United States

Ohio: Gain From Sale of Pass-through Not Subject to Personal Income Tax

May 16, 2016
From KPMG TaxWatch

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The Ohio Supreme Court recently determined that the state could not constitutionally impose individual income tax on a nonresident’s capital gain that arose from the sale of the individual’s interest in a pass-through entity. The taxpayer owned a seventy-nine percent interest in a pass-through entity that conducted a significant portion of its sanitary supplies business in Ohio. In 2004, the taxpayer recognized a large capital gain from selling his interest in the pass-through entity. Ohio personal income tax was not paid on the 2004 capital gain. In 2009, the Ohio Department of Taxation audited the taxpayer’s 2004 return and assessed tax. After the Ohio Board of Tax Appeals upheld the assessment, the taxpayer appealed to the Ohio Supreme Court.

Under Ohio law, individual income tax is imposed on capital gains realized by a nonresident investor in a pass-through entity if that investor held a 20 percent or more interest in the entity during the three-year period that includes the year of the sale. The capital gain is apportioned to Ohio based on a percentage of the entity’s business conducted in the state during the three-year period. It was clear to all parties that Ohio could permissibly tax the taxpayer’s distributive share of the partnership’s income (loss in the instant case) from business activity in Ohio. However, the issue was whether the state could also levy individual income tax on the gain from the sale of the business entity. The court concluded that the state could not tax a nonresident’s out-of-state sale of intangible property simply because the entity being sold conducted some of its business in Ohio. Notably, the taxpayer was not provided any Ohio protections and benefits related to the sale of the partnership interest. The court concluded that the relevant statute violated the Due Process clause as applied to the taxpayer. Please contact Brandon Erwine at 614-249-1877 with questions on Corrigan v. Testa.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.