Pass-Through Entity Investors May Face Ohio Tax Bills

September 17, 2008

The Ohio Department of Taxation (ODT) has announced it will target Ohio residents that previously claimed certain resident tax credits on their Ohio personal income tax returns. The credits relate to taxes paid to other states on profits from certain entities known as pass-through entities (e.g., limited liability companies, partnerships, and S corporations). ODT’s position has been subject to criticism and may be challenged if ODT moves forward with its targeted enforcement. In efforts to encourage cooperation with its position, ODT has offered to waive penalties for Ohio residents who voluntarily pay income tax and interest with respect to the credits by December 1, 2008. Thus, Ohio residents who claimed the credits must decide before the “voluntary” deadline whether to (1) pay taxes and seek a refund, or (2) wait until the taxes are assessed and then decide whether to challenge the assessment. If an Ohio resident elects to wait until an assessment is made, they may be unable to avoid penalties if the challenge to ODT’s position is unsuccessful.

Generally, Ohio residents may receive an Ohio resident tax credit on their income taxes equal to income taxes paid to another state. ODT’s position, however, is that Ohio residents are not entitled to claim a resident tax credit for another state’s corporate income tax imposed on pass-through entities (e.g., Kentucky’s corporate income tax in 2005 and 2006). This position suggests that Ohio taxpayers must amend their federal returns to account for the increase in Ohio taxes due. In addition, Ohio residents are not entitled to the credit for another state’s non-income tax (e.g., Michigan’s single business tax). Further, ODT takes the position that a taxpayer will not receive the resident credit for taxes paid to other states even if they elect to become personally liable for the taxes.

Despite its controversial position, ODT intends to target taxpayers that have been taking a resident tax credit for other states’ corporate income and non-income taxes. After December 1, 2008, ODT will issue billing assessments for taxes, interest, failure-to-pay-timely penalty, interest penalty, and, if applicable late filing penalty to these taxpayers. In general, the assessments will be for years ending on or after June 30, 2005 with respect to taxpayers who claimed credits for other states’ corporate income taxes and for all years within the statute of limitations with respect to taxpayers who claimed credits for other states’ non-income taxes.

Taxpayers who wish to voluntarily pay taxes and interest related to the disallowed credits may use the form located at the following website link: http://tax.ohio.gov/divisions/communications/information_releases/documents/IT_PAY_Form_Final_081208.pdf. As stated above, making payment does not prevent a taxpayer from challenging the Tax Commissioner’s position and requesting a refund of all tax and interest paid. The information release explaining ODT’s position in more detail can be obtained at the following website link: http://tax.ohio.gov/divisions/communications/information_releases/IT-2008_01.stm.

Frost Brown Todd’s State and Local Tax Practice Group has experience dealing with the ODT on the taxation of individuals and pass-through entities. For further information, please contact Frost Brown Todd’s Tax Law Group at (513) 651-6800.

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