North Carolina Tax Legislation Update: What Changes are Coming for North Carolina Taxpayers?
After months of negotiations and after many compromises, the Current Operations Appropriations Act of 2021 (COAA, 2021) has been signed into law by North Carolina Governor Roy Cooper. This bill not only addresses North Carolina’s conformity to the various federal tax law changes that have been made over the past year, it also contains a significant number of changes to existing individual and corporate tax laws that will impact all North Carolina taxpayers.
The following is a summary of the various tax provisions included in the COAA, 2021:
Change to the Federal Conformity Date: 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 Consolidate Appropriations Act, 2021 (CAA, 2021) and the American Rescue Plan Act (ARPA) are now part of the North Carolina statutes unless North Carolina statute specifically requires an adjustment to be made. The following are some of the tax provisions that were extended or enacted by Congress under either the CAA, 2021 or ARPA for which North Carolina specifically requires taxpayers to make an adjustment:
- The provision requiring an addback of expenses related to tax-exempt PPP loan proceeds has been revised and is now only applicable to tax years beginning on or after January 1, 2023. Therefore, for tax years beginning before that date, North Carolina tax law follows the federal tax law. That means that for tax years prior to that date (2020, 2021 and 2022 tax years) expenses related to tax-exempt PPP loans are now deductible for North Carolina purposes. This provision also applies to other expenses related to tax-exempt income such as Economic Income Disaster Loan (EIDL) grants, EIDL loan subsidy payments and Shuttered Venue and Restaurant Revitalization grants. Before amending any returns impacted by this provision, we recommend waiting to see what, if any, guidance the North Carolina Department of Revenue (NCDOR) publishes that may simplify the amended return process.
- Federal law allows taxpayers to exclude, subject to certain caps, the forgiveness “qualified principal residence indebtedness” from income. North Carolina requires any amounts excluded under this federal provision to be added back to North Carolina taxable income.
- Under the CARES Act and later extended by the CAA, 2021 federal law allows employees to exclude from federal taxable income certain amounts paid by their employer on their behalf for principal and interest on student loans. North Carolina requires any amounts excluded under this federal provision to be added back to North Carolina taxable income.
- The CAA, 2021 extended the federal provision allowing taxpayers to deduct “qualified mortgage insurance premiums” through the 2021 tax year. Any amounts deducted on the federal return under this provision must be added back when calculating allowable itemized deductions for North Carolina purposes.
- For 2021 and 2022 tax years, North Carolina will continue to allow a 50% deduction for food and beverages provided by a restaurant versus the 100% deduction temporary allowed by the CAA, 2021 for federal purposes.
- ARPA included a provision allowing taxpayers to exclude the discharge of certain student loans from income for tax years 2021 through 2025. Any amounts excluded under this provision are required to be added back when determining North Carolina taxable income.
- ARPA enacted the provision allowing for the exclusion of up to $10,200 of unemployment compensation from federal taxable income. North Carolina requires any amounts excluded under this federal provision to be added back to North Carolina taxable income.
- The CAA, 2021 extended the CARES Act provision that allowed certain cash contributions to be deductible up to 100% of AGI. North Carolina does not follow this federal provision and requires an adjustment to be made when determining a taxpayer’s North Carolina itemized deductions.
It is important to note that the bill does not require an adjustment to the federal 7.5% AGI threshold for itemized medical expense deductions. The CAA, 2021 made this threshold permanent for federal purposes for tax years beginning in 2021 (versus the 10% threshold) and North Carolina has chosen to follow this federal provision.
Decrease in the Individual Income Tax Rate: The current North Carolina individual income tax rate is 5.25%. Starting in 2022, a lower rate will begin to phase-in for all individual taxpayers. For 2022, the rate will reduce to 4.99% eventually reaching 3.99% for tax years beginning after 2026.
Increase in the Standard Deduction: Beginning with the 2022 tax year, the standard deduction will increase for all filing statuses:
|2021 Tax Years||2022 and Subsequent Tax Years|
|Married Filing Joint/Surviving Spouse||$21,500||$25,500|
|Head of Household||$16,125||$19,125|
|Married, filing separate||$10,750||$12,750|
Increase in the Child Deduction: Beginning with the 2022 tax year, the Adjusted Gross Income (AGI) phase-out levels for the deduction will increase and the amount of the deduction is set to increase by $500 per child.
Exclusion of Certain Military Pension Income: Beginning with the 2021 tax year, certain military pensions taxable for federal income tax purposes can be excluded from North Carolina taxable income. This applies to military retirees with at least 20 years of service or who were medical retired. The exclusion also applies to amounts received by a beneficiary of a military retiree with at least 20 years of service or who was medically retired.
Complete Phase-Out of the Corporate Income Tax Rate: The current North Carolina corporate tax rate is 2.5%. That rate will remain in effect until tax years beginning in 2025 at which point the corporate tax rate will start phasing out until it is completely phased out for tax years beginning in 2029.
|Taxable Years Beginning||Corporate Tax Rate|
Changes to the Corporate Franchise Tax: Effective for taxable years beginning on or after January 1, 2023 (i.e., franchise tax reported on 2022 and subsequent years corporate tax returns), the franchise tax calculation will be significantly simplified. The current calculation requires taxpayers to calculate three (3) franchise tax factors and the franchise tax is then determined based on the highest of the three factors. Under the new rules, franchise tax will be based solely on the corporation’s net worth. The existing definition of net worth will still be used to determine a company’s net worth.
Election by Pass-Through Entities to Pay North Carolina Tax at the Entity Level: In an effort to reduce the impact of the $10,000 federal State and Local Tax (SALT) cap, North Carolina has created a new regime allowing pass-through entities to elect to pay the tax at the entity level. This provides a potential benefit to the shareholders or partners of these entities by having these taxes be deductible at the entity level for federal purposes; therefore, escaping the shareholder or partners $10,000 SALT limitation. These provisions are effective for tax years beginning on or after January 1, 2022.
Introduction of a Separate Net Operating Loss (NOL) Calculation for Individuals: North Carolina currently has a separate NOL calculation for corporations but has not had a similar provision for individuals. This bill requires North Carolina taxpayers to addback any NOL included in their federal AGI and then calculate and deduct a separate NOL for North Carolina purposes. These changes are effective for tax years beginning on or after January 1, 2022.
Expansion and Extension of Mill Rehabilitation and Historic Rehabilitation Credits: This law reenacts and extends the Mill Rehabilitation Credit under the provisions that existed for projects for which an application for eligibility certification was submitted on or before January 1, 2015. In addition, the Historic Rehabilitation Credit is also being expanded and the dates that qualified expenditures may be incurred has been extended six (6) years.
Miscellaneous Provisions: The law includes a technical correction allowing those taxpayers that were required to addback the additional amounts deductible under 163(j) for federal purposes under the CARES Act (utilizing 50% of adjusted taxable income versus 30% and the ability to use 2019 adjusted taxable income versus 2020, if beneficial) to deduct the amount added back in 5 equal installments staring with the 2021 tax year. The bill also has a provision stating that an addback of these amounts is not required if these amounts have already been added back under another provision of the North Carolina law.
The NCDOR will be moving to a graduate late payment penalty system versus charging a flat 10% late payment penalty. There will now be a 2% penalty if the failure is for not more than one month, with an additional 2% per month, not to exceed a maximum 10% penalty. This provision will be effective for tax assessed on or after July 1, 2022.
Please don’t hesitate to reach out to your trusted BRC advisor if you have any questions regarding how these changes may impact you.