2012 North Carolina Tax Law Changes
Article Date: Tuesday, February 19, 2013
Written By: Keith A. Wood
PART ONE | PERSONAL INCOME TAX DEVELOPMENTS
I. Various Sunset Dates Extended for a Number of Incentive Credits that Were Scheduled to Expire in 2012. | Under House Bill 1025 (Session Law 2012-36), sunset dates for the following personal income and corporate tax credits have been extended from Jan. 1, 2013 to Jan. 1, 2014:
1. The Article 3J credits for creating jobs, investing in real property
and investing in business property;
2. The work opportunity tax credit;
3. The tax credit for premiums paid on long-term care insurance;
4. The refundable earned income credit;
5. The credit for adoption expenses; and
6. The qualified business venture credit.
Also, the sunset dates for historic rehabilitation credit and the mill rehabilitation credit are extended from January 1, 2014 to January 1, 2015. All other credits (other than the credit for rehabilitating historic structures and historic mill property) are scheduled to expire after 2013.
II. North Carolina Adopts Educator’s Expense Deduction. | The federal educator’s expense deduction was scheduled to expire beginning with the 2012 tax year. G.S. 105-134.6(d)(9) has been amended to allow for a specific North Carolina state educator’s expense deduction beginning with the 2012 tax year to the extent that the deduction has not been claimed for purposes of determining federal AGI (i.e. if the federal legislation is not extended for tax years 2012 and beyond). House Bill 1015 (Session Law 2012-74). The maximum educator’s expense deduction for North Carolina tax purposes is $250 per educator or $500 for married filing jointly taxpayers if both spouses are educators. These expense deductions are limited to expenses incurred to purchase books or other non-athletic supplies, including computer equipment, software and other items used in the classroom.
III. Clarifying Changes to Prorating North Carolina Income for Part-Year Residents and Non-Residents. | In 2011, the General Assembly changed the starting point for calculating North Carolina taxable income from federal “taxable income” to federal “adjusted gross income.” This past summer, the General Assembly enacted S.B. 826 (Session Law 2012-79) amending G.S. 105-134.5 to make it clear that, for purposes of prorating North Carolina taxable income for non-residents and part-year residents, the relevant proration factor should refer to “gross income” rather than to “adjusted gross income.”
IV. Clarifying Changes to Modifying Adjusted Gross Income. | Effective Jan. 1, 2012 G.S. 105-134.6(a2) has been revised to clarify that in determining a taxpayer’s North Carolina taxable income, the taxpayer can choose to use the North Carolina standard deduction amount or the federal itemized deduction amount. However, the allowable North Carolina standard deduction amount is the lesser of (i) the North Carolina standard deduction amount shown on the statutory tables, or (ii) the federal standard deduction amount allowable under the federal tax code. (SB 826, Session Law 2012-79).
V. NCDOR Issues a Directive to Interpret the New Individual Income Tax Deduction for Net Business Income. | On June 11, 2012, the NCDOR issued a new Directive (No. PD-12-2) interpreting the new $50,000 “Net Business Income Tax Deduction” for North Carolina income tax purposes under G.S. 105-134.6(b)(22). The Directive is presented in a “frequently asked questions” (FAQ) format and includes the following observations:
1. S corporation wages are not “business income” of an S corporation. The Directive states that, for purposes of determining the net business income of an S Corporation, wages paid to the S Corporation owners are not considered to be net business income.
Example: The taxpayer is a 25 percent shareholder of an S corporation from which he receives non-passive income. The taxpayer reports $25,000 of the non-passive income on his Schedule E resulting from $25,000 of ordinary income as shown in his Form 1120-S K-1. The $25,000 is the shareholder’s portion of the $240,000 total S corporation income less $140,000 of wages paid to the S Corporation owner and to others (S corporation net income of $100,000). The total non-passive income of the S Corporation is $100,000 ($240,000 total income minus $140,000 of wages). The taxpayer may claim a net business income tax deduction of only $25,000, even though the S Corporation shareholder also received wages from his S Corporation. In other words, the wages paid to the S corp shareholder by the S corporation are not net business income.
2. The Directive provides that all of the taxpayer’s net business income and net business losses must be aggregated before determining the net business income tax deduction.
