Most states tax at least some types of business income derived from the state. As a rule, the details of how income from a specific business is taxed depend in part on the business’s legal form. In most states, corporations are subject to a corporate income tax while income from “pass-through entities” such as S corporations, limited liability companies (LLCs), partnerships, and sole proprietorships is subject to a state’s tax on personal income. Tax rates for both corporate income and personal income vary widely among states. Corporate rates, which more often are flat regardless of the amount of income, generally range from 4% to 9%, and personal rates, which often vary depending on the amount of income, can range from 0% (for small amounts of taxable income) to around 9% or more in some states.
A few states have no corporate income tax, and a few other states have no personal income tax.
Apart from taxing business income through a corporate income tax or a personal income tax, many states impose a separate tax on at least some businesses, sometimes called a “franchise tax” or “privilege tax.” This is frequently defined as a tax simply for the right or “privilege” of doing business in the state. As with state taxes on business income, the specifics of a state’s franchise tax often depend in part on the legal form of the business. Franchise taxes are generally either a flat fee or an amount based on a business’s net worth.
Ohio has a commercial activity tax (“CAT”) that applies to nearly every Ohio business and is based on gross receipts. Ohio also has a corporation franchise tax and associated “litter tax.” However, the latter taxes have largely been phased out and are not covered here. Generally speaking, if you run an Ohio business, you will be subject to the commercial activity tax. In addition, if income from your business passes through to you personally, that income will be subject to taxation on your personal Ohio tax return.
The commercial activity tax, considered a tax on the privilege of doing business in Ohio, is computed based on your business’s gross receipts, as follows:
Ohio has special online registration requirements for the commercial activity tax, as well as special rules about how often, and when, businesses must pay the tax. For example, businesses with over $1 million in gross receipts must pay this tax on a quarterly basis; the quarterly returns are due by the 10th day of the second month following each calendar quarterly tax period (May 10th, August 10th, November 10th, and February 10th).
While Ohio does not generally tax businesses based on their net income, it does tax individual income at marginal rates ranging from 0.587% up to 5.925%.
Let’s briefly look at additional details for five of the most common forms of Ohio business: corporations (C corporations), S corporations, LLCs, partnerships, and sole proprietorships.
Corporations. With rare exceptions not covered here, Ohio corporations are subject to the commercial activity tax.
Example: For the latest tax year, your Ohio corporation had gross receipts of $2,000,000. Other things being equal, your corporation will owe Ohio commercial activity tax in the amount of $2,750 ($150 + .26% of $1,000,000).
S Corporations. An S corporation is created by first forming a traditional corporation, and then filing a special form with the IRS to elect “S” status. Unlike a traditional corporation, an S corporation generally is not subject to separate federal income tax. Rather, taxable income from an S corporation is passed through to the individual shareholders, and each shareholder is subject to federal tax on his or her share of that income. In other words, S corporations are “pass-through” entities. (Note that a shareholder’s share of the S corporation’s income need not actually be distributed to the shareholder in order for the shareholder to owe tax on that amount.) Ohio recognizes the federal S election with regard to income tax, but nonetheless requires S corporations to pay the commercial activity tax. In addition, an individual S corporation shareholder will owe tax to the state on his or her share of the company’s income.
Example: For the latest tax year, your S corporation had gross receipts of $2,000,000 and net income of $1,000,000. The corporation will owe commercial activity tax in the amount of $2,750 ($150 + .26% of $1,000,000). In addition, the $1,000,000 of net income will be allocated to you and your fellow shareholders, and you will each pay tax on your own portions on your respective state tax returns. The marginal rates for each shareholder will vary depending on his or her overall taxable income for the year.
Limited Liability Companies (LLCs). Like S corporations, LLCs are pass-through entities and are not required to pay federal income tax. However, LLCs are required to pay Ohio’s commercial activity tax on gross receipts. In addition, net income from an LLC is distributed to individual LLC members, who then must pay federal and state taxes on the amounts distributed to them.
Note that while by default LLCs are classified for tax purposes as partnerships (or, for single-member LLCs, “disregarded entities”), it is possible to elect to have your LLC classified as a corporation. However, because Ohio’s commercial activity tax applies in the same manner to corporations, partnerships, and disregarded entities, your choice in this regard will not affect how your business is taxed by the state.
Example: For the latest tax year, your multi-member LLC, which has the default tax classification of partnership, had gross receipts of $2,000,000 and net income of $1,000,000. The LLC will owe commercial activity tax in the amount of $2,750 ($150 + .26% of $1,000,000). In addition, the $1,000,000 of net income will be divvied up between you and your fellow LLC members, and you will each pay tax on your own portions on your respective state tax returns. The marginal rates for each member will vary depending on his or her overall taxable income for the year.
Partnerships. Income from partnerships is distributed to the individual partners, who then pay tax on the amount distributed to them on both their federal and state tax returns. Partnerships are also required to pay Ohio’s commercial activity tax on gross receipts.
Sole Proprietorships. Income from your business will be distributed to you as the sole proprietor, and you will pay tax to the state on that income. In addition, your business is also required to pay Ohio’s commercial activity tax on gross receipts.
Note on Multistate Businesses and “Nexus”
Our primary focus here is on businesses operating solely in Ohio. However, if you’re doing business in several states, you should be aware that your business may be considered to have “nexus” with those states, and therefore may be obligated to pay taxes in those states. Also, if your business was formed or is located in another state, but generates income in Ohio, it may be subject to Ohio taxes. The rules for taxation of multistate businesses, including what constitutes nexus with a state for the purpose of various taxes, are complicated. If you run such a business, you should consult with a tax professional.
For further guidance on Ohio’s commercial activity tax, check the Department of Taxation website; a special FAQ page on that site is particularly helpful. For information on business-related taxes in other states, check Nolo’s 50-State Guide to Business Income Tax. And, if you’re looking for detailed guidance on federal income tax issues, check Tax Savvy for Small Business, by Federick Daily (Nolo).