Tax Bill Advances in North Carolina General Assembly

By William W. Nelson

House Bill 1080, containing the Revenue Laws Study Committee’s recommended tax changes, was introduced in the General Assembly on May 14, 2020.[1] The bill has passed its first reading and is now in committee. This Alert summarizes the more important provisions of the current version of House Bill 1080. Readers should note that none of the provisions discussed below are currently effective and will not become effective unless and until the bill is enacted and signed by the Governor or otherwise becomes law. 

Provisions covered in this Alert:

Internal Revenue Code Update

Although federal adjusted gross income and federal taxable income are the starting points for computing North Carolina taxable income for individuals and corporations, respectively, the North Carolina Constitution prohibits automatic conformity to the Internal Revenue Code (the “Code”). As a result, the General Assembly annually updates the reference to the Code in the North Carolina Revenue Act in order to incorporate some or all of the changes made to the Code during the preceding year. The current Code reference is to the Code in effect on January 1, 2019. The bill would update the reference date to May 1, 2020.[2]

Congress enacted two bills amending the Code between the existing reference date and May 1, 2020: The Taxpayer Certainty and Disaster Relief Act of 2019 (the “TCDRA”), included as Division Q of the Further Consolidated Appropriations Act, 2020,[3] and the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”).[4]

The TCDRA extended a number of expiring federal tax provisions from which North Carolina has historically decoupled: the gross income exclusion for the discharge of qualified principal residence indebtedness, the treatment of mortgage insurance premiums as qualified residence interest and the deduction for qualified tuition and related expenses.[5] The bill would continue to decouple from these extended federal provisions through 2020.[6]

The CARES Act included numerous tax provisions intended to improve the cash position of individuals and businesses in response to the economic shock caused by the COVID-19 pandemic and government lock-down orders. For a discussion of the CARES Act tax provisions, see Tax Provisions of the CARES Act. The bill would decouple from the following CARES Act provisions: 

  • Net Business Interest: The CARES Act increased from 30% to 50% the amount of adjusted taxable income that can be offset by net business interest expense for 2019 and 2020. The bill would require corporate taxpayers to add back the additional interest expense deduction.[7]
  • Charitable Contribution Percentage Limitations: North Carolina permits individual taxpayers to claim a charitable contribution deduction equal to the federal deduction allowed under Code section 170. That section imposes percentage limitations on the charitable contribution deduction allowed in any given year, with the excess carried forward to later years. The CARES Act suspended the percentage limitation on charitable contributions made in 2020. The bill would limit 2020 individual charitable contribution deductions to the pre-CARES Act federal deduction amount.[8]
  • Net Operating Losses: The CARES Act eliminated the prohibition on the carryback of net operating losses (“NOLs”) arising in 2018, 2019 and 2020. The CARES Act also suspended the 80% limitation on the amount of taxable income that could be offset by NOLs for 2018, 2019 and 2020. The bill would decouple from these changes by requiring individual taxpayers to add back the amount of any 2018, 2019 or 2020 NOL (other than farming losses) carried back to a prior year.[9] The amount added back would be deducted in five equal installments beginning in 2021.[10] In addition, individual taxpayers would be required to add back the amount of any carryforward deductions for NOLs (other than farming losses) arising in 2018, 2019 or 2020 in excess of the pre-CARES Act 80% limitation.[11] The amount added back would be deducted in five equal installments beginning in 2021.[12]
  • Qualified Education Loans: The CARES Act expanded the gross income exclusion for employer-provided education assistance to cover interest and principal on qualified education loans paid by an employer in 2020. The bill would require such qualified education loan payments to be added back to North Carolina income to the extent excluded for federal purposes.[13]
  • Excess Business Losses: The Tax Cuts and Jobs Act imposed a limit on the deduction of excess business losses by noncorporate taxpayers. The CARES Act retroactively delayed the application of this limitation until 2021. The bill would decouple from this provision by requiring individual taxpayers to add back any business losses deducted for federal purposes in 2018, 2019 and 2020 in excess of the amounts that would have been deductible under the pre-CARES Act limits.[14] The amount added back would be deducted in five equal installments beginning in 2021.[15]
  • Charitable Contribution for Non-itemizers: The CARES Act allowed individual taxpayers a $300 above-the-line deduction for cash charitable contributions made in 2020. The bill would require individual taxpayers to add this deduction back in computing North Carolina income.[16]
  • Paycheck Protection Program Loans: The CARES Act expanded the Small Business Act to create a small business interruption loan program (the Paycheck Protection Program or “PPP”). PPP loans are intended to help taxpayers make payroll, rent and utility payments during the COVID-19 pandemic. If the loan proceeds are used for these purposes, the CARES Act provides that the loans will be forgiven and the amount forgiven excluded from gross income. The Internal Revenue Service announced in Notice 2020-32 that expenses funded by a forgiven PPP loan may not be deducted. It is expected that Congress may override the IRS’s position and permit such expenses to be deducted.[17] The bill would require both individual and corporate taxpayers to add back the amount of any expenses deducted for federal purposes to the extent funded by a forgiven PPP loan.[18]

