IT 2006-02– Inapplicability of Ohio Resident Credit with
Kentucky Corporate Income Tax – Issued March, 2006
The purpose of this information release is to address the
inapplicability of the Ohio resident credit with respect to
Kentucky corporation income tax paid by or for pass-through
entities in which Ohio residents have an equity investment.
INAPPLICABILITY OF THE OHIO RESIDENT CREDIT
As this information release explains below,
Ohio residents are not entitled to claim the Ohio Revised
Code section (“R.C.”) 5747.05(B) resident tax credit with
respect to the Kentucky corporation income tax imposed on
single member limited liability companies (“LLCs”)
disregarded for federal income tax purposes, LLCs treated as
partnerships for federal income tax purposes, LLCs treated as
S corporations for federal income tax purposes, S
corporations, limited liability partnerships, and limited
partnerships. This information release hereinafter
refers to these entities as “KY-taxable PTE’s.” This
credit is not available even if the Ohio resident elects to
pay the Kentucky corporation income tax on behalf of the
KY-taxable PTE.(1)
The credit is unavailable because of (i) the application of
R.C. 5747.05(B)(4) and (ii) the application of R.C.
5747.05(B)(2) – either division by itself is sufficient to
make the credit unavailable.
Kentucky
Corporation Income Tax
Effective for taxable years beginning on or after January 1,
2005 the Kentucky corporation income tax base was expanded to
include KY-taxable PTE’s. The Kentucky corporate income
tax on KY-taxable PTE’s is a tax imposed on the business
entity, itself. Kentucky law does not impose this tax
on the investors, and the equity investors are not primarily
liable for (but, per an administrative rule, can elect to
become liable for) any unpaid Kentucky corporate income tax
imposed on the KY-taxable PTE. For comparison, see Ohio
form IT-4708 composite income tax return: under Ohio Revised
Code section 5747.08 equity investors in pass-through
entities can choose to have their pass-through entities pay
the Ohio income tax otherwise due by the equity investors,
but each equity investor remains personally liable for
her/his unpaid Ohio individual income tax, if any.
R.C.
5747.05(B)(4)
This portion of Ohio law states that
Ohio residents cannot claim the resident credit “ . . . to
the extent that for any taxable year the taxpayer had
directly or indirectly deducted, or was required to directly
or indirectly deduct, the amount of income tax liability to
another state or to the District of Columbia in computing
federal adjusted gross income.”(2)
Internal Revenue Code (“IRC”) sections 165 and 212 allow the
taxpayer to deduct, among other things, state income
taxes. If the state income taxes are imposed either on
an individual’s trade or business or on the individual’s
property held for the production of rents and royalties, then
the individual must deduct such state income taxes when s/he
computes federal adjusted gross income.(3)
When a state imposes an income tax on a pass-through entity
either conducting a trade or business or holding property for
the production of rents and royalties, then each individual
having a distributive share of income from that pass-through
entity must deduct, when determining her/his federal adjusted
gross income, her/his proportionate share of such income
taxes.(4)
Because the Kentucky corporation income tax is imposed on the
KY-taxable PTE itself, then each individual who has an equity
investment in the KY-taxable PTE is required to deduct, when
determining her/his federal adjusted gross income, her/his
proportionate share of the Kentucky corporate income tax
imposed on the KY-taxable PTE. As such, R.C.
5747.05(B)(4) applies to deny to the Ohio taxpayer the
resident credit with respect to the Kentucky corporate income
tax, imposed on the KY-taxable PTE, which the Ohio taxpayer
directly or indirectly deducted, or was required to deduct
directly or indirectly, when computing her/his federal
adjusted gross income.
R.C.
5747.05(B)(2)
Because the Kentucky corporation income tax is imposed on the
KY-taxable PTE, itself, and is not imposed directly on the
equity investors in the KY-taxable PTE, Ohio
residents who are equity investors in KY-taxable PTE’s are
not entitled to claim the R.C. 5747.05 resident credit with
respect to the Kentucky corporation income tax for which the
KY-taxable PTE is liable. R.C. 5747.05(B)
provides for a resident credit when (if) a portion of the
Ohio resident’s Ohio adjusted gross income is subjected to
tax by another state. With respect to the Kentucky
corporation income tax, it is the pass-through entity – and
not the equity investor – which is subject to the
tax.
