Impact of NC income tax overhaul hits taxpayers

Kathleen Johnson was at Liberty Tax Service to see how the tax law changes would affect her.
Kathleen Johnson was at Liberty Tax Service to see how the tax law changes would affect her. cliddy@newsobserver.com

The most sweeping overhaul of North Carolina tax law in a generation went into effect in January 2014, but it didn’t start hitting home until recently for most taxpayers.

As people file their first state income taxes that actually are impacted by the new law, the size of their refund, or the amount that they owe, can’t help but influence their opinion of the state’s new income tax system.

Ultimately, the collective judgment of individual taxpayers could have political ramifications. That’s because the tax plan was hailed as a major accomplishment that will spur the state’s economy by the Republican-dominated state legislature that pushed it through and by Gov. Pat McCrory, who signed it into law.

At the other end of the political spectrum, Democrats and advocacy groups for the poor and low-income workers opposed the new system, arguing that it benefited the wealthy and shifted more of the tax burden on those who can least afford it.

The new system was designed to be simpler by eliminating the tiered income tax rates that were pegged to income levels and lowering the rates for everyone to a flat 5.8 percent in the 2014 tax year and 5.75 percent this year. At the same time, it eliminated dozens of deductions and credits, including the earned income tax credit for the working poor and deductions for medical expenses, retirement income, child-care expenses and college 529 plans.

The impact of eliminating those deductions varies depending on taxpayers’ individual circumstances.

For example, losing the deduction for medical expenses is reverberating among seniors.

Murry Bubar was shocked this year when he did the taxes for his ex-wife, as he always does, and found that she owed $104 under the new system.

His ex-wife, Barbara Bubar, is 79, blind and lives in the Alzheimer’s unit of an assisted-living facility. Bubar’s income from savings and an annuity amounted to $9,300 last year.

“This is the first time in years she has had to pay any state taxes,” Bubar said. “Her medical bills are more than her income.”

At the Charlotte office of accounting firm PricewaterhouseCoopers, whose clientele tends more toward the upper end of the income scale, tax director Michelle Hottenstein said she really couldn’t generalize about how the new tax system is affecting individual clients.

“We’re seeing varying results,” she said. “It really is so much driven by the specific circumstances of the taxpayer.”

For example, she said, although business owners certainly benefit from the reduction in the overall tax rate, for some the countervailing impact of the elimination of a deduction on the first $50,000 of business income can end up being a wash.

Brandon Britt, who owns three Liberty Tax Service franchises in Johnston County, said many of his lower-income customers have just one question about their income taxes: “How much am I getting back?”

But this year many, of those customers are experiencing what Britt describes as “sticker shock” when it comes to their state taxes.

“A lot of the lower income people who were used to getting refunds of, say, $100, $200, $300 from the state of North Carolina are ending up owing the state of North Carolina $100 or $200,” Britt said. “I am seeing a larger percentage of my clientele owing the state of North Carolina than has happened in the past.”

Check withholding

But although for many the threshold issues are whether they’re getting a refund and how it compares to last year’s, that really doesn’t provide a full picture of how much state income tax they’re paying.

Indeed, there are undoubtedly taxpayers upset about the size of their refund, or the size of the check they’re writing when they file their taxes, who actually are paying less in total state income taxes than they did a year ago. But they don’t realize it because they haven’t factored in how much they had withheld from their paychecks during 2014 compared to 2013.

The new tax plan required people to fill out revised NC-4 withholding forms, the equivalent of the federal W-4. Many taxpayers found those new forms perplexing, in part because the new tax system eliminated personal exemptions as well as a number of tax credits that boosted the number of allowances taxpayers previously claimed.

So some people ended up not having enough withheld to avoid writing a check when they file their taxes.

“If your tax bill goes down by $100 but your withholding went down $200, your tax liability is $100 less, but you have to pay $100,” said David Hylton, tax director at accounting firm Carter in Charlotte.

At the same time, there certainly are disgruntled taxpayers – some of whom rail against the Republicans for changing the rules of the game – whose total tax liability is more under the new tax system.

Indeed, the amount withheld isn’t a factor in everyone’s taxes. Bubar, for example, said that given his ex-wife’s low income, she hasn’t had state income taxes withheld for years.

Two views of the changes

Sen. Bob Rucho, a Mecklenburg County Republican and a lead architect of the tax law, said taxpayers who focus on their refund amounts are short-sighted.

“Why would they want to get refunds?” Rucho said. “That means they overpaid taxes to the government. … Why would you want the government to hold your money rather than you using it as you see fit?”

