LLC loophole takes $1 billion per year from Ohio communities, rewards mostly wealthy residents
Posted July 21, 2022 in Press Releases
New analysis from Policy Matters Ohio shows that each year, the Business Income Deduction — known as the “LLC loophole” — costs Ohio communities an estimated $1 billion, without spurring job growth or improving Ohioans’ wellbeing. The analysis shows that the loophole is among Ohio’s most expensive tax breaks; it disproportionately rewards a small number of high-income individuals; its benefits to small business owners are marginal at best; and it has negligible overall economic impact.
The tax break can be applied to any Ohio-based business income made by the owners of S corporations, partnerships, certain limited liability companies, and sole proprietorships, which are collectively known as passthrough entities. The loophole allows these individuals to evade taxes on the first $250,000 they make from their passthrough entities. Any income above that is taxed at only 3% — below the state top rate of 3.99% for regular income. However, research shows that nationally almost half of passthroughs do not qualify as businesses and only 14% of passthroughs spend at least $5,000 on wages and salaries.
“Most Ohio lawmakers have signed off on redirecting resources from our communities and into the bank accounts of well-off people who can avail themselves of accounting tricks,” said State Policy Fellow and report author, Guillermo Bervejillo, Ph.D. “The beneficiaries of this loophole are disproportionately older, white, men. This giveaway is not just siphoning funds from support services, like schools, public health, or refundable tax credits for working people, it’s expanding inequality. While this loophole has been on the books, Ohio underperformed the nation not only in job growth, wages and educational attainment, but also in quality-of-life indicators like life expectancy and infant mortality.”
Policy Matters’ analysis shows that households with at least $160,000 of business income in 2020 accounted for more than half of the value of the loophole but only 10% of total business income tax filers. These 68,500 tax filings represent over $551 million in forgone taxes using today’s tax rates. Meanwhile, 58.7% of those who claimed business income in tax year 2020 — representing roughly 381,000 tax returns — claimed less than $20,000 and received less than 7.6% of the total value of the deduction portion of the loophole. These households received less than $800 a year, and often much less: not nearly enough to make hiring or expansion decisions.
“The amount most people receive from the LLC loophole isn’t enough to make or break most viable businesses, but it’s extremely costly to the people of Ohio,” Bervejillo said. “Budget cuts that started under Gov. John Kasich have taken about $1 billion a year from the local government fund which paves our roads, makes sure our stores and restaurants are clean, and keeps our air and water safe. By closing the LLC loophole, our lawmakers can restore that funding. They could also use it to more fairly fund public education or to expand our public transportation system. Any number of uses would be more beneficial to the people of Ohio than a useless tax break that costs us $1 billion a year with very little to show for it.”