Example: The taxpayer reports a net profit of $60,000 from a non-passive business activity on his federal Schedule C and a partnership loss of $70,000 from a non-passive business activity on his federal Schedule E. Is the taxpayer entitled to any net business income deduction? No. If non-passive losses exceed non-passive income, the taxpayer is not entitled to any net business income deduction for the year.
3. The Directive provides that non-passive income of one spouse is not reduced by the non-passive loss of the other spouse.
Example: Taxpayers are a married couple filing jointly. Mr. Taxpayer reports a net loss of $60,000 from a non-passive business activity on his federal Schedule C, and Mrs. Taxpayer reports partnership income of $70,000 from a non-passive business activity on Schedule E. Are the taxpayers entitled to a deduction? The Department advises that the Taxpayers may claim a net business income deduction of $50,000 against Mrs. Taxpayer’s non-passive partnership income because the maximum dollar amount of the deduction is applied separately to each spouse. Although Mr. Taxpayer suffered a loss from a non-passive activity, the Taxpayers may claim a net business income tax deduction of $50,000 against the non-passive income from Mrs. Taxpayer’s partnership income. In other words, Mr. Taxpayer’s sustained net loss is not offset against Mrs. Taxpayer’s non-passive income.
4. The Directive provides that the $50,000 maximum deduction is applied separately to non-passive income for each spouse of two spouses filing a joint return.
Example: Taxpayers are a married couple filing jointly. Mr. Taxpayer reports a net profit of $20,000 for non-passive business activity on his federal Schedule C, and Mrs. Taxpayer reports a net profit of $60,000 from an unrelated non-passive business activity on federal Schedule C. What deductions are available to the taxpayers? The taxpayers are entitled to claim a net business income deduction of $70,000 ($20,000 for husband and $50,000 for wife).
5. The Directive makes clear that married taxpayers may be entitled to net business income tax deductions for non-passive income generated through the same pass-through business entity.
Example: Taxpayers are a married couple filing jointly. Mr. Taxpayer owns 60 percent of a single pass-through entity, and Mrs. Taxpayer owns the other 40 percent. Mr. Taxpayer reports $60,000 of non-passive income from the pass-through activity, and Mrs. Taxpayer reports $40,000 of income from the pass-through entity on federal Schedule E. What is the deduction available to the taxpayers? The taxpayers are entitled to claim a net business deduction of $90,000 ($50,000 for husband and $40,000 for wife).
PART TWO | NORTH CAROLINA SALES AND USE TAX DEVELOPMENTS
VI. Items Given Away by a Merchant Are Now Treated as Sold for Sales Tax Purposes. | Under new G.S. 105-164.12C, if a retailer of prepared food gives food to its patrons or employees free of charge, the retailer is deemed to have sold the items given away for sales tax purposes. Likewise, if a retailer gives away an item of inventory – on the condition that the customer must purchase another item of inventory – for sales tax purposes, the item given away is treated as sold along with the item that is actually sold. G.S. 105-164.12C provides: “In all other cases, property given away or used by any retailer or wholesale merchant is not considered sold, whether or not the retailer or wholesale merchant recovers its cost of the property from sales of other property.”
VII. Clarifying Changes to the Sales and Use Tax Exceptions for Installation Charges. | Senate Bill 826 (Session Law 2012-79) made clarifying changes to the sales and use tax exemptions under G.S. 105-164.13 with respect to installation charges that are separately stated on an invoice or on a similar billing document. Under former law, installation charges were exempt from sales tax if they were “separately stated on the invoice at the time of sale.” Now, under revised G.S. 105-164.13(49), installation charges will also be exempt from sales tax if they are “separately stated on an invoice or similar billing document given to the purchaser at the time of sale.”
PART THREE | CORPORATE INCOME TAX DEVELOPMENTS
VIII. NCDOR Must Issue “Forced Combination” Rules Under G.S. 105-130.5A Before It May Adjust Net Income or Force Filing of Combined Return. | Taxpayers have long argued that the NCDOR has provided virtually no guidance on how it interprets the combined reporting statutes. The NCDOR has now been ordered to adopt rules regarding its interpretation of new “combined reporting statute” G.S. 105-130.5A, which was enacted in 2011. Under new G.S. 105-262.1, the NCDOR may not redetermine North Carolina taxable income or require a combined return until it adopts new rules interpreting new G.S. 105-130.5A. SB 824 (Session Law 2012-43), June 14, 2012.
