North Carolina Enacts Significant Tax Reform and PPP Borrowers May Be Eligible for a Refund

By: Jeff Glickman, SALT Partner

At a glance

• The main takeaway: The state’s 2021 Appropriations Act carries a few key provisions that North Carolina taxpayers need to be mindful of going forward.
• Know what to expect: The provisions include reductions to the personal income tax rate, corporate income tax phaseout, simplification of the corporate franchise tax, PPP tax treatment conformity, and adoption of an elective pass-through entity tax.
• Get professional expertise: Contact Aprio’s State and Local Tax (SALT) team for help with sifting through these new provisions and developing a strategy to address them.

Schedule a free consultation today to learn more!

The full story:

On November 18, 2021, North Carolina Governor Roy Cooper signed the 2021 Appropriations Act (S.B. 105), containing several notable tax provisions that are summarized below.

Personal income tax rate reduction[1]

Beginning in 2022 and for the next six years, the state’s personal income tax rate will be reduced. The current 5.25% rate will go down as follows:

• 2022 – 4.99%
• 2023 – 4.75%
• 2024 – 4.6%
• 2025 – 4.5%
• 2026 – 4.25%

Beginning in 2027, the rate will stabilize at 3.99%.

Corporate income tax phaseout[2]

The state’s corporate income tax begins to phase out in 2025, when the current rate of 2.5% will reduce to 2.25%. Then, the rate will reduce further as follows: for taxable years beginning in 2026, the rate will be 2%; in 2028, the rate will be 1%; and after 2029, the rate will be 0%. A potential drafting error does not identify a specific rate in 2027 or 2029, so presumably the rates for 2026 (2%) and 2028 (1%) will carry over to the following respective year.

Simplification of the corporate franchise tax[3]

Currently, the state’s corporate franchise tax is imposed on the highest of three bases:

1. Apportioned net worth
2. 55% of the appraised value of the corporation’s real and tangible personal property in the state, as determined for property tax purposes
3. The corporation’s total actual investment in tangible property in the state

Effective for taxable years beginning on or after January 1, 2023 — and applicable to the calculation of the franchise tax reported on the 2022 and later corporate income tax returns — the legislation eliminates the second and third bases. Therefore, the corporate franchise tax will be computed based solely on apportioned net worth.

Conformity with federal PPP treatment[4]

Prior to the legislation, North Carolina was one of a few states that did not provide full conformity with federal Paycheck Protection Program (PPP) loan tax treatment, requiring taxpayers to add back expenses that gave rise to PPP loan forgiveness and that were deducted on the federal tax return.

Effective immediately, the new law deletes the nonconforming language. In addition, it clarifies that expenses deducted on the federal return that were allocated to income excluded or exempt from tax are required to be added back for North Carolina purposes for taxable years beginning on or after January 1, 2023. Therefore, if you added back your PPP expenses on your North Carolina 2020 income tax return, you should be able to file an amended return and get a refund.

Pass-through entity tax[5]

Effective for tax years beginning on or after January 1, 2022, North Carolina joins the growing list of states that allow pass-through entities (PTEs) to elect to pay income tax at the entity level (PTE tax) as a workaround to the federal SALT deduction cap.

The election — made on a timely filed return — is available to entities taxed as S corporations or partnerships, except publicly traded partnerships and partnerships that at any time during the year had an owner that was not (1) an individual, (2) an estate, (3) a trust permitted to be an S-corporation shareholder under IRC section 1361(c)(3), or (4) an exempt organization permitted to be an S-corporation shareholder under IRC section 1361(c)(6). Therefore, partnerships with partners that are corporations or partnerships are not eligible to make the election.

Income subject to the PTE tax is the sum of each PTE owner’s distributive share of income attributable to North Carolina, plus each resident PTE owner’s distributive share of income not attributable to North Carolina. The PTE tax rate is the applicable rate under the personal income tax and PTEs will generally be required to comply with estimated tax payments in the same manner as corporations. On their individual North Carolina returns, PTE owners will make an adjustment to their federal adjusted gross income for the income or loss that was included in the PTE’s income.

We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This content was featured in the November/December 2021 SALT Newsletter.

[1] S.B. 105, Section 42.1.

[2] S.B. 105, Section 42.2.

[3] S.B. 105, Section 42.3.

[4] S.B. 105, Section 42.4.

[5] S.B. 105, Section 42.5.

Disclosure

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.