Web Content Viewer
Actions
Income - Business Income and the Business Income Deduction
Income - Business Income and the Business Income Deduction

For tax years 2016 and forward, the first $250,000 of business income earned by taxpayers filing “Single” or “Married filing jointly,” and included in their federal adjusted gross income, is 100% deductible. For taxpayers who file “Married filing separately,” the first $125,000 of business income included in their federal adjusted gross income is 100% deductible. Any remaining business income above these thresholds is then taxed at a flat 3% rate.

For tax year 2015, 75% of the first $250,000 of business income earned by taxpayers who filed “Single” or “Married filing jointly,” and included in their federal adjusted gross income, was deductible. For taxpayers who filed “Married filing separately,” 75% of the first $125,000 of business income included in their federal adjusted gross income was deductible.

See R.C. 5747.01(A)(28).

Any individual with any business income is eligible to claim the deduction, regardless of residency status or where the income is earned. Business income from pass-through entities qualifies for the deduction regardless of the individual’s ownership percentage.

The deduction can only be claimed by filing an individual income tax return (Ohio IT 1040), and completing the Ohio Schedule IT BUS. Entities are not eligible to claim the Business Income Deduction (i.e. on the IT 1140, IT 4708, or IT 1041).

See R.C. 5747.01(A)(28).

“Business income” means income, including gain/loss from any of the following:

  • Transactions, activities, and sources in the regular course of a trade or business operation;
  • From real, tangible, and intangible property if the acquisition, rental, management, and disposition of the property constitute integral parts of the regular course of a trade or business operation;
  • From a partial or complete liquidation of a business, including gain or loss from the sale or other disposition of goodwill; OR
  • Compensation and guaranteed payments paid by a pass-through entity, or a professional employer organization (PEO) on its behalf, to an investor who directly or indirectly owns 20% or more of the entity.

Business income could include income from a sole proprietorship, farming, or a pass-through entity (including any partnership, S Corporation, or LLC).

“Nonbusiness Income” means income that is not business income. This generally includes:

  • Compensation and guaranteed payments;
  • Rents and royalties; AND
  • Interest, dividends and capital gains.

See R.C. 5747.01(B), (C) and 5733.40(A)(7).

Only business income qualifies for the deduction. The determination as to whether an item of income is business income is a very fact intensive analysis. As such, it is not always possible to provide a quick and easy determination regarding business income. In its simplest form, the character of income as "business income" depends on the presence of a trade or business where the income arises from:

  • The regular activities or transactions of said business (the Transactional Test);
  • The acquisition, use, or disposition of business property, provided the property is integral to the regular business operations (the Functional Test); OR
  • A partial or complete liquidation of the trade or business (i.e. winding up of the entire business or a line of business) including gain or loss from the sale or other disposition of goodwill.

If the income at issue fits one of these three tests, then it is most likely business income.

Income is characterized at the time it is earned. For example, if the income is earned by a pass through-entity in the regular course of a trade or business, then the income will retain its "business income" character as it passes through to the entity's investors. However, remember that the mere presence of a pass-through entity does not, in and of itself, indicate the existence of a trade or business.

Taxpayers should report their income as business income based on their own analysis of the facts related to the income at issue as applied to the above-listed tests. They should attach a short statement to their return explaining their position on items of business income, which should include all relevant facts and law used in making the determination. Since this determination is subject to review by the Department of Taxation, taxpayers should retain any records that support their claim that certain income is business income.

See R.C. 5747.01(B).

The determination as to whether an item of income is business income is a very fact intensive analysis. As such, it is not always possible to provide a quick and easy determination regarding business income. The following examples are meant to provide a general guide in determining what is and is not business income. Additionally, see the “Ohio Definitions and Examples of Business Income and Nonbusiness Income” section of the individual income tax instructions for more examples.

Example A: Jamaal manages a portfolio of mineral rights for various properties in Ohio. He routinely, through the course of business transactions, trades and manages this portfolio. In this case, the income from these mineral rights could be considered business income eligible for the Business Income Deduction.

Example B: Christine lives on a golf course that hosts a yearly local tournament. In years when she’s not in town, she rents out her house during the tournament. Since she irregularly and temporarily rents her primary residence, she is not conducting a business, and thus the rents are not business income.

Example C: Victoria and her sister Cathy wish to earn some extra money. They pool their funds to invest in the stock market. They make the investment through a pass-through entity, VC Ventures, which they set up for this purpose. After their initial investment, they spend minimal time researching, managing or trading the stocks. Despite their inactivity, the stock does well and generates a capital gain of $1,000,000 for each of them.

The capital gain is nonbusiness income. Victoria and Cathy’s minimal actions are not enough to demonstrate that they are engaged in a trade or business. Additionally, although they set up VC Ventures, the mere presence of a pass-through entity also does not create a trade or business.

Example D: Stan is actively engaged in the “sharing economy.” He provides rides as part of a ride-share program, rents out a room in his home via the internet, and performs various tasks for hire via an application on his phone. If Stan regularly engages in these activities, the resulting income could be business income eligible for the Business Income Deduction

For more information on the sharing economy, see the IRS-created Sharing Economy Resource Center.

Guaranteed payments or compensation paid by a pass-through entity to an investor who directly or indirectly holds at least a 20% interest in the entity are reclassified as business income under Ohio law. Thus, they are eligible for the Business Income Deduction.

The investor’s interest can be in either the profits or the capital of the entity. Additionally, as long as the investor owned at least 20% at any point during the tax year, any guaranteed payments or compensation paid by that entity to the individual are business income.

Additionally, if guaranteed payments or compensation are paid by a professional employer organization (PEO) on behalf of the entity to an investor who owns at least 20%, the amounts are reclassified as business income. For more information on PEOs, see this Ohio Tax Alert.