Personal Income Tax Changes

Breast Cancer Research Donation

In 2017, the General Assembly enacted a temporary provision permitting individuals entitled to a refund of personal income taxes to elect to contribute all or part of the refund to the state Department of Health and Human Services to support early detection of breast and cervical cancer. This provision is set to expire at the end of this year. The bill would extend the provision through 2025.[19]

Nonresident Pass-Through Business Owners

Under current law, the manager of a pass-through business with one or more nonresident owners or partners must file a composite return reporting the nonresident’s share of the business’s income attributable to North Carolina and pay the nonresident’s North Carolina income tax on such income. However, the business does not have to pay the nonresident’s North Carolina tax if the nonresident owner or partner is not an individual and the business provides an affirmation signed by the nonresident that it will pay the tax due with its own return. The bill would clarify, in accordance with existing Departmental practice, that the affirmation must be provided annually by the due date of the business’s information return.[20] This provision would be effective upon enactment.[21]

Franchise Tax Changes

Add-Back for Affiliated Indebtedness

Under current law, the net worth franchise tax base is subject to an adjustment for affiliated indebtedness. Specifically, the corporation must add back to its net worth base any indebtedness owed to a “parent, subsidiary, an affiliate or a noncorporate entity in which the corporation or any affiliated group of corporations owns more than 50% of the capital interests,” except to the extent that the affiliated indebtedness is attributable to capital borrowed by the creditor from unrelated parties.[22] Also under current law, for income tax purposes a corporation may deduct interest expense paid to a “related member” only to the extent it constitutes “qualified interest expense,” i.e., only to the extent it is proportional to the amount of interest paid by the related member to an unrelated lender.[23]

The bill would amend the franchise tax adjustment to be consistent with the income tax adjustment. That is, the franchise tax net worth base add-back would be equal to the amount of indebtedness that creates interest expense that is required to be added back for income tax purposes.[24] This change would be effective with the 2021 franchise tax year reported on 2020 income tax returns.[25] The proposed change arguably could require a larger or smaller adjustment to net worth than current law to the extent the income tax definition of “related member” differs from the existing franchise tax concept of parent, subsidiary, affiliate or controlled noncorporate entity.

Corporate Income Tax Changes

Transactions Among Affiliates

Intercompany transactions were the source of much litigation a number of years ago. As a result, the General Assembly enacted section 105-130.5A to clarify the Secretary’s powers to make adjustments to intercompany transactions and to require the filing of a combined return.

