On November 18, 2021, North Carolina State Governor, Roy Cooper, signed the Current Operations Appropriations Act of 2021 (the Act).
The following individual income, business income, property and franchise tax statutes that become effective immediately or at varying future time periods are briefly reviewed and discussed below.
- Reductions in the personal income tax rates
- Increases in the standard and child tax deductions for personal income tax
- Elimination of the tax on certain military pension income
- Net Operating Loss (NOL) Addback and Deduction
- Itemized deductions
- Addbacks under Federal Law
- Staged phase-out of the corporate income tax
- Reduction and simplification of the corporate franchise tax
- State and Local Tax (SALT) cap workaround
- Conformity to federal tax law for PPP Loans and related assistance
- Various business meal and interest deductions
- Related member interest expense deduction
- Administrative, procedural, technical, collection and clarifying changes
Following is a more detailed analysis and overview of these tax provisions contained in the Act.
Individual Tax Provisions
Individual Tax Rates
North Carolina personal income tax rates decrease from 5.25% in the 2021 tax year to:
- 4.99% for the 2022 tax year
- 4.75% for the 2023 tax year
- 4.60% for the 2024 tax year
- 4.50% for the 2025 tax year
- 4.25% for the 2026 tax year and
- 3.99% for tax years after 2026.
Standard Tax Deduction
Effective for the tax years beginning after 2021, the standard deduction increases from:
- $21,500 to $25,500 for taxpayers with a filing status of married filing jointly or surviving spouse
- $16,125 to $19,125 for taxpayers with a filing status of head of household and
- $10,750 to $12,750 for taxpayers with a filing status of single or married filing separately.
Child Tax Deduction
Individuals who can claim a federal child tax credit can claim a North Carolina deduction from federal adjusted gross income (AGI) for each dependent child. The child deduction ranges from $500 to $2,500 based on a taxpayer’s North Carolina AGI and filing status.
Effective for tax years beginning after 2021, the deduction range is $500 to $3,000. Taxpayers are not eligible for the deduction if the taxpayer’s North Carolina AGI is more than:
- $140,000 for taxpayers with a filing status of married filing jointly or surviving spouse
- $105,000 for taxpayers with a filing status of head of household or
- $ 70,000 for taxpayers with a filing status of single or married filing separately.
Military Pension Income Deduction
Effective for tax years beginning on or after January 1, 2021, North Carolina personal income taxpayers can deduct retirement pay from the U.S. military if the taxpayer:
- served 20 or more years or
- retired due to a physical disability.
Beneficiaries of a retired member are eligible for the deduction. The deduction does not apply to military severance pay.
Net Operating Loss (NOL) Addback and Deduction
Taxpayers computing North Carolina personal income tax liability currently must addback any federal NOL carryforward if:
- the taxpayer does not absorb the federal NOL deduction for the current tax year and
- the taxpayer will carry forward the federal NOL to a later tax year.
Effective for tax years beginning after 2021, the addback applies to any federal NOL deduction. North Carolina also allows a state NOL deduction for personal income taxpayers beginning after the 2021 tax year. The carryforward period for NOLs is 15 tax years. A taxpayer’s State net operating loss for a taxable year is the amount by which business deductions for the year exceed gross business income for the year as determined under the Federal Internal Revenue Code with certain modifications.
North Carolina allows an itemized deduction for IRC Sec. 170 charitable contributions. Federal legislation suspended the 60% federal limit on cash contributions for the 2020 and 2021 tax years. The 60% deduction limit continues to apply to personal income taxpayers who claim North Carolina itemized deductions for the 2021 tax year. Taxpayers who itemize can carryforward charitable contributions that exceed the limit for tax years beginning on or after January 1, 2021.
North Carolina also allows an itemized deduction for home mortgage interest under IRC Sec. 163(h). However, it does not allow the deduction to include mortgage insurance premiums.
Addbacks under Federal Tax Law
Home Loan Debt Forgiveness Addback
North Carolina requires a personal income tax addback through the 2025 tax year if a taxpayer claims a federal exclusion under IRC Sec. 108(h) for income from the forgiveness of home loan debt.
Student Loan Debt Addback
Effective for tax years through 2025, North Carolina personal income taxpayers must addback amounts excluded from federal gross income for:
- student loan payments by an employer and
- student loan debt forgiveness.
Unemployment Compensation Addback
Federal legislation added an exclusion from federal gross income for 2020 unemployment compensation. Effective for the 2020 tax year, North Carolina personal income taxpayers must addback the amount excluded from the taxpayer’s federal gross income.
Business Tax Provisions
Corporate Income Tax Phaseout
North Carolina is reducing the corporate income tax rate from 2.5% to:
- 2.25% for the 2025 tax year
- 2.00% for the 2026 and 2027 tax years
- 1.00% for the 2028 and 2029 tax years, and
- 0.00% for tax years after 2029
Taxpayers currently compute the North Carolina corporation franchise tax based on the larger of:
- net worth
- actual investment in tangible property in North Carolina or
- 55% of the appraised value of North Carolina tangible property.
Effective for taxable years beginning on or after 01/01/2023, the calculation of the NC franchise tax reported on the 2022 and later corporate income tax returns, will be modified by eliminating the two tax bases calculated using property values.
State and Local Tax (SALT) Cap Workaround – Payment of NC Income Taxes by flow thru entities with Credit to Owners
North Carolina joins a growing list of states to enact a workaround for owners of pass-through businesses (S Corporations, Partnerships, LLCs). The individuals will reduce their state taxable income by the amount of business income already taxed at the entity level. The Act creates a workaround to the federal Tax Cuts and Jobs Act’s (TCJA) $10,000 cap on state and local tax (SALT) deductions by allowing passthrough entities to elect to pay tax at the entity level. S corporations and partnerships can elect to pay tax on North Carolina income, effective for tax years beginning after 2021, (i.e., January 1, 2022 and thereafter).
