The recent Ohio biennial budget bill included an income tax credit for investments in qualifying small businesses. This was a late addition, and it was made in response to some rather depressing statistics about Ohio business over the last decade:
· Ohio has lost more jobs than any state other than California and Michigan
· Ohio has ranked in the bottom 10 states for population growth
· Ohio’s economy has ranked in the bottom 5 states
The new tax credit is referred to as “Invest Ohio.” The credit will run for two years (Ohio has biennial budgets), and the state estimates that the program will cost $100 million. The state hopes to stimulate at least 30,000 jobs, at which number the state anticipates to breakeven.
The credit is nonrefundable. You need to have an Ohio income tax to make this worthwhile.
Let’s go through the steps:
(1) This is an income tax credit. More specifically, only taxpayers with income taxes will be able to use it. You may recall that Ohio C corporations pay a Commercial Activity Tax (or “CAT”) in lieu of income taxes, so this credit is not for C corporations. Rather it is for individuals, passthroughs, trusts and estates.
(2) You have to be an eligible small business.
a. Your total assets are $50 million or less OR your total sales are $10 million or less
i. Because of the “or,” you must meet one of the two tests to qualify.
b. You must have enough presence in Ohio to qualify. There are two alternative tests:
i. More than half your employees are in Ohio.
1. It doesn’t matter how many employees you have. Just one (yourself) is enough.
ii. You have more than 50 full-time equivalent employees in Ohio.
1. This does not need to be more than half.
NOTE: Let’s go over this, as it may not be clear. If you have 2 employees and both are in Ohio, you qualify. If you have 274 employees, of which more than 50 are in Ohio, you qualify. Technically, this second test is done by full-time equivalents rather than employees, but you get the idea.
(3) Fresh money is going into the business as equity.
a. This fresh money is going to acquire, increase or maintain an equity interest.
i. You are not playing banker here. This is not a “Loan from Owner.”
ii. You are receiving shares, units – something- that indicate ownership.
iii. An easy example is someone who becomes a new shareholder in an S corporation by investing $25,000. This is fresh money and he/she has acquired an ownership interest.
1. What is you already own 100%? You cannot go over 100%.
a. Answer: this will count.
(4) You have to spend the money in an approved way.
a. You have to buy tangible personal property.
i. Desks, a copier, computer monitors or a business van will qualify.
b. You can buy real property, as long as it is in Ohio. Ohio will not subsidize that Florida condo.
c. You can buy intangibles, such as patents, copyrights or trademarks.
i. The one that occurred to me was enterprise software or a website.
d. Compensation for new or retrained employees for whom the business is required to withhold Ohio income tax.
i. I am not sure my firm has clients that would incur employee “retraining.”
ii. A new employee will count.
1. There is a big EXCEPT here: the employee cannot be an owner, manager or officer.
iii. The Ohio tax withholding becomes an issue for the border residents. For example, I live in northern Kentucky but work in Cincinnati. I do not have Ohio withholding because of the reciprocal tax agreement. As I read this, I would not qualify.
(5) You have to spend this new money within six months.
(6) The credit is 10 percent.
a. There is a maximum however.
i. The maximum credit is $1,000,000 per taxpayer.
1. If you are married, this becomes $2 million.
b. My understanding is that this $1 million limit is for the first credit period, which is two years. If the credit is renewed, my understanding is that you will get a brand new $1 million limit.
(7) Tax credit period
a. The first period of the program runs from 7/1/2011 to 6/30/2013 (remember: biennial budget).
b. The timing of this credit is odd.
i. You have to wait until the period is up (6/30/13) before you can claim the credit.
1. So an investment in 2011 gets no payoff until 2013.
2. At least you can use it in the same year the period expires.
c. You then get 7 years to use up the credit. More specifically, an investment in 2011 would get to use its credit in tax years 2013 to 2019.
d. IF THE PROGRAM IS CONTINUED IN 2013 …
i. Then the waiting period becomes five years rather than two. That is a long time to it for a credit to kick-in. An investment in 2014 would have to wait until 2019 before using the credit.
(8) You have to keep the money invested for the credit qualifying period.
a. That is, you cannot put money in and take it right back out.
b. But, then again, the first period is only two years. This is not a long time.
(9) Paperwork
a. There is paperwork for …
i. The application and qualification,
ii. The certification, and
iii. A pledge not to dispose of the investment before the end of the holding period
b. In short, the business and its owner will have paperwork. This makes sense, as Ohio wants (at a minimum) to keep track of how many people are using the program.
c. The program is being administered by the Ohio Department of Development. They are your contact, not the Department of Taxation.
(10) Owners of passthrough entities will claim the credit based on their distributive or proportionate share of the entity.
Rick Kruse and I agree that the key point to this credit is the fresh cash. Perhaps the cash is funded by savings, by borrowings, or perhaps by a circular transaction, but somehow new money has to enter the picture. The problem may be getting the fresh cash in the owner’s name.
Think about the following examples:
(1) The S corporation buys a truck. There is a down payment and a term note for the balance. Even if the shareholders sign on the note, there has been no fresh cash into the business, so there would be no tax credit.
(2) The LLC wants to buy shop equipment. There are three members. Only one of the members is willing (or able) to start the required “fresh cash” sequence. Perhaps he/she is the only one with enough savings, enough credit or enough collateral to borrow. Therefore, only one of the members can initiate the “fresh cash” cycle. This situation may be more about member dynamics than tax planning.
(3) The partnership constructs a building. The construction loan is signed by the partners. Under this loan, the draws are disbursed directly by the bank to the contractors and suppliers. Whereas one can argue “fresh cash,” there has been no increase in equity. There has been only an increase in debt.
Here is one that intrigues me:
(4) A key employee is awarded 50 shares under a stock bonus program. The stock vests, so the employee recognizes taxable income on his/her personal return. The business in turn purchases equipment within the requisite six month period. Do we have a "fresh cash” cycle?
BTW, the instructions and directions for this credit are virtually nonexistent as I write this. For the time being there are questions with no answers. For example, can one set up a new company in order to qualify as an “eligible small business” or will the new company being aggregated with an existing company? This is a basic technique – and therefore a basic question - for any tax practitioner.
If your business qualifies as an Ohio eligible small business, you simply must consider this credit in your tax planning. If you will be buying equipment, or trucks, or software, or hiring ANYWAY, why not plan for the credit? If you can’t make it work then you can’t, but at least consider it.
