Breaking down the 2013 tax package
Posted July 18, 2013
Updated July 19, 2013
Raleigh, N.C. — Lawmakers started the 2013 legislative session hoping to fundamentally remake North Carolina's tax code. Tax reform had long been a kind of Holy Grail for Republican and Democratic lawmakers alike.
But efforts to overhaul a tax code first drawn in the 1930s have consistently run into opposition from industries that have been the beneficiaries of long-standing breaks. This year was no different.
Most measured assessments of the deal lawmakers and Gov. Pat McCrory reached this year say that it is a first step on the road to modernizing North Carolina's tax structure, but it does not achieve the sweeping reform at which lawmakers had originally aimed.
“We applaud Gov. McCrory and members of the General Assembly for taking an important step towards real tax reform in North Carolina," said Rollin Groseclose, an accountant and member of the North Carolina Association of Certified Public Accountants, which has been evaluating different versions of the tax reform bill.
McCrory and legislative leaders say they will return in future sessions to push tax reform further.
In broad strokes, the 2013 tax measure reduces the state's three-tiered individual income tax rate to a single rate and simplifies the deductions available to taxpayers. The tax rate for corporations is also lower. Lawmakers did not change the sales tax rate, but they did tweak how the sales tax applies to a handful of items, most notably electric and natural gas utilities.
As for how the tax bill will affect any one individual, family or business, there is room for debate. Republican proponents of the measure point to an analysis by the legislature's nonpartisan fiscal research staff that shows taxpayers across all categories will see at least some slight reduction in tax burden under the bill. But an analysis by the liberal-leaning North Carolina Budget and Tax Center predicts that taxpayers who make less than $84,000 per year will end up paying more in taxes, once all the tax code changes go into effect.
An additional analysis by the legislature's nonpartisan fiscal staff does pick out some individual scenarios among older adults and young families in which taxpayers will end up paying more in taxes every year. Part of the reason those 65-plus may pay more is because the bill eliminates an exemption for retirement income contained in the current tax code.
Both proponents and opponents of the plan acknowledge that the biggest breaks will go to the highest income earners. Democrats have generally decried this as unfair to low-income workers, who are going to bear the brunt of service cuts brought about to compensate for the tax changes, while Republicans have generally argued that those who pay the most in taxes ought to get the biggest cuts.
Here is a listing of the major changes in this year's tax reform bill:
Individual income taxes
- Eliminates North Carolina's three-tiered income tax rates of 6, 7 and 7.75 percent. Individual income will be taxed at 5.8 percent in 2014 and 5.75 percent in subsequent years.
- Eliminates "personal exemptions."
- Increases the standard deduction taxpayers may take, in part to offset the loss of personal exemptions. Currently, the top deduction a couple married filing jointly could take is $6,000. Married couples now get a $15,000 standard deduction. Individuals would get a deduction of $7,500.
- For taxpayers who wish to itemize their deductions rather than taking the standard deduction, the new law will cap at $20,000 the combined deduction on mortgage interest and property taxes that taxpayers may take on their primary residences. Itemizing taxpayers may continue to claim unlimited charitable contributions as they are claimed on a federal income tax return.
- Eliminates a $4,000 deduction for government retirement income and a $2,000 deduction for private retirement income.
- Does not change how Social Security income is handled.
- Boosts the child tax credit by $25, to $125, for families with incomes below $40,000. The child tax credit remains $100 for families with incomes between $40,000 and $100,000. There is no child tax credit for families with income over $100,000.
- Eliminates credits for child care, permanent and total disability, property taxes paid on farm machinery, education expenses and charitable contributions for those who do not itemize their deductions.
- Eliminates a deduction for contributions to North Carolina 529 college savings plans.
- Eliminates the estate tax. Although not technically an individual income tax, it is levied on an individual estate at death.
