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 dont know about the tax break.
Its 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 doesnt apply to passive income, such as certain types of real estate and other investments, income claimed on Form W-2, and owners who arent 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 dont 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 doesnt 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 states 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 corporations net revenue, or increasing a spouses 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.