1. Summary of NC Tax Deduction.
New for 2012 the North Carolina General Assembly has provided a tax deduction for, mostly, small business owners, that report non-passive business income in their adjusted gross income (AGI) of their personal federal income tax returns. Specifically, the amended North Carolina General Statute 105-134.6(b)(22) provides that the first $50,000.00 of this non-passive business income is deducted from your North Carolina Income Tax Return. This deduction applies to each spouse so each spouse may deduct $50,000.00 for an aggregate amount of no more than $100,000.00 as a deduction from North Carolina income.
2. Passive Income Versus Non-Passive Income.
First, only active income business income is applicable, but does not apply to passive-income. This definition is governed by IRC Section 469, and Treasury Regulation 1-469 provides guidance on this definition. Generally though, business income reported on Schedules C, E, and F on IRS Form 1040, that does not include passive losses or passive income. With regard to income reported on Part II of Schedule E – non-passive income is computed by subtracting from non passive income, all non-passive loss and deductions under Section 179.
With regard to rental income, the definition of passive versus non-passive income turns primarily on whether the taxpayer is a “real estate professional” as that term is defined in the Internal Revenue Code or whether the taxpayer has actively participated in the rental income production.
3. Income from S-Corporations and C-Corporations are partially limited or totally excluded.
With regard to C-Corporations, Section 105-134.6(22) specifically excludes from such income from benefiting from the deduction. C-Corporation income is also not reported on Schedule C, E, or F of IRS Form 1040. With regard to S-Corporations, any business income reported on the taxpayer’s K-1 is eligible for the deduction, however, this specifically excludes any salaries paid to individual taxpayers. The reasonable compensation rule for S-Corporations provides that an officer of a S-Corporation should receive a salaried compensation (with appropriate wage taxes and withholding) that represents at least 1/2 of a shareholder’s compensation paid as a distribution (not subject to employment taxes).