In the waning hours of the long and contentious legislative session, the North Carolina General Assembly approved a number of significant state tax changes. Those changes are now headed to Gov. Roy Cooper (D), who has previously expressed opposition to a number of them—including a corporate rate cut in a tax many view as onerous.
As ratified by the General Assembly, S.B. 578 would reduce the corporate franchise tax and eliminate one method of calculating that tax. S.B. 557 would adopt “market based sourcing” for purposes of apportioning the corporate income and franchise tax, require “marketplace facilitators” to collect sales tax, expand the definition of “holding company” for franchise tax purposes, and increase the standard deduction for individual income taxpayers.
Both bills were ratified on Oct. 31, 2019, and presented to the governor on Nov. 1, 2019. The governor may either sign the bills, allow them to become law without his signature or veto them. As of Nov. 6, the governor had taken no action.
Reduction of Corporate Franchise Tax
The rate of the North Carolina franchise tax is currently $1.50 for every $1,000 of a C corporation’s franchise tax base. For S Corporations, the rate is $200 for the first $1 million of the corporation’s tax base and $1.50 for every $1,000 of the base that exceeds $1 million. S.B. 578 would reduce the rate to $1.29 for taxable years beginning on or after Jan. 1, 2021, and applicable to the calculation of the tax reported on the 2020 return. It would further reduce the rate to $.96 for taxable years beginning on or after Jan. 1, 2022, and applicable to the calculation of the tax reported on the 2021 and later returns. The rate reduction applies to all corporations other than electric power companies, which would remain subject to the current rate though taxable year 2026. Beginning in 2027, electric power companies would be taxed at the same rate as other corporations. The franchise tax applies to limited liability companies that elect to be taxed as corporations under the federal tax code.
Elimination of One Alternative Franchise Tax Base
Currently, the franchise tax base is the greatest of: (i) the apportioned net worth base, (ii) 55% of the appraised value of real and personal property located in North Carolina, or (iii) the total actual investment in tangible personal property in the state. Effective for taxable years beginning on or after Jan. 1, 2021, and applicable to the calculation of the tax reported on the 2020 and later returns, S.B. 578 would eliminate the second alternative base.
Fiscal Impact of S.B. 578
According to the fiscal note, when fully implemented, the rate reduction and elimination of the alternative base would result in franchise tax savings of approximately $300 million a year for corporate taxpayers.
Market Based Sourcing
Senate Bill 557 would adopt market based sourcing for purposes of calculating the apportionment formula used to apportion the corporate income and franchise tax bases effective for taxable years beginning on or after Jan. 1, 2020. North Carolina adopted the single sales factor apportionment formula beginning in taxable year 2018, and this would change how the numerator of that factor is calculated. Under market based sourcing, receipts are sourced to North Carolina (included in the numerator) if the taxpayer’s “market” for the receipt is in the state. The legislation provides rules for determining if the taxpayer’s market is in the state. For example, receipts from the sale of tangible personal property are in the state if the property is delivered in the state. Receipts from intangible property are in the state if the intangible is used in the state. Receipts from services are in the state if the service is delivered to a location in the state. There are special rules for banks and wholesale content distributors. According to the legislative bill summary, at least 30 states have adopted market based sourcing.
Market Place Facilitators
Senate Bill 557 would require “marketplace facilitators” to collect sales tax if annual North Carolina gross sales exceed $100,000 or 200 separate transactions. This is the same threshold the General Assembly enacted last year for “remote retailers” in the wake of the landmark Wayfair decision from the U.S. Supreme Court (authorizing states to require remote retailers with no physical presence in the state to collect tax if sales exceeded these thresholds). A marketplace facilitator is someone that contracts with third parties to sell goods and services on its platform. The legislation would require the marketplace facilitator to collect sales tax on the third party seller’s behalf. The new law would become effective for sales occurring on or after Feb. 1, 2020. More than 30 states have some variation of marketplace facilitator laws.
Senate Bill 557 also revises the definition of a “holding company” for franchise tax purposes. The maximum franchise tax on holding companies is $150,000, and the revisions would expand that definition to allow at least one additional corporation to qualify for the reduced tax. According to the legislative bill summary, the new definition is “tightly drawn” and contains three requirements, one of which is that the parent company generate over $5 billion in revenue from products it manufactures. News reports indicate the legislation is intended to protect Reynolds American from double taxation, which would benefit by about $4 million annually. The legislation would be effective for taxable years beginning on or after Jan. 1, 2020, and applicable to the calculation of the franchise tax reported on the 2019 and later returns.
Increase in Standard Deduction
Finally, S.B. 557 would increase the standard deduction for individual income taxpayers effective for taxable years beginning on or after Jan. 1, 2020. The standard deduction would increase 7.5% for each filing status. For married filing jointly taxpayers, it would increase from $20,000 to $21,500.
Fiscal Impact of S.B. 577
According to the fiscal note, the largest fiscal component of S.B. 557 is the marketplace facilitator legislation, which would result in additional state and local sales tax revenues of over $200 million a year. The next largest component is the increase in the standard deduction, which would save individuals approximately $180 million a year. Finally, the corporate tax changes would result in a slight increase in corporate tax collections of approximately $5 million a year. Overall, S.B. 577 would result in an increase in state and local tax collections of about $160 over the next five years.
If Gov. Cooper either signs the ratified legislation or allows it to become law without his signature, the tax changes will become law. If, however, the governor vetoes one or both of the bills, the tax changes in the vetoed legislation will not become law unless and until the General Assembly votes to override the veto. A veto override requires a three-fifths majority in each chamber. Any override vote likely would not occur until January at the earliest (if at all).
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Kay Miller Hobart, partner at Parker Poe, has more than 20 years of experience in state tax controversy matters and tax litigation at all levels of state and federal court. She can be reached at firstname.lastname@example.org or 919.835.459.