NC Tax Legislation and Proposed Federal Tax Changes
Enacted NC Tax Changes in NC Budget Bill
The Budget Bill (Senate Bill 105), enacted on November 18, included several changes to North Carolina tax law – some retroactive and some prospective.
Business Tax Changes
Deduction for Expenses Paid with PPP Loan Funds. Expenses paid in 2020 and 2021 with forgiven Paycheck Protection Program (PPP) loans can be deducted. These deductions were previously disallowed for NC income tax purposes. Taxpayers must file amended 2020 returns to claim refunds. Unfortunately, the tax return e-filing system has been shut down for individual returns until late January 2022. We intend to prepare amended returns on behalf of all affected clients, but will not be able to e-file the amended returns until the e-file system opens next year. We may prepare paper amended returns if NCDOR indicates they can process them efficiently.
Corporate Tax Rate Reduction. The corporate income tax rate will be reduced from 2.5% this year down to zero in 2030.
Franchise Tax Simplification. The corporate franchise tax will be based only on the net worth of the business, not its property cost or county tax value, effective with the 2022 tax return.
State and Local Tax (SALT) Workaround. Beginning in 2022, S-Corporations, LLCs and partnerships may make an annual election to pay NC income tax at the individual income tax rate on behalf of owners. By doing so, the business can claim a deduction for the NC tax paid on its federal tax return. This election is intended to allow owners to avoid the $10,000 cap on state and local tax deductions on the owners’ individual federal tax returns. However, the tax to be paid by the company could be higher than the tax an owner would pay so an analysis of tax savings should be made.
Individual Tax Changes
Individual Tax Rate Reduction. Reductions in the individual income tax rate from 5.25% this year down to 3.99% after 2026 (4.99% in 2022).
Increased NC Standard Deduction. The bill increases the zero tax bracket (also known as the standard deduction) and the child tax deduction in 2022.
Military Retirement Pay Exemption. The bill adds a tax exemption for military retirement pay received by retirees with at least 20 years of service beginning in 2021.
Enacted Federal Tax Legislation
Some recent federal tax changes that have been enacted include:
Employee Retention Tax Credit. The ERTC was retroactively sunset as of October 1, 2021 by the Infrastructure Investment and Jobs Act unless the employer is a “recovery startup business”. A Recovery Startup Business is a business that started after February 15, 2020 and has average annual revenues of less than $1 million. As a result wages paid in the fourth quarter of 2021 will generally not be eligible for the credit.
Research and Development Expenses. R&D expenditures cannot be deducted in the year incurred after 2021. They will have to be capitalized and amortized over 5 years (15 years if research is performed outside the US). This new law does not change the R&D tax credit. It is possible that Congress will reverse this change since the impact will be great for companies that spend heavily on product development.
Child Tax Credit and Advanced Child Tax Credit Payments. The child tax credit was increased, and part of the increase was paid in advance beginning in July this year. Any payments received must be reconciled on your tax return with the actual tax credit allowed with any excess payments generally having to be repaid. If you received any advance payments, be sure to look out for, and send us, IRS Letter 6419 that will be sent to you in January 2022.
Child Care Credit. The tax credit for paying someone to care for a dependent while you work has been significantly increased. The amount of the tax credit depends on how much you paid for child care, how many dependents you have and your income level. Keep records of who you pay and how much you paid and send to us with your tax organizer next year.
Deferred 2020 Self Employment and Household Employee Taxes. If any of these 2020 taxes were deferred under the CARES Act, they must be paid 50% by December 31, 2021 and 50% by December 31, 2022.
Charitable Donations. For 2021, cash charitable contributions can offset up to 100% of your income. The usual limit is 60%. Also, charitable contributions of up to $100,000 can be made from an IRA required minimum distribution (RMD). Donations made out of an IRA RMD produce a tax benefit even if you do not itemize your deductions.
Proposed Federal Legislation
The Build Back Better (BBB) Act was passed by the House on November 19, 2021, and now will be considered by the Senate. Key tax provisions include:
State and Local Tax (SALT) Cap. The $10,000 limit on state local taxes an individual may claim as an itemized deduction is proposed to be increased to $80,000 this year.
The 3.8% Net Investment Income Tax. This tax would be extended in 2022 to tax all profits of S corporations, all sales of S corporation stock and certain rent received from an S corporation for taxpayers with income over thresholds: $500,000 for married joint returns and $400,000 for single filers.
Back Door Roth IRA. If your income is too high to contribute to a Roth IRA, you can contribute to a regular IRA then roll the funds tax-free to a Roth IRA the next day but only if you do not have another traditional IRA. Check with us before implementing. This strategy may be repealed at the end of this year. You also should consider contributing to a Roth IRA or rolling traditional IRA funds to a Roth IRA if your income and taxes are expected to be lower this year than in future years.
Estate and Gift Taxes. We have not heard of any proposed changes to estate or gift taxes since proposed changes were dropped from the BBB Act by the House a month ago but they could be added back by the Senate. Be prepared to act before the end of the year if the previously proposed changes could affect your estate plans.
Other Developments
Current Federal and State Tax Targets include:
Virtual Currency. The IRS is coming after transactions in virtual currencies. They want to tax all virtual currency transactions including trades of different types of virtual currencies. Also, if more than $10,000 of virtual currency is held in an account outside the US, you may be required to file a Report of a Foreign Bank Account. Please contact us before making any transactions. Also, send us information about transactions made in 2021 when we prepare your tax return next year.
Out of State Taxes. Many states are aggressively pursuing businesses located outside their state that are transacting business within their state. If you are not sure of the income tax or sales tax rules for a state in which you conduct business or make sales, including e-commerce, please contact us to discuss.
If you have any questions about how any of these tax changes may affect you, or to discuss any year-end tax planning strategies, please contact us.