The North Carolina General Assembly voted to override Gov. Roy Cooper’s veto of budget legislation. The legislation updates the IRC conformity date for computing corporate and personal income tax liability and includes many other income tax changes.
The legislation updates the IRC conformity date from January 1, 2017 to February 9, 2018.
Sales Factor Sourcing Rules
The legislation requires that a corporate income taxpayer’s sales factor include receipts from certain incidental services. The requirement applies to incidental services sold as part of, or in connection with, the sale of tangible personal property in North Carolina.
Under current law, a taxpayer’s sales factor must include receipts from services if the taxpayer performs the income producing activities in North Carolina. The legislation incorporates existing Department of Revenue sourcing rules for services. An “income-producing activity” means an activity performed for the ultimate purpose of generating the sale of the service. It applies to activities directly performed by the taxpayer or its agents. If the taxpayer performed income-producing activities in and outside North Carolina, the taxpayer must source the receipts based on a ratio that compares:
- the income-producing activities performed in the state; and
- the total income-producing activities performed everywhere.
Repatriation Transition Tax Adjustments
The Tax Cuts and Jobs Act of 2017 (TCJA) enacted the IRC Sec. 965 repatriation transition tax. The new Code section requires taxpayers with untaxed foreign earnings and profits to pay a tax as if those earnings and profits had been repatriated to the U.S. IRC Sec. 965(c) allows a deduction for a portion of the repatriated earnings that reduces the overall tax rate.
The legislation allows taxpayers computing North Carolina corporate income tax liability to subtract IRC Sec. 965 income. However, taxpayers must addback the IRC Sec. 965(c) deduction.
FDII and GILTI Adjustments
The TCJA added Code sections concerning intangible income earn by corporations outside the United States.
IRC Sec. 951A requires U.S. shareholders of any controlled foreign corporations (CFC) to include its global intangible low-taxed income (GILTI) in gross income for the tax year. This provision operates in a manner similar to Subpart F.
IRC Sec. 250 provides domestic corporations with reduced rates of U.S. tax on foreign-derived intangible income (FDII) and GILTI. It also allows a deduction for a portion of the domestic corporations FDII and GILTI.
The legislation allows taxpayers computing North Carolina corporate income tax liability to subtract GILTI. However, taxpayers must addback the IRC Sec. 250 deduction.
Deferred Gain on Opportunity Zone Property
The TCJA created IRC Sec. 1400Z-2(b) which allows taxpayers to elect to exclude gain on the sale or exchange of property from income if the taxpayer reinvests the gain in a qualified state opportunity zone. The taxpayer must reinvest the gain within 180 days of the sale or exchange. The election allows the taxpayer to defer gain until the earlier of:
- the tax year in which the investment is sold or exchanged; or
- December 31, 2026.
If the taxpayer recognizes deferred gain on December 31, 2026, before the fund investment is sold, the recognized gain increases the basis in the fund.
The legislation requires an addition adjustment in determining North Carolina income tax liability for the deferred gain. The adjustment does not result in a difference in basis of the assets for North Carolina and federal income tax purposes.
Individual income taxpayers must also add the amount of gain that the taxpayer would include in federal adjusted gross income but for the step up in basis.
The legislation allows taxpayers to subtract gain when the taxpayer recognizes it for federal income tax purposes. This adjustment would prevent double taxation of income since the taxpayer already reported the deferred gain as income in North Carolina.
Domestic Production Activities Deduction
The legislation repeals the income tax addbacks for the domestic production activities deduction (DPAD) under IRC Sec. 199. The TJCA repealed the federal DPAD for tax years beginning after 2017.
Addback for Renewable Energy Property Donations
The legislation eliminates the corporate income tax addback for charitable contributions of property when the taxpayer also claims the North Carolina renewable energy property donation credit. The addback applied to charitable contributions made to:
- nonprofit organizations; and
- North Carolina state and local government agencies.
Franchise Tax Depreciation Adjustment
Corporations computing the net worth basis of the North Carolina franchise tax can claim a deduction for accumulated depreciation, depletion, and amortization. A corporation must apply the method it used for its federal tax return when determining the deduction. In addition, the corporation must also determine the value of the underlying assets applying the same method it used for federal income tax purposes.
Tax Exemption for Foreign Captive Insurance Companies
The legislation provides an exemption from North Carolina insurance gross premiums tax to foreign captive insurance companies formed and licensed under the laws of another state. North Carolina captive insurance companies must file a return and pay tax on premiums for business done during the year.
Personal Income Tax Filing Thresholds
The legislation ties North Carolina personal income tax filing thresholds to the state’s standard deduction instead of federal income tax filing thresholds. Taxpayers must file a North Carolina income tax return if their federal gross income exceeds:
- $17,500 for taxpayers with a filing status of married filing jointly or qualifying widow(er);
- $14,000 for taxpayers with a filing status of head of household; or
- $8,750 for taxpayers with a filing status of single or married filing separately.
Nonqualified Withdrawals From IRC Sec. 529 Education Savings Plans
The legislation modifies the personal income tax addback for nonqualified withdrawals from IRC Sec. 529 education savings plans. Effective for tax years after 2017, North Carolina requires the addback to federal adjusted gross income if the taxpayer does not use the amount withdrawn to pay for education expenses permitted under IRC Sec. 529.
The addback provision previously referred to “qualified higher education expenses”. The TJCA amended IRC Sec. 529 to allow the plans to distribute no more than $10,000 in tuition expenses during the tax year for designated beneficiaries enrolled at a public, private, or religious elementary or secondary school.
The North Carolina addback does not apply if the withdrawal was:
- rolled over to a savings accounts for individuals with disabilities and their families, called an ABLE account; or
- not subject to the additional tax imposed by IRC Sec. 529(c)(6).
Automatic Filing Extensions
Effective for tax years beginning on or after January 1, 2019, North Carolina grants an automatic return filing extension to all taxpayers, including partnerships, if the taxpayer received an automatic extension to file a federal income tax return.
Federal Determinations and Amended Returns
The legislation changes the requirements for reporting federal audit adjustments to the Department of Revenue. A taxpayer must file a North Carolina income tax return if:
- the IRS or other competent authority changes or corrects the taxpayer’s federal taxable income or federal adjusted gross income; and
- the federal change or correction affects the taxpayer’s North Carolina income tax liability.
The return must reflect each federal change or correction. The taxpayer must file the return within 6 months after receiving notice of each federal change or correction.
The legislation adds a requirement that taxpayers file an amended North Carolina return if they filed an amended federal return. If the amended federal return would increase the taxpayer’s North Carolina income tax liability, then the taxpayer must file an amended state return within 6 months. If the amended federal return would decrease the taxpayer’s North Carolina income tax liability, then the taxpayer can file the amended state return within the limitations period for seeking a refund.
The federal determination and amended return requirements also apply to:
- employers, pension payers, and other payers required to withhold North Carolina income taxes.
Penalties apply to taxpayers who fail to follow the federal determination and amended return requirements. Taxpayers also forfeit the right to any refund.
Assessment Limitations Period
If a taxpayer files a return as a result of filing a federal amended return, the legislation provides that North Carolina can assess any tax due within:
- 1 year after the taxpayer filed the return; or
- 3 years after the taxpayer’s original return was filed or due, whichever is later; or
- 3 years after the date the taxpayer filed an federal amended return, if the taxpayer does not file a state return
S.B. 99, Laws 2018, effective July 1, 2018 and as noted