Some small business owners became entangled in Ohio income tax audits due to arrangements outsourcing their human resource functions to a professional employer organizations or PEO. The hallmark of a PEO relationship is the co-employment whereby the PEO issues payment, as well as fulfilling other HR functions, but works at the client / employer’s worksite. R.C. 4125.01, et seq. Normally, wages and guaranteed payments paid by a small business / pass-through entity paid to a 20%-plus owner is added back to the business’ income under R.C. 5733.40(A)(7). However, since the compensation in these situations are paid by the PEO to the owner, the Ohio Department of Taxation denied the small business or business income deductions on such compensation since the owner did not own at least 20% of the PEO – i.e., the entity issuing payment.
Legislation has been introduced in both the Ohio House and Senate to correct this inequitable result – H.B. 334 and S.B. 186. The Senate version has been passed and is now pending before the House. The Department also released a statement that it has suspended audit activities related to this issue.