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Nov 4, 2015, 12:00 PM by PICPA State and Federal Taxation Committees

For purposes of claiming a resident credit for taxes paid to OH, the shareholder should classify the portion of OH taxable income attributable to the compensation add-back as compensation.

Scenario:

A taxpayer is a Pennsylvania resident who owns 100 percent of a PA S Corporation which does business in PA and several other states, including Ohio. For income tax purposes, the state of Ohio requires an addback to taxable income for any salaries, wages, guaranteed payments, etc. which are paid to a more than 20 percent owner of a pass-through entity. Presume that for the 2015 tax year, the S Corporation earns a taxable profit of $250,000 after deducting a $750,000 salary to its shareholder and that 20 percent of the S Corporation’s taxable income is apportioned to Ohio. 

For Ohio tax purposes, the $750K salary is added-back to the S Corporation’s tax base and the shareholder thus reports $200,000 in taxable income to OH ($250K S Corp Income + $750K salary addback = $1 Million pre-apportioned OH tax base x 20 percent apportionment factor = $200K OH taxable income).

Q:

For purposes of claiming a credit for taxes paid to OH on his PA tax return, should the shareholder classify the OH compensation addback of $150,000 ($750K salary X 20 percent OH apportionment factor = $150K) as Compensation or should the entire $200K taxed by OH be classified as business income?

A:

For purposes of claiming a resident credit for taxes paid to OH, the shareholder should classify the portion of OH taxable income attributable to the compensation add-back as compensation. Using the figures in the above example, the $150,000 of the OH taxable income attributable to the compensation add-back should be classified as compensation and the $50,000 of the OH taxable income attributable to the taxable profit should be classified as business income.