Granted, the Ohio resident who is an equity investor in a
KY-taxable PTE will include in his/her Ohio adjusted gross
income his/her proportionate share of the income which, in
the hands of the pass-through entity, was subject to Kentucky
corporate income tax (just as the Ohio resident who is an
equity investor in a C corporation which is doing business in
Kentucky and which has a dividend pay-out ratio of 100% will
include in his/her income a proportionate share of the C
corporation’s income that was subject to Kentucky corporate
income tax). But it is not the Ohio resident’s income
which is subject to the Kentucky corporate income tax;
rather, it is the entity’s income which is subject to the
Kentucky corporate income tax.
Kentucky law also provides that partners, members, and
shareholders of the KY-taxable PTE’s shall continue to report
and pay Kentucky individual income tax on the distributive
share of net income, gain, loss, or deduction determined as
merely as practicable in a manner identical to that required
for federal income tax purposes except to the extent required
by differences between Kentucky income tax law and federal
income tax law and regulations. These partners,
members, and shareholders will receive a Kentucky income tax
credit based upon their proportionate share of the Kentucky
corporate income tax which the KY-taxable PTE paid. See
Kentucky Revised Statutes 141.010 and 141.420.
To the extent Ohio residents remain liable for any Kentucky
individual income tax after allowance of all Kentucky credits
(both nonrefundable and refundable credits other than
withholding tax and estimated income tax payments) and to the
extent that division R.C. 5747.05(B)(4) does not apply (see
discussion above), the Ohio resident may claim the resident
credit equal to the lesser of the following two
amounts:
- The amount of Ohio income tax otherwise due on such
portion of the resident taxpayer’s Ohio adjusted gross income
subjected to Kentucky income tax. However, the amount
shall not exceed the portion of total Ohio tax due that the
amount of the resident taxpayer’s Ohio adjusted gross income
subjected to Kentucky income tax bears to the total Ohio
adjusted gross income of the resident taxpayer. See
R.C. 5747.05(B)(1).
- The amount of Kentucky income tax liability reduced by
all Kentucky credits (nonrefundable and refundable other than
estimated income tax and withholding tax). The credit
computed under this provision shall not exceed the amount of
Ohio income tax otherwise due before application of any
credits. See R.C. 5747.05(B)(2). Note that if the
Ohio resident taxpayer elects, under the provisions of 103
KAR 15:020E, to pay the Kentucky corporation income tax, or
any portion of that tax, otherwise due by the KY-taxable PTE
in which the Ohio resident taxpayer is an equity investor,
then such payment is part of the “amount of
Kentucky income tax liability.” However, to the extent
that R. C. 5747.05(B)(4) applies (see discussion, above), the
Ohio resident cannot claim the resident credit.
- Ohio resident taxpayers who claim the resident credit
with respect to Kentucky corporate income tax paid by, or on
behalf of, the KY-taxable PTE will be subject to assessment
for unpaid tax, failure-to-pay penalties, and interest.
For those taxpayers who have filed their Ohio income tax
return before April 1, 2006 and they have claimed the credit,
they can avoid failure-to-pay penalties if by October 15,
2006 they file an amended Ohio income tax return (Ohio form
IT-1040X) and pay the additional tax and interest (at an
annual interest rate of 6.0 percent).
For any questions regarding this matter, please contact the
Taxpayer Services Division at (800) 282-1780, the Individual
Income/School District Income Tax Division at (614) 387-0224,
or e-mail questions to ODT via "Contact Us" on the
department’s home page at tax.ohio.gov.
ENDNOTES:
(1) See 103 KAR 15:020E.
(2) Note that R.C. 5747.01(A) uses the phrases
“federal adjusted gross income” and “Ohio adjusted gross
income.” “Federal adjusted gross income” means the IRC
section 62(a) definition of “adjusted gross income.”
“Ohio adjusted gross income” means federal adjusted gross
income as further adjusted by the amounts set forth in
divisions (A)(1) through and including (A)(21) of R.C.
5747.01.
(3) See IRC section 62. IRC section 62(a)’s
“general rule” states as follows: “For purposes of this
subtitle, ‘adjusted gross income’ means, in the case of an
individual, gross income minus the following
deductions:” This provision does not provide that the
taxpayer has the option to forego any deduction listed in
that section; rather, this provision sets forth the
definition of “adjusted gross income.” To comply
with the definition, each individual must deduct, and is
required to deduct, the amounts set forth in IRC sections
62(a)(1) through and including 62(a)(18).
(4) See IRC sections 702(a), 1363, and 1366.