Tax reform in North Carolina is heating up this summer with the introduction of several legislative bills to reform North Carolina’s tax code and additional proposed bills may be coming. Parker Poe recently held a panel discussion with prominent legislators and tax figures to address the proposed changes, as well as the challenges and uncertainty that tax reform poses. Among the distinguished panelists were Senator Bob Rucho; Cheryl Gilreath, Corporate Tax Director for BB&T; Jeff Epstein, Chief Operating Officer for the North Carolina Department of Revenue; and Parker Poe’s own Ray Stevens, former director of the South Carolina Department of Revenue and currently a partner leading the Firm’s state and local tax practice in our Columbia office.

Reforming North Carolina’s tax regime is being driven by several factors. First, North Carolina has not fundamentally changed its tax code since the 1930s when the state’s economy was fundamentally different. The changes in our economy have resulted in an unpredictable revenue stream for the State. Another factor driving tax reform is high tax rates. North Carolina has some of the highest tax rates in the Southeast, which has contributed to the State being less competitive in attracting businesses.

The Senate has proposed a major plan for tax reform dubbed the “Tax Fairness Act.” Some of the proposed changes were discussed by the panel. Under the Senate plan, the individual income tax rate would change to a statewide flat 5.25% tax rate by 2015, replacing the three-tiered system. It would also completely phase out the corporate income tax by 2017 and phase out the business franchise tax by 2018. The franchise tax would be replaced with a flat $5,000 tax for doing business in the state that would apply to corporations with shareholders and a $750 fee for all other businesses. The proposal would eliminate the estate tax. The sales tax will remain unchanged at 6.75% and would not expand the sales tax to include services such as haircuts, legal services, accounting services and car repairs similar to the House plan. The plan would also cut back or eliminate several tax incentives received by certain industries.

The North Carolina House proposed its own version of tax reform. Under the House plan, the individual income tax rate would change to a statewide flat 5.9% tax rate, replacing the three-tiered system. Individuals would be allowed to exempt the first $12,000. The corporate income tax rate would drop from 6.9 to 5.4 percent over five years. The sales tax rate would drop from 6.75 to 6.65 percent starting in 2014, but would broaden the tax base to include services related to physical items, such as warranties and delivery services. The House plan also would repeal the estate tax. The budget impact of the House plan is expected to result in $221.8 million in cuts over two years.

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Several important issues were addressed by the panel. First, proposals to expand the sales tax base to include services will have a dramatic effect on the services industry. Business owners should be aware of the effect that taxation of services will have on their business. Second, business owners need to understand the additional costs of compliance that will accompany the proposed reform. This will include educating current employees on the changes and how it affects the business and may mean hiring additional staff or other professionals to handle sales tax issues that arise.

While many uncertainties still exist, one thing is for sure – tax reform in North Carolina is on the horizon and will affect both individuals and businesses alike.