North Carolina Small Business Income Deduction

Last year, NC State legislators passed an important law, The Appropriations Act of 2011, which affects many small business owners in North Carolina.  This new law allows most small business owners a substantial deduction, up to $50,000 (or if married up to $100,000, see below) on their personal income tax returns.   Per the State of North Carolina, this temporary change in the law would affect at least 250,000 small businesses in the state and is intended to stimulate hiring and provide incentive for growth.  Further, North Carolina legislators dropped from the bill an income limitation on how it defines small businesses for this deduction.  Since there is no limit to the size of the business, the following small businesses may qualify for this deduction:

•    Schedule C – Sole Proprietorships
•    Schedule E – Partnerships and S-Corporations
•    Schedule F – Farming

In analyzing this tax deduction for small businesses, North Carolina enacted one rule that could limit some taxpayers.   The small business income exclusion does not include income that is considered passive income under current IRS regulations.  The taxpayer must actively manage the business in order to obtain the income exclusion on their personal income tax filing. 

Married taxpayers with two business incomes could receive up to a maximum $100,000 deduction under the revised and temporary North Carolina laws ($50,000 deduction each).   For example, both husband and wife own 50% of Partnership Z, LLC and are active participants in the business.  Partnership Z, LLC reports $125,000 taxable income or $62,500 to each member at the end of 2012.  After reducing their income by $50,000 each, husband and wife would only have to pay tax on $12,500 of Partnership Z income on their North Carolina income tax return for a total of $25,000 of taxable income instead of the full  $125,000.

Using the 2011 NC income tax rates, they could save up to $7,750 in NC taxes.   It is important to note that there are many factors to take into account when planning for this income tax deduction like guaranteed payments, personal W-2 wages from S-Corp income, and bonus depreciation.  While this new law does not impact your 2011 taxes directly, planning does need to occur in order to maximize the deduction going forward.   Call our office to see how we can assist you make the most of your tax situation with this and many other changes in tax law for 2012 and beyond.

Usefulness

Usefulness is many things in this vast world.  The following passage will focus on what qualities usefulness entails as it relates to the most important component in your business. 

What are the most important tools in your business?  Very few business owners are blessed enough to survive without embracing and understanding them.  I would even argue that the majority of the exceptional-few, who get by without utilizing them, have someone on their team who does understand them.  This is beginning to sound like a riddle, I know. 

The answer: Your company’s financial statements are the most important tool, but only if they are useful.  The meaning of useful, in this respect, relates to how your financials’ accessibility, clarity, and reliability influence your business’s financial health.

As the term “useful” suggests, the fundamental requirement necessary to fulfill the term is the act of using.  This may sound obvious, but it is an absolute necessity.  If you do not use your financials in your decision making processes, then you will not be “in the know” about the financial health of your company.  Inadequate financial awareness leads to risky uncertainties, which can quickly translate to costly repercussions.  On the other hand, there are many benefits to having useful financials at your disposal.  Including greater access to credit, lower interest rates for loans, analysis for projected growth, and most importantly, more money for your business.    

Once you’ve made a commitment to use your financials, you can begin to appreciate the following qualities that describe readily useful financial statements. 

1. Easily readable
No one wants to make reading harder. It imperative your company’s financials are easily readable, concisely stated, and focused on what is important.   

2. Understandable
Reading is great, understanding reigns supreme.  Gaining a strong understanding takes training and patience.  Concisely stated financials aid in the ease of understandability, but to attain a level of financial literacy that will serve your company well often requires insight from a trained professional.  

3. Timely
Timely financial statements allow you to make timely decisions.  Timely decisions allow you to capitalize on opportunities or avert disasters.

4. Consistency
Anyone can record transactions, although, unless you have learned the accounting principles and apply them regularly, you will not be able to achieve consistency.  Without consistency, the financials aren’t useful.

5. Comparable
This goes hand in hand with being consistent.  Financials will never be   comparable without being consistent.  Comparability allows you to plan by using the past to predict the future.