North Carolina Governor Roy Cooper signed into law H.B. 1080 (the “Bill”) on Tuesday, June 30, 2020. The Bill (i) decouples certain provisions of the state’s tax laws from provisions of the Internal Revenue Code of 1986, as amended (the “Code”), including certain business tax relief included in the federal Coronavirus Aid, Relief, and Economic Security (CARES) Act enacted on March 27, 2020 and (ii) includes other significant changes to the North Carolina corporate income, franchise, and state and local sales tax laws. As a result of the passage of this Bill, North Carolina joins a growing number of states seeking to mitigate the anticipated impact that federal relief provided to businesses will have on state revenues.
Under the Bill, North Carolina will apply the Code as enacted on May 1, 2020. However, the state will depart from certain provisions of the CARES Act that were designed to help improve cash flow for businesses affected by the COVID-19 pandemic, but which have the effect of significantly reducing the state’s revenues.
North Carolina will not conform to the following federal tax provisions:
- Business interest limitation — Under the CARES Act the limitation on the deduction of business interest expense under section 163(j) is relaxed and enables corporate taxpayers (i) to elect to increase the section 163(j) limitation from 30% to 50% for any taxable year beginning in 2019 or 2020 and (ii) for tax years beginning in 2020, to use their 2019 adjusted taxable income to calculate the applicable interest expense limitation (which due to the economic downturn would likely produce a higher result). H.B. 1080 decouples the North Carolina tax law from this temporary increase of the section 163(j) deduction limit.
- Net operating losses — The CARES Act allows business taxpayers to aggregate NOLs from tax years 2018, 2019, and 2020 and carry them back up to five years allowing corporations to potentially apply losses to years in which the federal corporate tax rate was 35%. Additionally, the Act temporarily removes an 80% taxable income limitation applicable to NOLs, allowing NOLs to fully offset taxable income for tax years beginning before January 1, 2021. The Bill decouples the North Carolina tax law from the additional carryback and the increased NOL limitation.
- Excess business losses — The taxpayer must add back the taxpayer’s excess business losses to its North Carolina taxable income.
- Debt Forgiveness — The Bill adds back to North Carolina taxable income the portion of any indebtedness (including the Paycheck Protection Program loan) that is forgiven and excluded from gross income for federal tax purposes (including under the CARES Act).
- Deduction of Mortgage Insurance Premiums — The amount allowed as a deduction for interest paid or accrued during the taxable year for a qualified residence for North Carolina income tax purposes will not include the amount paid for mortgage insurance premiums treated as qualified residence interest and the deductions allowed may not exceed $20,000.
- Employer payments of student loans — A taxpayer must add back for North Carolina income tax purposes the amount excluded from the taxpayer’s federal gross income for payment by an employer, of principal or interest, on any qualified education loan.
- 2020 charitable contribution percentage adjustment — For tax year 2020, the CARES Act suspended percentage limitations on charitable contributions under Code section 170. The Bill does not conform to that suspension, instead requiring individual taxpayers to apply the pre-CARES Act federal deduction amount to their individual charitable contribution deductions for North Carolina income tax purposes.
- Non-itemizer cash charitable contributions — The CARES Act permits individual taxpayers who do not itemize a $300 above-the-line deduction for cash charitable contributions. The Bill requires North Carolina taxpayers to add this deduction back into their reportable NC income.
North Carolina will conform to the following provisions:
- Medical expense deduction — North Carolina will lower the threshold amount for the medical expense deduction, reducing the threshold from 10% to 7.5% for 2019 and 2020 tax years. This reduced threshold is expected to reduce the state’s revenue by about $36 million in fiscal year 2021, however the state is prepared to transfer funds from the state’s Medicaid Transformation Reserve to offset the revenue loss.
Other Significant Tax Law Changes
In addition to the conformity related changes, the Bill includes the following additional changes to the North Carolina tax law which are summarized below:
- Corporate income tax — The Bill provides that when an adjustment to tax is made to an intercompany transaction resulting in an assessment of additional tax against one company and a potential refund to a related company, the refund may not be paid until the related assessment has become collectible.
- Franchise tax — The North Carolina franchise tax requires a corporation to add back to its net worth base any indebtedness owed to a related party in which it owns more than 50% of the capital interests. This add-back applies except to the extent the subject debt is attributable to capital borrowed from unrelated parties. Under the Bill, this adjustment is amended so that the add-back will be equal to only the amount of indebtedness that creates interest expense that is required to be added back for federal income tax purposes.
- Nonresident pass through business owners — Under current law, in order for a nonresident owner of a pass through business (that is not an individual) to be exempt from filing a composite return in North Carolina, the taxpayer is required to file an affirmation statement declaring that it will pay its tax directly on its own tax return filed in the state. The Bill clarifies that this statement must be filed annually by the due date of the business’s information return in order for the exemption to apply.
- State and local sales tax — The Bill included the following changes to North Carolina sales tax laws:
- Refunds for digital property purchases by exempt organizations — Nonprofits and governmental entities may apply for sale tax refunds for purchases of certain digital property made on or after July 1, 2020.
- Marketplace facilitators — All facilitators who have a physical presence in North Carolina are required to collect and remit sale taxes on sales to North Carolina purchasers. Additionally, the Bill also requires marketplace facilitators such as Uber Eats, to collect and remit local meal taxes on sales of prepared food and beverages in the five counties that levy such taxes, including Cumberland County, Dare County, Mecklenburg County, Wake County, and the town of Hillsborough. This provision applies to sales made on or after July 1, 2020 in those counties.
- Sales by Auctioneers — Under H.B. 1079, which was enacted on June 5, 2020, the House provided temporary relief from the assessment of sales taxes on certain tag sales or estate sales at a person’s home and on certain auctions of fixtures and equipment conducted at a business location if such sales take place during the period that begins on February 1, 2020 and ends on October 1, 2020.