IX. North Carolina Issues Notice Regarding the Calculation of a Current Year Net Economic Loss. | On Aug. 17, 2012, the Department of Revenue issued a Notice regarding its interpretation of the net economic loss statute. G.S. 105-130.8 allows a deduction to a corporation that has sustained a net economic loss (“NEL”) in any of the preceding fifteen years. Pursuant to the Notice the NCDOR has determined that certain items that are not taxable under G.S. 105-130.5 (such as foreign dividends and U.S. Government interest) should not reduce a loss in the year in which the loss is created. However, for future loss carryforward years, the NEL carryforward is offset by nontaxable income recognized in the carryforward year.
PART FOUR | TAX COLLECTION PROCEDURE
X. Governor Perdue’s Executive Order Establishes Task Force on Fighting Employee Misclassification. | 1. Introduction: On Aug. 22, 2012, Governor Perdue signed an Executive Order (No. 125) to create a new task force to combat employee misclassification. According to the Executive Order, the Governor’s office believes many North Carolina businesses are misclassifying true employees as independent contractors to avoid compliance with health, safety and licensing requirements, as well as to avoid paying income and payroll taxes on employee wages.
2. Members of the New Task Force: The task force will be comprised of representatives from the following North Carolina agencies: the Industrial Commission, the Department of Revenue, the Department of Public Safety, the Department of Commerce, the Division of Employment Security, and the Commission of Insurance.
3. Duties of the New Task Force: The duties of the task force include: (a) identifying sectors of the economy where employee misclassification occurs most; (b) determining regulatory or other changes in state laws that prohibit employee misclassification; (c) identifying ways to increase the filing of complaints by employees against non-compliant employers; (d) formulating new methods for preventing employment misclassification; (e) soliciting the assistance of law enforcement agencies and district attorneys to implement effective procedures for referring appropriate cases for prosecution; and (f) promulgating methods for sharing information among members of the task force.
XI. Changes to the North Carolina Innocent Spouse Relief Rules for Understatements of Tax. | Previously, under the innocent spouse relief rules of G.S. 105-152(e), a North Carolina spouse could receive innocent spouse relief for his or her spouse’s understatement of tax only if that taxpayer had received similar innocent spouse relief for a federal tax liability. G.S. 105-152(e) has been amended now to provide that a requesting innocent spouse qualifies for innocent spouse relief (for North Carolina tax purposes) if the spouse could qualify for innocent spouse relief under the federal Section 6015 rules, even if the spouse had not actually applied for innocent spouse relief under the federal Section 6015 rules. SB 826 (Session Law 2012-79).
XII. North Carolina Can No Longer Use Contingent Fee Based Contractors for Audit or Assessment Purposes. | North Carolina has long contracted with third parties (on a contingency fee basis) for collecting delinquent tax debts. Under new G.S. 105-243.1, the State and all cities and counties are now prohibited from entering into contingent fee based contracts for tax audit or tax assessment purposes. This change is effective as of July 1, 2012, and applies to tax audit and tax assessment contracts entered into after that date. House Bill 462 (Session Law 2012-152).
XIII. NCDOR Announces Changes to Its Offer in Compromise Process. | On July 9, 2012, the NCDOR issued a press release announcing changes to its offer in compromise program. North Carolina now will use the IRS expense standards to determine disposable income for purposes of qualification for an OIC. Also, under the new program, the NCDOR will provide a counter-offer when an original OIC offer is denied. In its press release, the NCDOR stated that it believes the simplified and improved OIC process will result in an increase in the number of OICs submitted by taxpayers and accepted by the NCDOR. •
Keith A. Wood is an attorney with Carruthers & Roth, P.A. in Greensboro.
Views and opinions expressed in articles published herein are the authors' only and are not to be attributed to this newsletter, the section, or the NCBA unless expressly stated. Authors are responsible for the accuracy of all citations and quotations.