Indirect ownership does not include constructive ownership (i.e. ownership through a family relationship). For a detailed explanation of “indirect” ownership, see this Ohio Tax Alert.

See R.C. 5733.40(A)(7).

Taxpayers report their business income and loss from all sources on a single IT BUS. Additionally, taxpayers who file married filing jointly should report business income from both spouses on a single IT BUS. The sources of business income should be listed on Part 4 of the IT BUS.

A taxpayer cannot simply list the amounts on these federal schedules on the IT BUS. Only items of business income that are included in federal adjusted gross income should be included on the IT BUS. For example, personal interest from a savings account is reported on Schedule B but is nonbusiness income.
See R.C. 5747.01(A)(28) and 5747.01(B).

All items of business income must be included. “Business income” includes both business gains and business losses. Thus, if the loss is included in the calculation of your federal adjusted gross income, you must include it when calculating your business income.

For example, a taxpayer that reports a gain from one sole proprietorship on federal Schedule C and a loss from another should net the amounts together and report the sum on line 2 of the IT BUS.

However, business losses that a taxpayer was required to carry forward to a future tax year due to federal limitations should not be included because they were not used in the calculation of federal adjusted gross income.

See R.C. 5747.01(B).

These deductions do not constitute “business income” and thus should not be included on the IT BUS. They are adjustments claimed on an individual’s personal return, and are not items of business gain or loss. See R.C. 5747.01(A)(28) and 5747.01(B).

You must list each source of business income, along with your direct/indirect ownership percentage, on Part 4 of the IT BUS. If your ownership percentage changed, list the highest percentage owned at any point during the tax year. 

If the source is a sole proprietorship, enter 100% as your ownership percentage.

If you are filing a joint return and both spouses owned the same business, list the business twice along with each spouses’ respective ownership percentage.

If you are an “employee” for federal income tax purposes, any amount paid to you by your employer is considered compensation under Ohio law. “Employee” includes statutory employees and common law employees, even if they report those wages on federal Schedule C.

Compensation is not business income and therefore does not qualify for the Business Income Deduction.

See R.C. 5747.01(C) and (D).

Generally, rents and royalties, regardless of the source, are nonbusiness income and thus are not eligible for the Business Income Deduction. However, rent and royalty income generated as part of a trade or business or by property that is an integral part of a trade or business operation may be business income.

Thus, if you received income from a company for the right to extract minerals from your property, or from the sale of said minerals, the income is generally nonbusiness income. However, if you can show that you are engaged in a trade or business related to these activities, or the income is from business property (such as farmland), then the income may be business income.

See the FAQ “What are some examples of business income vs. nonbusiness income?” for more information.

See R.C. 5747.01(B) and (C).

Capital gains are generally considered nonbusiness income. Nonbusiness capital gains are not eligible for the Business Income Deduction.

Capital gains include gains from the sale of intangible personal property, such as an individual’s ownership interest in a business. Please note, capital gains resulting from the sale of an individual’s ownership interest in a business that are “deemed asset sales” (e.g. I.R.C. 338(h)(10)) are still considered to be the sale of intangible personal property for Ohio income tax purposes, and thus are generally not eligible for the Business Income Deduction.

See R.C. 5747.01(C).

The Business Income Deduction can only be allocated against business income. Use Ohio form IT NRC to determine the proper allocation of your business income and the Business Income Deduction.

The Ohio Resident Credit is based on the portion of Ohio adjusted gross income (OAGI) subjected to income tax by another state. Because the Business Income Deduction (BID) reduces OAGI, it may be that the income being taxed by the other state(s) is no longer in OAGI and thus no longer eligible for the Resident Credit.

In making this determination, resident taxpayers may allocate their Business Income Deduction against any Ohio business income first. Any remaining portion of the deduction should be allocated against the non-Ohio portion of business income.

Example: Jamie has $300,000 of business income and takes the maximum $250,000 deduction on Ohio Schedule A. Jamie determines that $150,000 of the business income is Ohio-sourced and $150,000 is sourced to Indiana. Jamie’s Indiana tax return shows $150,000 of income taxed and she paid $4,845 in income tax to Indiana. In determining what portion of her OAGI was taxed by Indiana, she must allocate the $250,000 BID.

She allocates $150,000 of the BID against the Ohio portion of business income. The remaining $100,000 of the BID is allocated against the $150,000 of Indiana business income. This means that only $50,000 ($150,000 - $100,000) of the Indiana-sourced business income is still in Jaime’s OAGI. So when she calculates her Resident Credit, she reports the portion of OAGI subjected to tax by other states as $50,000.

For tax years 2019 and forward, the Business Income Deduction does not reduce either school district income tax base.

For tax years prior to 2019:
Traditional Tax Base:
Taxpayers who claim the Business Income Deduction on their Ohio return are required to add back the deduction amount on their Ohio SD 100 school district income tax return.

Earned Income Tax Base: Taxpayers who reside in an earned income base tax school district are not required to add back any of the Business Income Deduction in calculating their school district tax base.

For more information, see the FAQ category "Income - School District".

See R.C. 5478.01(E)(1).

The federal QBID has no impact on your Ohio return. First available for tax year 2018, the federal QBID was created as part of the Tax Cuts and Jobs Act (TCJA). It is taken after the computation of federal adjusted gross income (FAGI). Since the Ohio income tax return starts with FAGI, it does not factor into your Ohio income tax calculation.

Furthermore, the federal QBID is separate from Ohio’s Business Income Deduction. Thus, you cannot simply claim the federal QBID as your Ohio Business Income Deduction. Instead, you must continue to complete the Ohio Schedule IT BUS.

See R.C. 5747.01(A)(28).

Additional Resources

Additional Resources