North Randall  Richmond Heights  Walton Hills  Burton  Yellow Springs  Indian Hills  Wyoming  Liberty Village Center  Fairport Harbor  Painesville  Perry  Seville  Riverside  Peninsula  Bowling Green  Perrysburg Source: Ray Turk, CPA

Appendix 2 The following municipalities received a majority vote in November of 2004 allowing each municipality to tax a resident S Corporation shareholder’s distributive share of income on an Ohio-apportioned basis:  Ashtabula County – Geneva on the Lake Village, Orwell Village  Auglaize County – Minster Village, New Bremen Village, New Knoxville Village, St. Mary’s City  Columbiana County – Columbiana City, East Liverpool City, East Palestine City, Lisbon Village, Salem City  Cuyahoga County – Bedford City, Brook Park City, Brooklyn Heights Village, Chagrin Falls Village, Cleveland City, Cleveland Heights City, Cuyahoga Heights Village, Euclid City, Highland Heights City, Lakewood City, Maple Heights City, Oakwood Village, Parma Heights City, Seven Hills City, Solon City, South Euclid City, Valley View Village, Warrensville Heights City, Woodmere Village  Delaware County – Powell City  Fairfield County – Pickerington City  Franklin County – Gahanna City  Gallia County – Gallipolis City  Geauga County – Chardon City  Hancock County – Findlay City  Huron County – Willard City  Lake County – Eastlake City, Grand River Village, Mentor City, Wickliffe City, Willoughby City, Willoughby Hills City  Licking County – Heath City, Johnstown Village, Newark City  Lorain County – Amherst City, Avon City, Avon Lake City, Lorain City, Sheffield Lake City, Sheffield Village  Lucas County – Holland Village, Maumee City, Oregon City, Sylvania City, Whitehouse Village  Mahoning County – Campbell City, Canfield City, Sebring Village  Medina County – Brunswick City  Ottawa County – Port Clinton City, Streetsboro City  Richland County – Bellville Village, Butler Village, Lexington Village, Mansfield City, Ontario City  Sandusky County – Fremont City  Seneca County – Fostoria City  Shelby County – Anna Village, Botkins Village, Jackson Center Village, Fort Loramie Village, Russia Village  Stark County – Alliance City, Canton City, North Canton City  Summit County – Akron City, Barberton City, Boston Heights Village, Cuyahoga Falls City, Fairlawn City, Green City, Lakemore Village,

Macedonia City, Munroe Falls City, Northfield Village, Norton City, Richfield Village, Stow City, Twinsburg City  Union County – Marysville City  Van Wert County – Van Wert City  Warren County – Mason City  Wayne County – Wooster City  Wood County – North Baltimore Village Source: Ray Turk, CPA

Media Relations Office Washington, D.C. Media Contact: 202.622.4000 www.IRS.gov/newsroom Public Contact: 800.829.1040

Wage Compensation for S Corporation Officers

FS-2008-25, August 2008 Corporate officers are specifically included within the definition of employee for FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax Act) and federal income tax withholding under the Internal Revenue Code. When corporate

• fficers perform services for the corporation, and receive or are entitled to receive

payments, their compensation is generally considered wages. Subchapter S corporations should treat payments for services to officers as wages and not as distributions of cash and property or loans to shareholders. S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. The Internal Revenue Code establishes that any officer of a corporation, including S corporations, is an employee of the corporation for federal employment tax purposes. S corporations should not attempt to avoid paying employment taxes by having their

• fficers treat their compensation as cash distributions, payments of personal expenses,

and/or loans rather than as wages. This fact sheet clarifies information that small business taxpayers should understand regarding the tax law for corporate officers who perform services. Who’s an employee of the corporation? Generally, an officer of a corporation is an employee of the corporation. The fact that an officer is also a shareholder does not change the requirement that payments to the corporate officer be treated as wages. Courts have consistently held that S corporation

• fficer/shareholders who provide more than minor services to their corporation and

receive or are entitled to receive payment are employees whose compensation is subject to federal employment taxes. The Treasury Regulations provide an exception for an officer of a corporation who does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration. Such an officer would not be considered an employee. What's a Reasonable Salary?

The instructions to the Form 1120S, U.S. Income Tax Return for an S Corporation, state "Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation." The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly. However, if cash or property or the right to receive cash and property did go the shareholder, a salary amount must be determined and the level of salary must be reasonable and appropriate. There are no specific guidelines for reasonable compensation in the Code or the

• Regulations. The various courts that have ruled on this issue have based their

determinations on the facts and circumstances of each case. Some factors considered by the courts in determining reasonable compensation: Training and experience Duties and responsibilities Time and effort devoted to the business Dividend history Payments to non-shareholder employees Timing and manner of paying bonuses to key people What comparable businesses pay for similar services Compensation agreements The use of a formula to determine compensation Medical Insurance Premiums treated as wages. The health and accident insurance premiums paid on behalf of the greater than 2 percent S corporation shareholder-employee are deductible by the S corporation as fringe benefits and are reportable as wages for income tax withholding purposes on the shareholder-employee’s Form W-2. They are not subject to Social Security or Medicare (FICA) or Unemployment (FUTA) taxes. Therefore, this additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement, issued to the shareholder, but would not be included in Boxes 3 or 5 of Form W-2. A 2-percent shareholder-employee is eligible for an AGI deduction for amounts paid during the year for medical care premiums if the medical care coverage is established by the S corporation. Previously, “established by the S corporation” meant that the medical care coverage had to be in the name of the S corporation.

In Notice 2008-1, the IRS stated that if the medical coverage plan is in the name of the 2percent shareholder and not in the name of the S corporation, a medical care plan can be considered to be established by the S corporation if: the S corporation either paid or reimbursed the 2percent shareholder for the premiums and reported the premium payment or reimbursement as wages on the 2percent shareholder’s Form W-2. Payments of the health and accident insurance premiums on behalf of the shareholder may be further identified in Box 14 (Other) of the Form W-2. Schedule K-1 (Form 1120S) and Form 1099 should not be used as an alternative to the Form W-2 to report this additional compensation. —30—