New NC tax break could save small business owners thousands

vbridges@newsobserver.comApril 8, 2013 

  • What is the tax break? •  The law created a state net business income tax deduction of up to $50,000, or in the case of some married couples, up to $100,000 on their personal income tax returns. •  In general, sole proprietorships, partnerships, S corporations and farming business qualify for the deductions. Passive revenue and shareholders don’t qualify. •  For more information on the income tax deduction, go to dor.state.nc.us/index.html. For more information on passive and active revenue visit irs.gov.

  • Value of tax break questioned •  Proponents of the tax break say it will give small business owners capital to invest in their business and create jobs. Opponents say the tax break, one of the largest cuts in a decade, reduces needed revenue. Critics also point out that legislators dropped from the initial bill an income limitation for businesses that can benefit from the deduction. That means the tax break ultimately benefits owners of small and large firms alike, as long as the business has the proper structure and qualified revenue. •  A December report from the North Carolina Justice Center, a progressive advocacy and research organization that seeks to eliminate poverty in the state, contends that the tax deduction could end up costing the state $552 million and is unlikely to help support small business and job creation. About 70 percent of the tax cut goes to the top 20 percent of taxpayers with positive business income, according to the center’s report. •  The tax break was passed by the General Assembly as part of a 2011 budget deal, and no sunset date was listed. Senate Finance Committee Co-Chairman Sen. Bob Rucho, a Republican from Mecklenburg County, said the benefit has helped increase the number of private sector jobs in North Carolina and he doesn’t expect any changes in 2013. However, Rucho said, he does expect the tax break to be impacted in following years by broader state tax reform effort.

The husband and wife team behind Will Johnson Building Company recently learned that they qualified for a state tax break that would save them at least $3,875.

The money was a welcome surprise for owners Laurie and Will Johnson, who plowed through their savings to keep their custom home building and remodeling business in Chapel Hill afloat during the Great Recession.

“Truthfully, I just said it was a gift from God,” said Laurie Johnson, who serves as secretary and treasurer of the family business.

The Johnsons are among hundreds of thousands of business owners who could qualify for a state income tax deduction on their personal income tax returns.

Effective Jan. 1, 2012, the law allows sole proprietors and active shareholders of S corporations, partnerships and limited liability companies to deduct up to $50,000 of active net business income on their personal state income tax returns.

“In a nutshell, that is offering a lot of savings in a way of actual income in the pockets of small business owners,” said Lauren Massie, a tax specialist with Simply Taxes in North Raleigh. The firm specializes in working with sole proprietorships and individuals.

Massie and other tax professionals from Raleigh to Charlotte say many small business owners and self-employed contractors don’t know about the tax break.

“It’s the best-kept secret there has been,” said J.A. Lesemann Jr., managing member of the Huntersville firm Lesemann & Associates and chair of the N.C. Association of Certified Public Accountants.

The deduction doesn’t apply to passive income, such as certain types of real estate and other investments, income claimed on Form W-2, and owners who aren’t active in the business.

The deduction can be found on the North Carolina individual tax return form D-400 on line 48, which is labeled “Adjustment for net business income that is not considered passive income.”

“If it was late at night or you are in a hurry, you might just glance right past it,” said Ward Simmons, a Charlotte certified public accountant and owner of Ward Simmons CPA, P.A.

Following rules carefully

Small business owners also need to make sure they don’t underestimate or overestimate their income that qualifies for the deduction, tax professionals say. The maximum benefit an individual can receive is about $3,875, and some married couples could claim twice that amount.

Husband and wife S corporation shareholders can claim a net business income deduction of up to $100,000, but only if revenue they receive from the business parallels that amount.

In general, if a husband has a net business income of $30,000 and the wife has $100,000, jointly they can only claim an $80,000 deduction.

“That is where people I think are going to the most confused if they are doing it in their head,” Lesemann said.

Another tricky area is determining whether the revenue is active or passive, as defined by the Internal Revenue Service, particularly when real estate is involved, tax professionals say.

Active and licensed real estate agents who own rental properties would likely be able to deduct related income, while someone else with a full-time job who owns an unrelated limited liability company that leases property may not, Lesemann said.

In general, passive revenue, such as investments and companies in which an owner doesn’t participate, cannot be included in the deducted business income, and passive partners and spouses cannot claim the deduction.

Will Johnson Building Company had profit in 2012 for the first time in years. Laurie Johnson said she would probably use the tax savings to help pay for the three-and-a-half new positions created this year or to put a down payment on a replacement for their 1995 van. The company employs 11 people, including the Johnsons and their son and his wife.

A surprise for many

Susan Shackelford, a freelance writer and editor based in Charlotte, said she would use the tax savings on a long-term care insurance policy or dental work.

While Shackelford is grateful, she was shocked to learn about the tax break given the state’s budget challenges. Shackelford said she is concerned about a lack of funding for essential services such as education and Medicaid.

“Given the straits that our state is in financially, I was just very, very surprised that was a tax break,” she said.

The N.C. General Assembly Fiscal Research Division estimated that the tax would cost the state about $336 million in revenue. The division estimated 750,000 tax filers would qualify for the deduction, but only 450,000 would be able to use it due to business losses.

Tax pros say some small business owners may want to consider taking steps to maximize their tax benefit in 2013 by reducing the wages they pay themselves to increase an S corporation’s net revenue, or increasing a spouse’s share in the business.

Small business owners should consult tax professionals to understand any implications of any changes, but changes should be made quickly, said Neely McLaughlin, a partner with accounting firm Blackman & Sloop in Raleigh.

“The earlier the better,” said McLaughlin, because the net income is generally determined by the number of days they own the business.

Bridges: 919-829-8917

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