Frequently Asked Questions Regarding the Deduction for Net Business Income
For tax years beginning on or after January 1, 2014, this deduction is no longer available.
This document supplements Directive PD-12-2 and addresses questions received subsequent to that Directive.
- If an individual is classified as a statutory employee on their W-2, can that individual claim the net business income deduction?
- A statutory employee reports all items of income and expense for the related activity on federal Schedule C. If the individual reports a net profit from the activity, they may claim the deduction for net business income for the lesser of the Schedule C net profit (rather than the amount shown on the W-2) or $50,000.
- A self-employed individual cuts hair in a shop and pays for booth rental. That individual receives from the operator of the shop a Form 1099 that shows income earned of $30,000. What net business income deduction is this individual entitled to claim?
- This individual must report the $30,000 as income and may claim expenses for the related activity on federal Schedule C. If the individual reports a net profit from the activity, they may claim the deduction for net business income for the lesser of the Schedule C net profit (rather than the amount shown on the Form 1099) or $50,000.
- If there is a passive activity with losses that are carrying forward and there is a complete disposition of that passive activity, under IRC 469(g) the carried-forward losses are treated as “not from a passive activity.” In this situation, if the taxpayer also has substantial nonpassive business income, would those freed-up passive losses count against him and offset his nonpassive business income, thereby reducing or eliminating the North Carolina business deduction of up to $50,000?
- For purposes of this deduction, passive income means the income generated from the conduct of an activity of a trade or business that satisfies the definition in IRC section 469. Likewise, a passive loss means the loss generated from the conduct of an activity of a trade or business that satisfies the definition in IRC Section 469. Treasury Regulation §1.469 provides official interpretation on when income or loss is considered passive. We follow the treatment of classifying income or loss as passive or nonpassive based on this treasury regulation and IRC Section 469. Because IRC Section 469(g) treats the disposition of the entire interest in a passive activity as “a loss which is not from a passive activity,” the loss must be offset against any current nonpassive business income in determining the North Carolina business deduction available.
- Are capital gains subject to the net business deduction on the North Carolina return?
- Capital gains or losses are not considered in determining the net business deduction.
- The taxpayer has net business income of $30,000 from an S corporation in which he materially participates under IRC 469. He also has an LLC that owns a commercial building. The commercial building is leased 100% to the S corporation that he owns. The LLC produces net rental income of $5,000. Under IRC Reg 1.469-2(f)(6), the net rental activity income from property is treated as not from a passive activity if the property is rented for use in a trade or business activity in which the taxpayer materially participates. What is the amount of the North Carolina business deduction?
- The taxpayer may claim a North Carolina business deduction of $35,000.
- An individual had the following items of income and deductions on his federal income tax return: Business income of $40,000 subject to self employment tax, a deduction of $1,700 for self employment tax, a deduction of $2,000 for self employed Simplified Employee Pension (SEP) plan, and a deduction of $3,000 for self employed health insurance. What is the amount of the NC Small Business Deduction?
- The business deduction is not limited to Small Businesses. This individual may claim a North Carolina business deduction of $40,000, presuming the business income is nonpassive income. Adjustments to income have no impact on determining the business deduction.
- An individual had nonpassive business income of $30,000 and an addition to adjusted gross income on the North Carolina return of $6,000 for section 179 expense claimed on the federal return. What is the amount of the business deduction?
- This individual may deduct $30,000 as a business deduction on the North Carolina individual income tax return. Additions to adjusted gross income on the State return are not considered in determining the business deduction.
- An individual had nonpassive business income of $30,000 and a deduction from adjusted gross income on the North Carolina return of $6,000 for bonus depreciation. What is the amount of the business deduction?
- This individual may deduct $30,000 as a business deduction. Deductions from adjusted gross income on the State return are not considered in determining the business deduction.
- What is the North Carolina stance on part-year residents and the $50,000 business deduction? For example, if a taxpayer had $100,000 of income, $50,000 from Florida while a Florida resident and $50,000 from North Carolina while a North Carolina resident, does that individual get a $50,000, $25,000 or zero deduction? Does this change if the situation is a non-resident who has North Carolina business income?
- Presuming that all of the $100,000 net business income included in federal adjusted gross income is not considered passive, the taxpayer is entitled to a $50,000 deduction. The $50,000 deduction will reduce both the numerator and the denominator of the fraction in computing the North Carolina proration percentage. For the part-year resident, the numerator includes income from all sources while a resident of the State and, during the period the individual is a non-resident, all income from North Carolina sources. For the full year non-resident, the numerator is based on all income from North Carolina sources. The law does not limit the $50,000 deduction strictly to North Carolina business income.
- Can we confirm that the $50,000 business deduction applies to S-Corp K-1 income if it is not subject to self-employment tax?
- The K-1 for the S-Corp return (Form 1120-S) has no self-employment tax line similar to that on the K-1 (block 14 – self-employment earnings (loss)) of the Partnership return (Form 1065). Despite the fact this item is not included on the K-1 of the S-Corp, that income is subject to the $50,000 deduction unless this is passive income.
- Please address the following situation: Husband owns an operating business, an S-Corp, from which he reports income of $60,000 on his federal return. He is clearly nonpassive with regard to this business. Wife may or may not have ownership, but does not work there. There is also an LLC which rents real estate to the operating business, owned 50/50 by husband and wife. The income of $10,000 from the rental LLC is clearly nonpassive with regard to the husband under the self-rental rule (see 1.469-2(F)(6)). But how is the rental LLC treated for the spouse? Keep in mind that under IRC 469, the passive/nonpassive determination for a married couple is made jointly. Thus, she is also nonpassive under IRC 469 with regard to the rental LLC because he is nonpassive under the self-rental rule. It would seem that the spouse is eligible for a business income subtraction in this case, but clarification here would be appreciated.
- Taxpayers may claim a business deduction of $55,000 on their joint return. ($50,000 for husband and $5,000 for wife)
- Under Reg. 1.469-4(d)(1), an operating business can in certain situations be grouped with a rental activity, potentially converting the rental income or loss from passive to nonpassive. Will the federal treatment under this Regulation be followed for the North Carolina business income deduction?
- Treasury Regulation §1.469 provides official interpretation on when income or loss is considered passive. We follow the treatment of classifying income or loss as passive or nonpassive based on this treasury regulation and IRC Section 469.