 When the Secretary requires adjustments to an intercompany transaction, those adjustments will usually result in increasing the income of one affiliate and reducing the income of the other, producing an assessment against one affiliate and a refund opportunity for the other. The bill would provide that in such a case the refund may not be made until the corresponding assessment has become collectible and that the amount of the refund, when made, must reflect “any changes made by the Department under this section.” [26]

The idea behind these changes is to prevent a situation where (i) the Department makes an adjustment to an intercompany transaction that produces a refund for one party and an assessment for another, (ii) the party entitled to the refund accepts it and the refund is paid, (iii) the party subject to the assessment fights the assessment and then succeeds in getting it reduced through an administrative settlement or proceedings at the Office of Administrative Hearings. In that case, the Department will have paid a refund to one party based on a proposed assessment to the other party that is larger than what is ultimately determined to be due. By this point the statute might have run on the Department’s ability to recover the overpaid refund.

Sales Tax Changes

Nonprofit Entity and Governmental Entity Refunds for Digital Property Purchases

Under current law, nonprofit entities and governmental entities may apply for refunds of state and local sales taxes paid on purchases of tangible personal property and services.[27] The bill would expand this provision to permit these taxpayers also to obtain refunds of state and local taxes paid on certain digital property, applicable to purchases made on or after July 1, 2020.[28]

Sales Subject to Use Tax

Current law provides that individual taxpayers must file returns and pay use taxes on items purchased “outside the State.”[29] After the Supreme Court’s decision in South Dakota v. Wayfair, Inc.[30], the tax on many out-of-state purchases will be collected by requiring the seller to collect the use tax, and such transactions will not be required to be reported by the purchaser. Accordingly, the bill would eliminate as obsolete the reference to purchases “outside the State.”[31]

Marketplace Facilitators

Last year, the General Assembly passed legislation requiring marketplace facilitators to collect tax on facilitated sales if the facilitator exceeded an economic nexus threshold of $100,000 in in-state sales or 200 transactions directed into the state.[32] The bill would make two changes with respect to marketplace facilitators.

  • Change to Nexus Standard: First, the bill would replace the $100,000/200 transaction threshold requirement with a requirement that the facilitator be “engaged in business” in North Carolina.[33] The purpose of this change is apparently to ensure that facilitators who have a physical presence in the state collect sales taxes on sales to North Carolina purchasers even if they do not satisfy the economic nexus threshold. The effect of the change, however, is also to eliminate any safe harbor for facilitators who lack a physical presence in the state. This change would apply to sales made on or after July 1, 2020.[34]
  • Local Meals Tax: Second, the bill would require marketplace facilitators (such as Grub Hub) that are required to collect sales tax on facilitated sales of prepared food and beverages also to collect any applicable local meals tax on such sales.[35]  This change would be effective for sales occurring on or after July 1, 2020.[36] Currently, the only localities that have enacted meals taxes are Cumberland, Dare, Mecklenburg and Wake counties and the town of Hillsborough.

Digital Code

The bill would provide that the sales and use tax on certain digital property also applies to digital code. Thus, the sale or use of digital code is taxable to the same extent as the sale or use of certain digital property to which the code relates.[37] This change would be effective upon enactment.[38]

Administrative Changes

Confidentiality of Tax Information 

The Secretary is authorized to assign the responsibility and jurisdiction to enforce certain criminal tax provisions to employees of the Department’s Tax Enforcement Division. The bill would expand the list of these criminal tax provisions to include violations by state officials of the duty to maintain the confidentiality of tax information, which are Class I misdemeanors.[39] 

Trust Fund Taxes

  • Statute of Limitations: Under current law, where a taxpayer collects but fails to remit sales taxes, withheld income taxes or other trust fund taxes, the Department must assess the tax within the normal three-year limitation period unless it can prove a fraudulent intent to evade tax. Assessments with respect to fraudulent returns and fraudulent attempts to evade tax may be made at any time. Because fraud can be difficult to prove, the bill would add failures to remit trust fund taxes to the list of assessments that may be made at any time. This change would be effective upon enactment and would apply to assessments not barred by the current statute of limitations at that time.[40]
  • Criminal Liability: The bill would provide that a person’s status as a responsible person or not, and therefore his potential civil liability for trust fund taxes, has no bearing on his potential criminal tax liability.[41] In the past, some persons charged with crimes such as abetting the embezzlement of sales taxes but who were not responsible persons argued that they could not be held liable because they were not responsible persons. The provision in the bill is intended to foreclose such arguments.[42]

