Sweeping Changes Made to North Carolina Income and Franchise Taxes
By: Peter Baisch Jr., CPA, Senior Manager, State and Local Tax
On November 18th, 2021, North Carolina Governor Roy Cooper signed into law, S.B. 105, the biennium budget bill, which includes multiple changes to the state’s income and franchise taxes. The legislation revises the corporate income and franchise tax regime, IRC conformity provisions, pass-through entity tax elections, and personal income tax.
Corporate Income and Franchise Tax
The most drastic change to the state’s tax regime is a phase out of the corporate income tax. North Carolina already had one of the lowest corporate income tax rates in the nation at 2.5% in 2020. The phase out will begin in 2025, with the tax rate decreasing to 2.25%. The tax rate gradually will be reduced to 0% by 2030. The state’s franchise tax, which is applicable to both C corporations and S corporations, continues to apply the tax based on the net worth base, but discontinues the two alternative bases to compute the franchise tax. These new rules are effective for franchise tax years beginning on or after January 1, 2023. Since the franchise tax is a prospective tax, it will be applicable to most 2022 corporate income tax filers.
The legislation also updates several IRC conformity provisions. The law changes the state’s IRC conformity date to April 1, 2021, including any provision enacted as of that date that became effective either before or after that date. One of the key updates is related to the addback for expenses related to forgiven loans under the Paycheck Protection Program (“PPP”). The legislation removes this addback through 2022 and requires an addback for deductible expenses for tax years beginning on or after January 1, 2023, to the extent the expense is excluded or exempt from North Carolina income tax. Taxpayers who have already filed tax returns with the previous addback requirement should consider if amended returns need to be filed.
Another provision that was updated by legislation is related to the 50% section 163(j) limitation under the CARES Act. Previously, North Carolina decoupled from the 50% limitation and followed the 30% limitation under the Tax Cuts and Jobs Act of 2017 (“TCJA”). However, the law now adopts the 50% limitation for 2018 and 2019. The legislation provides guidance on how the previously disallowed interest should be deducted. Taxpayers will be able to deduct 20% of the disallowed amounts under section163(j) in each of the first five taxable years, beginning with the 2021 tax year, similar to how the state handles bonus depreciation deductions post-addback.
Pass-through Entity Tax Elections
With over twenty states enacting a version of a pass-through entity (“PTE”) tax, North Carolina is the latest to follow the trend of states trying to work around the $10,000 state and local tax deduction limitation that is placed on individuals under TCJA, also known as the SALT cap workaround. Beginning on or after January 1, 2022, an irrevocable annual election is available for S corporations and entities treated as partnerships to pay a PTE tax at the individual tax rate. The election must be made by the due date of the applicable tax return, including extensions, and the electing entity cannot have other partnerships or corporations as partners. Thus, only entities with individual, estate or trust owners can make the election. It is worth noting that beginning in 2022, the personal income tax rates will gradually be reduced from 5.25% to 3.99% by 2026.
Taxpayers should consider how these provisions will impact their North Carolina taxes. Start proactively planning by contacting your Cherry Bekaert tax advisor. Learn more about the bill and specific provisions.