A partnership or S corporation can make the election on its annual North Carolina return. It cannot change the election once it is made. S corporations and partnerships pay the tax at the same rate as North Carolina personal income taxpayers.
For nonresident shareholders or partners, the tax applies to income or loss from North Carolina sources. Tax payments are due at the same time as the S corporation’s or partnership’s North Carolina return. If there is an overpayment of tax, only the S corporation or partnership can request a refund.
Once the passthrough entity elects to pay the tax each shareholder or partner receives a credit for the tax paid. It cannot pass through any credits to its partners or shareholders, including unused credits, after it makes an election to pay the tax.
North Carolina provides a taxed S corporation or partnership a credit for taxes paid on its income to another state or country. The credit cannot be claimed by:
- shareholders of the taxed S corporation,
- partners of the taxed partnership, or
- fiduciaries and beneficiaries of estates and trusts who are shareholders or partners of the taxed S corporation or partnership.
A North Carolina taxpayer that is a shareholder or partner can deduct the taxpayer’s share of income included in the electing S corporation’s or partnership’s taxable income. There is a corresponding addback requirement for a North Carolina taxpayer’s share of loss from a taxed S corporation or partnership.
Federal Paycheck Protection Programs – Federal Conformity
The Act conforms to the federal treatment of expenses paid for with loans forgiven through the federal Paycheck Protection Program (PPP) and other federal pandemic-assistance programs. Prior to the passage of the Act, North Carolina taxpayers had to add back to state income the deductions allowed for federal tax purposes. Although welcome news for North Carolina taxpayers, amended tax returns will be required to be filed to obtain refunds for previous taxes paid to North Carolina based on higher reported income due to the disallowed deductions.
Business Meal Expense Addback
IRC Sec. 274 limits the federal deduction for most business meal expenses to 50% of those expenses for tax years after 2017. There is an exception for business meals provided by restaurants in 2021 and 2022. Taxpayers can deduct 100% of those expenses. Effective for the 2021 and 2022 tax years, North Carolina personal income taxpayers must addback the amount that exceeds the 50% limit.
Business Interest Expense Addback and Deduction
IRC Sec. 163(j) limits the federal deduction for business interest expenses. Federal legislation increased the limit from 30% to 50% of a taxpayer’s adjusted taxable income (ATI) for tax years 2019 and 2020.
North Carolina required an addback by corporate and personal income taxpayers for amounts that exceeded the 30% limit. The Act clarifies that the addback did not apply to amounts subject to another addback requirement. Effective beginning with the 2021 tax year, taxpayers who made the addition adjustment can deduct 20% of the addback amount over 5 years.
Related Member Interest Expense Deduction
Taxpayers computing North Carolina corporate income tax liability can deduct interest payments to related members from federal taxable income. North Carolina limits the deduction to the taxpayer’s proportionate share of interest paid to unrelated parties. The limitation does not apply to interest payments to related members disallowed under IRC Sec. 163(j). The exception is effective beginning November 18, 2021 and applies retroactively to tax years beginning after 2017.
Administrative, Procedural, Technical, Collection and Clarification Changes
Fixed Conformity Dates
The date for which North Carolina conforms to the federal tax law has been moved from May 1, 2020 to April 1, 2021. Absent a provision that specifically decouples from federal law, North Carolina now conforms to the federal tax laws in place as of April 1, 2021. This means the tax provisions included in the most recent Federal tax statutes such as the 2021 Consolidated Appropriations Act (CAA), the 2020 Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and the 2020 American Rescue Plan Act (ARPA) are now part of the North Carolina statutes unless a North Carolina statute specifically requires an adjustment to be made.
Federal Expense Deduction Addback
Effective for tax years beginning after 2022, North Carolina corporate and personal income taxpayers must addback federal expense deductions related to income entirely excluded or exempted from state tax.
Income Tax Withholding Return Changes
Effective beginning November 18, 2021, North Carolina will no longer require a withholding reconciliation return within 30 days from employers that:
- terminate a business or
- permanently cease to pay wages.
Instead, the withholding reconciliation return is due by:
- the last day of the month after end of the calendar quarter in which the employer terminates its business or
- January 31 of the following year.
North Carolina will also require the assessment of estimated withholding tax against withholding agents that:
- fail to file a return and pay the withholding tax or
- file a grossly inaccurate, false, or fraudulent return.
Late Payment Penalties
The Act provides that where the failure to timely pay taxes when due without intent to evade the tax, a penalty will be assessed equal to two percent (2%) of the amount of the tax if the failure is for not more than one month, with an additional two percent (2%) for each additional month, or fraction thereof, during which the failure continues, not exceeding ten percent (10%) in aggregate. This penalty does not apply in any of the following circumstances:
- When the amount of tax shown as due on an amended return is paid when the return is filed.
- When the Secretary proposes an assessment for tax due but not shown on a return and the tax due is paid within 45 days after the later of the notice of the proposed assessment or when it is collectible and is no longer contested.
- Many of the provisions of the Act have retroactive application and may require the filing of applicable forms to amend previously filed tax returns. Special rules may apply to partnerships that are subject to the partnership audit rules that became effective for tax years beginning after December 31, 2017.
- In applying the provisions of the Act to specific factual situations, there may still exist situations that differ from federal tax law. Unless specifically covered by the Act’s provisions, other various North Carolina state and local tax rules, including the tax impact of doing business in other states and international jurisdictions that may or may not conform to the U.S. Internal Revenue Code will require further analytical scrutiny to ascertain the departures from and/or conformity to federal tax law.
Please contact the professionals at Gilliam Bell Moser if you have any questions.