Overdue Tax Debts

Current law provides that the Department may impose a 20% collection assistance fee on any tax debt that remains unpaid 90 days after it becomes collectible. The bill would shorten this period to 60 days. The change would be effective August 1, 2020 and would apply to tax debts that become collectible on or after that date.[43] 

Identification Numbers

The bill would require taxpayers to include their full taxpayer identification numbers (as opposed to truncated numbers such as the last four digits of a Social Security number) on all filings with the Department unless specifically authorized to do otherwise.[44] 

Taxpayer Conferences 

Under current law, taxpayers are entitled to a conference with the Department after filing an objection to a proposed assessment or proposed denial of a refund. The bill would clarify that the taxpayer and the Department may reschedule a conference by mutual agreement.[45] 

Current law also provides that, if a taxpayer fails to attend a scheduled conference without prior notice to the Department, the parties are deemed to be unable to resolve their differences and the Department must issue a Notice of Final Determination. The bill would eliminate the reference to the absence of prior notification to the Department. As a result, the Department would be authorized to issue a Notice of Final Determination if a taxpayer is unable to attend a scheduled conference even if the taxpayer had given prior notice to the Department.[46]

Other Matters

In addition to the matters discussed above, House Bill 1080 would (i) make changes to the Tobacco Products Tax, the Motor Fuels Tax and the Severance Tax,[47] (ii) make technical changes to the apportionment method applicable to national broadcasters,[48] (iii) repeal obsolete corporate and personal income tax adjustments related to the state’s decision to decouple from a 2009 federal change allowing taxpayers to defer recognition of certain cancellation of indebtedness income,[49] (iv) repeal an obsolete adjustment to the federal definition of unrelated business income,[50] and (v) correct a statutory reference in a provision governing S corporation tax credits.[51] 

Another bill introduced on May 14, 2020, House Bill 1079, would make additional sales tax changes. This bill will be discussed in a future Alert. 

Conclusion 

The likelihood that H1080 will become law in its current form is unknown. For more information about the bill or updates on its progress in the General Assembly, please contact a member of Smith Anderson’s Tax Group, business lawyers who understand taxation.

[1] An identical bill was introduced in the Senate. See Senate Bill 727.

[2] H1080, §1.(a); N.C. Gen. Stat.§105-228.90(b)(1b).

[3] P.L. 116-94.

[4] P.L. 116-136.

[5] See P.L. 116-94, Division Q, §§101, 102 and 104.

[6] H1080, §1.(e) and 1.(f); N.C. Gen. Stat. §§105-153.5(a)(2)b and 105-153.5(c2)(1) and (2).

[7] H1080, §1.(c); N.C. Gen. Stat. §105-130.5(a)(31) and 105-153.5(c2)(16).

[8] H1080, §1.(d); N.C. Gen. Stat. §105-153.5(a)(2)a.

[9] H1080, §1.(f); N.C. Gen. Stat. §§105-153.5(c2)(8), (9) and (10). The addback requirement also applies to unabsorbed 2018, 2019 or 2020 NOL carrybacks that are carried forward to later carryback years. See H1080, §1.(f); N.C. Gen. Stat. §105-153.5(c2)(11).

[10] H1080, §1.(f); N.C. Gen. Stat. §§105-153.5(c2)(14).

[11] H1080, §1.(f); N.C. Gen. Stat. §§105-153.5(c2)(13).

[12] H1080, §1.(f); N.C. Gen. Stat. §§105-153.5(c2)(16).

[13] H1080, §1.(f); N.C. Gen. Stat. §105-153.5(c2)(18).

[14] H1080, §1.(f); N.C. Gen. Stat. §§105-153.5(c2)(12).

[15] H1080, §1.(f); N.C. Gen. Stat. §105-153.5(c2)(15).

[16] H1080, §1.(f); N.C. Gen. Stat. §105-153.5(c2)(19).

