Ohio Elective Pass-Thru Entity (PTE) Tax To Save On Personal Taxes
For 2022 (and future tax years), Ohio has introduced an elective tax that applies to pass-thru business entities (partnerships and s-corp only). I understand that it might seem odd to ELECT to pay an optional tax, but this one could save you on your personal IRS tax returns, ultimately. But see the bullets at the bottom of this article for some considerations and let’s talk about your specific situation to see if this may be a good idea for your company.
A more detailed explanation of how it works is below, but here is the Cliff’s Notes version - your business pays now, you’ll get the money back by way of a tax reduction (or refund) through Ohio personal taxes, and you’ll get a 2024 business write off to save you money in the future. We will charge $100 for filing the related forms.
Here’s is how it works:
For 2023, your business (again, s-corp or partnerships only) elects to file Form 4738 and it will pay 3% of your business profit (plus 3% of owner pay) by April 15, 2024. For 2023 taxes, you will get a credit on your personal Ohio return for the tax paid by the business. That is a dollar-for-dollar reduction of your Ohio tax liability (and if the credit is higher than your tax bill, you’ll get a refund).
For 2024, your business will have a tax deduction for the state taxes paid during 2024. And next year, the business profit reported on your 2024 business tax return will be reduced by that deduction. (thus the IRS savings on your personal taxes by electing this tax)
Here’s an example - let’s say you have a s-corp (ABC Inc), it has $100,000 profit for 2023, and it is owned by two Ohio residents 50/50 (Owner 1 and Owner 2). Let’s say each of them has a $60,000 salary each, as owner-employees of the s-corp. By electing to file and pay the tax with Form 4738, ABC Inc will owe $6600 in taxes by 4/15/24 (3% of the sum of $100k of profit + $60k salary of Owner 1 + $60k salary of Owner 2). But Owner 1 and Owner 2 will be able to each claim a credit of $3300 on their Ohio tax returns. So those transactions sort of cancel each other out. Another way to think of it — the business is paying a portion of the owners’ personal tax bill through the business.
And a year from now when filing the 2024 tax return for the business, we can claim a deduction for the $6600 paid in 2024, making each owner’s business profit (on their K-1) $3300 lower. That means each owner saves on their 2023 IRS taxes. Actual tax savings will vary per individual, but I would think low-end savings might be $500 in this scenario for each owner. Maybe assume at least 15% of the tax paid to the state will be saved.
This deduction is meant to be a workaround for the state and local tax (SALT) deduction that was limited in 2018 with some federal tax law changes. Before 2018, most people itemized their personal deductions if they owned a home and now, most people claim the standard deduction. A big part of that change was limiting the SALT deduction to $10,000 total (even if you paid more in state, local, and property taxes). It made the standard deduction a better deal for most people. By electing this new Form 4738 pass-thru entity tax, you are effectively getting a portion of that SALT deduction benefit back (by your business taking a deduction).
What’s the catch? Here are a few things to consider before electing this new tax:
Congress can change tax laws - and this Ohio law does reduce IRS tax revenue. So there’s always a chance the IRS will eliminate the deduction businesses can claim, rendering this elective tax ineffective.
There is a chance the IRS would ask you to claim the personal refund from the state as income the year you receive it, even if you do not itemize your personal deductions. This would be a limitation due to a more complex rule discussed here: https://www.irs.gov/pub/irs-drop/rr-19-11.pdf. Some tax practitioners are not recommending the Ohio PTE program because of this, so understand this is a risk you would want to strongly consider. If you have to claim the refunds as income, it will invalidate the tax savings and there would be no point in participating in the elective tax.
For 2023 and beyond, your business has to pay 3% of your profit + owner pay — cashflow for your business may make that tax bill a challenge.
Also for 2024, if you intend to elect this credit for 2024 taxes, you have to pay estimated taxes (with a 3% tax rate) this year or be charged interest/fees. So that’s 4 payments for your business to make this year to pay 3% of 2024 profit + owner pay as you earn this year.
Charitax will only calculate that estimated tax amount for monthly bookkeeping clients. Otherwise, you will be responsible for calculating and making timely 2024 quarterly payments if you want to continue to take advantage of the credit. They are due the 15th of the month following each quarter (for instance, they are due on 4/15/2024 for the quarter ending 3/31/2024) using these vouchers: https://tax.ohio.gov/static/forms/pass-through_entities/generic/pte-it4738upc-fi.pdf (select “IT 4738ES” on the voucher)).
This credit is not for sole proprietors or single-member LLCs taxed as a sole proprietor (i.e Schedule C filers) - it’s only for partnerships, s-corps, or LLCs taxed as one of those business types.
For further reading, here are FAQs about this elective tax from Ohio - https://tax.ohio.gov/help-center/faqs/pass-through-entities-fiduciaries-electing-pass-through-entities-epte-it4738 and https://tax.ohio.gov/static/ohiotaxalert/archivedalerts/ohiopteworkaround8522.pdf