Individual business income
The tax bill also eliminates a two-year-old deduction for personal business income. Taxpayers could deduct up to $50,000 in business income that counted against their personal taxes. Instead of filing their own income, many small businesses and partnerships pay taxes by way of their owner's income tax statement. This is a break that was used by full-time workers who had outside business income – an office worker who picked up extra money mowing lawns on the weekends or a communication professional who took on occasional freelance assignments – as well as lawyers and doctors.
According to an analysis given to lawmakers, some "390,000 filers would see a tax increase under the tax plan." The useful, if somewhat technical, explanation continued:
"By removing the $50K business income deduction, a Married Filing Jointly return with two children taking the standard deduction would need to have AGI greater than $253,000 in order to see a tax reduction. That’s the point where the lowering of the rate (and $1,000 difference between old standard deduction plus four exemptions and the new increased standard deduction) offsets the loss of the $50K deduction.
"According to the NC BearingPoint Tax Model, under the proposed plan, 60 percent of individual tax returns with business income that qualifies for the $50K business income deduction would see a tax increase, 23 percent would see a tax decrease and 17 percent would see no change. Approximately 650,000 returns would take advantage of that deduction. It’s difficult to say how many small businesses that is, since multiple businesses could be listed on the same return and the same business can be listed on multiple returns."
Corporate income and other business taxes and credits
- Drops the corporate income tax from its current rate of 6.9 percent to 6 percent in 2014. It will drop to 5 percent in 2015. The corporate income tax could drop as low as 3 percent by 2017 if the state reaches certain targets for the amount of money it takes in during 2016 and 2017.
- Extends tax credits for research and development until 2016.
- Allows the film production tax credit to expire in 2015.
- Does not change the franchise tax, which amounts to a statewide corporate property tax. Instead, the franchise tax was referred for study by the Revenue Laws Committee.
- Allows a number of tax credits, many of them aimed of business recruitment, to expire as they are scheduled to under current law.
Sales and other taxes
- The sales tax rate is unchanged. Throughout most of the state, the sales tax rate is 6.75 percent: 4.75 percent benefiting the state and 2 percent benefiting local government. Some local governments have imposed an extra quarter-cent sales tax, for a total of 7 percent, but that is not consistent across the state.
- Makes no changes to how food or prescription drugs are taxed. Groceries are currently taxed only at the local tax rate of 2 percent. Prescription drugs are untaxed.
- Movie tickets and other amusements, which had been taxed a lower but often unseen privilege tax rate, will now be taxed at the full sales tax rate.
- Replaces a current 3 percent franchise tax on electricity and piped natural gas with the 7 percent sales tax rate.
- Replaces preferential 2 and 2.5 percent tax rates for manufactured and modular homes with the state rate of 4.75 percent. However, local sales taxes would not apply to these homes because they will be taxed under local property tax rates.
- Eliminates exemptions for nutritional supplements sold by chiropractors, effective Jan. 1, 2014.
- Eliminates exemptions for meals sold at higher educational facilities, such as college cafeterias, effective Jan. 1, 2014.
- Eliminates certain sales tax exemptions for newspapers sold in vending machines, effective Jan. 1, 2014.
- Eliminates the Energy Star and back-to-school sales tax holidays, effective 2014.
- Eliminates a sales tax break on certain bakery items, effective July 1, 2014.
- Caps the state's gas tax at 37.5 cents per gallon through June 30, 2015.
- Applies sales taxes to certain service contracts associated with physical goods.
- Keeps a 2 percent discount given to manufacturers of cigarettes for paying their excise taxes on time. Senate tax writers had wanted to eliminate that provision.
- Limits tax breaks for farm equipment and supplies to farms that can show at least $10,000 in direct farm income.
- Caps the sales tax refund for nonprofits at $45 million, while ordering the Revenue Laws Study committee to look into further restricting the refunds nonprofits can claim.
- Orders studies for future changes in the tax code, including whether and how sales taxes could be applied to certain services.