[17] See Senate Bill 3612, which was introduced in Congress on May 5, 2020.

[18] H1080, §1.(c) and (f); N.C. Gen. Stat. §§105-130.5(a)(32) and 105-153.5(c2)(20).

[19] H.1080, §7.1; N.C. Gen. Stat. §105-269.8(c).

[20] H1080, §4.3; N.C. Gen. Stat. §105-154(d).

[21] H1080, §8.

[22] See N.C. Gen. Stat. §105-122(b)(2).

[23] See N. C Gen. Stat. §105-130.7B.

[24] H1080, §5.1.

[25] H1080, §5.1.(b).

[26] H1080, §5.4; N.C. Gen. Stat. §105-130A(k).

[27] See N.C. Gen. Stat. §105-164.14(b).

[28] H1080, §3.1.

[29] N.C. Gen. Stat. §105-164.16(d).

[30] 585 U.S. ___, 138 S. Ct. 2080 (2018).

[31] H1080, §3.2.

[32] See N.C. Gen. Stat. §105-164.4J.

[33] H1080, §3.3.(a).

[34] H1080, §3.3.(b).

[35] H1080, §3.5; N.C. Gen. Stat. §§153A-154.1 and 160A-214.1.

[36] H1080, §3.5.(c).

[37] H1080, §3.4; N.C. Gen. Stat. §105-164.4(a)(1).

[38] H1080, §8.

[39] H1080, §6.1; N.C. Gen. Stat. §105-236.1(a)(3).

[40] H1080, §6.2; N.C. Gen. Stat. §105-241.8(b)(2).

[41] H1080, §6.3; N.C. Gen. Stat. §105-242.2.

[42] See General Assembly Legislative Analysis Division, Analysis of 2019-BAxfz-22A (May 13, 2020), at 8-9.

[43] H1080, §6.4; N.C. Gen. Stat. §105-243.1(d). The statute also requires the Department to mail a notice to the taxpayer stating that the collection assistance fee will be imposed. In 2019, the General Assembly amended this section to permit the Department to mail the notice 60 days (rather that just 30 days) before the date the fee could be imposed. See S523, S.L. 2019-169, §5.1. H1080 also amends the effective date of the 2019 change to conform to the August 1, 2020 date of the current bill. Thus, if the bill becomes law, the Department would be able to include the fee notice in the collection notice.

[44] H1080, §4.4; N.C. Gen. Stat. §§105-163.1(12a), 105-228.90(b)(9) and (10) and105-252.1.

[45] H1080, §4.5; N.C. Gen. Stat. §105-241.13(b).

[46] H1080, §4.5; N.C. Gen. Stat. §105-241.13(b) and (c). The summary of the bill prepared by the General Assembly’s Legislative Analysis Division states that this change “does not make a substantive difference.” See General Assembly Legislative Analysis Division, Analysis of 2019-BAxfz-22A (May 13, 2020), at 7.

[47] H1080, §§2.1 through 2.13.

[48] H1080, §5.2.

[49] H1080, §4.2 and 5.3.

[50] H1080. §5.5. Specifically, the 2017 Tax Cuts and Jobs Act required tax exempt organizations to increase their unrelated business taxable income by any amount paid or incurred by the exempt organization for qualified transportation fringe benefits, qualified parking or on-site athletic facilities. The 2018 Appropriations Act decoupled from this federal change as it related to parking facilities, such that, for North Carolina purposes, unrelated business taxable income would not include any amount paid or incurred for a parking facility that otherwise would have been taxable under the new federal law. Section 302 of Division Q of the federal Further Consolidated Appropriations Act, 2020 (P.L. 116-94)) repealed the TCJA provision retroactively, so that the North Carolina adjustment is no longer required.

[51] H1080, §4.1, correcting a reference in N.C. Gen. Stat. §105-131.8 to N.C. Gen. Stat. §105-151, which was recodified in 2013 as N.C. Gen. Stat. §105-153.9.

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