By lowering North Carolina’s income tax rate, “everybody has the opportunity to get more money in their paychecks,” Rucho said.

Still, some taxpayers might have higher tax bills because they made more money in 2014, Rucho said. Others might have benefited from tax deductions and credits that have been eliminated.

“If you have a special tax preference, that means everybody else has to pay a higher tax rate to pay for your special tax preference,” he said. “We’re trying to get out of that by having government not pick winners and losers, but to treat everyone the same.”

Rucho added that, under the new tax system, “the largest percentage of people” ultimately will pay less state income tax.

But Cedric Johnson, public policy analyst for the N.C. Justice Center’s Budget and Tax Center, has a different take on the changes.

“Taxpayers making under ($67,000), which is around 80 percent of taxpayers in North Carolina, will, on average, see their taxes increase under the tax plan,” he said.

The Justice Center’s analysis encompasses both income tax and sales tax. In conjunction with the overhaul of the income tax, the state sales tax was expanded beginning last year. Added to the sales tax list was, among other things, service contracts for appliances and cars and a broad range of admissions charges, including movies and sporting events.

The working poor in particular are taking it on the chin because of the elimination of the earned income tax credit, which was designed to help them make ends meet, Johnson said.

“That alone took over $100 million out of local communities,” he said, adding that more than 900,000 tax filers claimed the earned income credit a year ago. Taxpayers can still claim the credit on their federal income taxes.

Loss of medical deduction

In addition, “what we’re hearing is that the elimination of the medical expense deduction is having an impact especially on seniors as they’re filing their taxes,” Johnson said. “For seniors, it can be a situation where they are spending thousands and thousands for long-term care or medical expenses that are not covered by insurance.”

Jane Felton, 84, of Charlotte is a retired CPA who recently finished filing her 2014 taxes – and was stunned.

“I got slammed,” she said. “The amount I have to pay the state this year is three times more than my federal tax. That’s a first for me.”

Felton says she lives on a fixed $30,000 yearly income from investments, Social Security and a small pension.

Normally, she files a standard return, but this time she decided to itemize after incurring medical bills from an aortic valve replacement, dental work and other issues.

In 2013, she paid $70 in state income taxes. A year later, after the new law took effect, she must pay more than $900. Her federal tax bill: $353.

She’d made some money from investments, so her taxable income was greater. But “out of curiosity,” she redid her returns using the 2013 state tax codes. She would have paid $400 a year ago – and receive a $200 credit for her long-term care insurance policy that is no longer provided.

“So I would have paid $200 under the old law,” she said.

The state took other “goodies from senior citizens,” she said, including a deduction for $2,000 in retirement incomes, and no medical expenses can be claimed.

“I think the people in Raleigh are playing to the wealthy,” Felton said. “I don’t know if this is an unintended consequence or not, but it is a consequence for many senior citizens.

State Rep. Rick Catlin, a Republican from Wilmington, is sponsoring a bill that would reinstate the deduction for medical expenses after fielding complaints from constituents.

Catlin said the loss of the deduction is costing seniors across the state $38 million a year.

“It’s a major impact on our senior citizens,” Catlin said. “It’s my job to be fair to all taxpayers, so I’m trying to restore that deduction.”

Any time there are changes in tax law, said Ryan Dodson, co-owner of a Liberty Tax Service franchise in Asheboro, “there are winners and there are losers.”

During a training session in November when Dodson was walking a group of about 10 employees through the new tax law, he asked each of them to pull out last year’s return and had them calculate their taxes anew, this time using the current tax system.

When he asked how many of them would have paid higher taxes under the new system, roughly half of them raised their hands. And when he asked how many would have paid less, the other half raised their hands.

Charlotte Observer staff writer David Perlmutt contributed.

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The new state income tax plan

The old tax plan in effect for the 2013 tax year and prior years had three income tax rates for individual taxpayers – 6 percent, 7 percent and 7.75 percent – depending on income.

The new plan installed a flat rate: 5.8 percent for the 2014 tax year, 5.75 percent thereafter.

In addition, the standard deduction previously was $3,000 for those filing singly and $6,000 for married filing jointly. The new standard deduction that went into effect in 2014 is $7,500 for filing singly and $15,000 for married filing jointly.

At the same time, however, dozens of deductions and credits were eliminated. They include the earned income tax credit for the working poor and deductions for medical expenses, retirement income, child-care expenses and college 529 plans.

In the legislature

The N.C. House committee on aging will discuss state Rep. Rick Catlin’s legislation, House Bill 46, which would reinstate the deduction for medical expenses. The committee will meet at 11 a.m. Wednesday in Room 423 of the Legislative Office Building.