A partnership that qualifies for a North Carolina corporate or personal income tax credit can claim the credit. It must then distribute the credit to each of its partners based on the partner’s distributive share of income.
North Carolina issued guidance on what happens to credits if:
- a partner and the partnership take part in a transaction known as a “disguised sale”; or
- the partnership terminates.
The guidance also lists legal resources to help with evaluating partnership credit distributions.
Tax Credits Denied in Disguised Sale
If a partnership transaction is a disguised sale, North Carolina tax credits cannot:
- be distributed to a partner; or
- create basis in the partnership.
North Carolina generally follows federal income tax law on determining:
- whether an arrangement is a partnership; and
- the amount a partner’s distributive share of a tax credit under IRC §§702 and 704.
The guidance states that North Carolina also follows federal treatment of disguised sales under IRC §707. A disguised sale occurs when:
- a partner transfers cash or property to the partnership; and
- the partnership distributes cash or other property to the partner in return.
IRC §707 prevents the partner from treating the transaction as a contribution to the partnership to defer or avoid tax on the disguised sale.
Credits Lost if Partnership Terminates?
A terminated partnership loses North Carolina credits. North Carolina applies IRC §708 in effect before 2018 to determine when a partnership terminates. A partnership termination takes place if:
- none of the partners continue to carry on any of the partnership’s business, financial operation, or venture; or
- there is a transfer of 50% or more of the total interest in partnership capital and profits within a 12-month period.
Transfers of 50% or more of a partnership within 12 months is known as a “technical termination.”
Important Notice: Tax Credits Involving Partnerships, North Carolina Department of Revenue, September 10, 2018, ¶202-807