North Carolina: Summary of Significant Income and Franchise Tax Legislation During the 2020 Session

The North Carolina legislature enacted a tax reform bill that made several changes to the state’s income tax code to address conformity with recent federal tax legislation.

By: Jeff Glickman, SALT Partner

On June 30, 2020, North Carolina Governor Roy Cooper signed House Bill 1080, which made many changes to the state’s tax code. Some of the significant income and franchise tax changes are summarized below.

Income Tax (Corporate and Personal)

HB 1080 made several changes to the state’s income tax code, with some changes affecting both individual and corporate taxpayers and others affecting just individual taxpayers. These changes include the following:

• The state’s income tax conformity date was updated from January 1, 2019, to May 1, 2020, affecting recent federal acts such as The Taxpayer Certainty and Disaster Relief Act of 2019 (TCDRA) and the Coronavirus Aid, Relied and Economic Security Act (CARES Act).
• The state will conform to TCDRA’s reduction of the unreimbursed medical expense deduction threshold from 10% to 7.5% for the 2019 and 2020 tax years but will generally decouple from other federal extenders. These are expiring federal tax provisions from which North Carolina has historically decoupled, such as the exclusion for the discharge of qualified principal residence indebtedness, the treatment of mortgage insurance premiums as qualified residence interest, and the deduction for qualified tuition and related expenses.
• For corporate and individual taxpayers, the bill decouples from the CARES Act’s net business interest expense threshold increase from 30% to 50%. Therefore, North Carolina taxpayers will only be permitted to offset 30% of adjusted taxable income by net business interest expenses and must add back any additional interest expense deducted for federal income tax purposes.
• In Notice 2020-32, the IRS stated its position that expenses are not deductible to the extent they resulted in a forgiven PPP loan. However, Congress may override the IRS. Therefore, the bill enacts a provision that for state corporate and personal income tax purposes, those expenses resulting in a forgiven PPP loan will not be deductible.
• For individual taxpayers, the state will also decouple from the net operating loss (NOL) changes made by the CARES Act. Therefore, individuals will not be able to carry back NOLs arising in 2018, 2019, and 2020. In addition, individuals will only be able to offset up to 80% of taxable income with NOLs arising in a prior tax year as set forth in the Tax Cuts and Jobs Act prior to the CARES Act’s suspension of the 80% limitation. The state will allow any add-back required due to these provisions to be deducted in five equal installments beginning in 2021.
• The bill also decouples from the changes made by the CARES Act related to deductions for charitable contributions made by individuals. North Carolina will still apply the pre-CARES Act percentage limitation on charitable contributions deductions. In addition, the state will not allow the $300 above-the-line charitable contribution deduction for taxpayers taking the standard deduction.

Franchise Tax

Currently, for purposes of calculating a corporation’s net worth franchise tax base, a taxpayer is required to add back any indebtedness owed to “a parent, a subsidiary, an affiliate, or a non-corporate entity in which the corporation or an affiliated group of corporations owns directly or indirectly more than fifty percent (50%) of the capital interests of the non-corporate entity,” unless such intercompany debt is ultimately attributable to debt from third parties.[1]

For North Carolina income tax purposes (like most states), corporations are required to add back to federal taxable income any interest expense attributable to debt owed to a “related member,” unless the interest meets certain exceptions to qualify as deductible. In North Carolina, such deductible interest is referred to as “qualified interest expense.”[2]

HB 1080 amends the franchise tax to conform to the state’s income tax rules for deductible and nondeductible intercompany interest expense. Accordingly, for purposes of calculating a taxpayer’s net worth for franchise tax purposes, the corporation will be required to add back the amount of intercompany indebtedness that creates interest expense but not qualified interest expense. In other words, the add-back to net worth will be for indebtedness with a related member that creates interest expenses that is required to be added back for state income tax purposes.

This change is effective for franchise tax years beginning on or after January 1, 2020, and therefore will be reported on 2020 income tax returns.

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 article was featured in the October 2020 SALT Newsletter.

[1] N.C. Gen. Stat. § 105-122(b)(2).

[2] See N.C. Gen. Stat. §§ 105-130.7A and 105-130.7B.