On November 18, after months of political negotiation (and four and half months into the new fiscal year), Governor Cooper signed the state’s 2021 budget bill into law. Below is a brief summary of the more impactful tax provisions, including state treatment of Paycheck Protection Program loan forgiveness, as well as future state tax rates:
Federal Internal Revenue Code Conformity
- Most significantly, NC now conforms to the federal tax treatment of PPP loan forgiveness. The state continues to treat forgiveness as tax-exempt income, while now allowing tax deductions for expenses paid with forgiven loans through 2022. We await potential guidance from the Department of Revenue on how to recapture this benefit given 2020 tax returns have already been filed. Presumably, amended state returns will be required, but perhaps the state will allow a more simplified approach given the burden created by this retroactive law change. Once guidance is issued, we will update clients to that effect. To quantify the tax benefit from this favorable change, simply multiply PPP loan forgiveness received by either the state individual rate (5.25%) or corporate rate (2.5%), as applicable.
- NC continues to decouple from 2020 and 2021 enhanced federal charitable contribution deduction limits.
- For calendar years 2021 and 2022, business meals provided by restaurants are afforded 100% federal deductibility (normally 50%). NC has decoupled from this treatment.
- In 2020, individuals could exclude up to $10,200 in unemployment benefits from taxable income, subject to certain limits. NC has also decoupled from this treatment.
Individual Income Tax Changes
- The following individual state income tax rate reductions are put in place:
- 2021 – 5.25% (current rate)
- 2022 – 4.99%
- 2023 – 4.75%
- 2024 – 4.6%
- 2025 – 4.5%
- 2026 and future years – 3.99%
- Beginning in 2022, NC will allow separate state net operating loss calculations for individuals. Currently, federal adjusted gross income is the starting point for calculating an individual’s state taxable income; thus, federal NOLs were embedded in the calculation, which created various anomalies.
Corporate Income Tax Changes
- The following corporate income tax rate deductions and eventual phase-outs are put in place:
- 2021 – 2024 – 2.5% (current rate)
- 2025 – 2.25%
- 2026 – 2027 – 2%
- 2028 – 2029 – 1%
- 2030 and future years – 0%
Franchise Tax Changes
- Currently, the franchise tax is applied to the highest of a corporation’s three bases:
- Net worth base
- Book value of NC tangible property base
- 55% of appraised value of NC tangible property base
Beginning with 2023 franchise tax calculations (reported on 2022 tax returns), the franchise tax will only be calculated using the net worth base, thus benefitting companies with heavy investments in hard assets in the state.
Pass-Through Entity Tax Changes
- The federal Tax Cuts and Jobs Act placed a $10,000 cap on the amount of state and local taxes individuals may deduct as part of their federal itemized deductions for tax years 2018 through 2025 (although this federal provision may be tweaked via potential “social infrastructure” legislation currently working its way through Congress). As a workaround, which has received the IRS’ blessing, many states have implemented an elective pass-through entity tax. NC is now joining in, effective 2022. For tax years beginning on or after January 1, 2022, certain partnerships and S corporations can make an annual election to be subject to an entity-level tax based on its NC income taxed at individual rates. High-level, this elective tax is an attempt to allow individuals a federal deduction for state taxes on flow-through income that escapes the $10,000 cap.
Again, these are just a few of the more significant provisions in the budget bill. More details can be found in this summary from the NCACPA. As always, email or call your Smith Leonard advisor with any questions or for a detailed application to your situation.