On Oct. 3, 2023, the North Carolina budget legislation became law without the signature of Gov. Roy Cooper.1 The legislation accelerates formerly planned lower individual income tax rates to earlier years and retains the possibility of further rate reductions based on state revenue goals. Also, the legislation places a corporate franchise tax cap on the first $1 million of a C corporation’s tax base and retroactively expands the availability of the elective pass-through entity (PTE) tax. Finally, the legislation imposes a new tax on for-hire ground transportation services beginning July 1, 2025.
Individual income tax rate reductions
The legislation advances previously enacted individual income tax rate reductions for taxable years beginning after 2023.2 The tax is imposed at the rates as follows:
The tax rate may be further reduced for taxable years beginning in 2027 through 2034 if the state’s general fund revenue exceeds a specified threshold (termed a “trigger amount”) for the preceding fiscal year.3 Specifically, the rate will be reduced by 0.50% for the tax year and subsequent tax years but it cannot be reduced below 2.49%. As a result, the rate potentially could be reduced three times between 2027 and 2034.
Corporate franchise tax cap
For taxable years beginning on or after Jan. 1, 2025, and applicable to the calculation of franchise tax reported on the 2024 and later corporate income tax returns, the first $1 million of a C corporation’s tax base is taxed at $500. The tax is then imposed at a rate of $1.50 per $1,000 of a C corporation’s tax base that exceeds $1 million.4 Under existing law, a C corporation’s entire tax base is taxed at a rate of $1.50 per $1,000. The tax cannot exceed $150,000 for holding companies, but there is no limitation for non-holding companies.5
Elective PTE tax expanded
The legislation amends the elective PTE tax regime with retroactive effect for tax years beginning on or after Jan. 1, 2022.6 As amended, an expanded group of trusts and corporations are allowed to be partners in a partnership making a PTE tax election. Existing law allows an eligible partner to be a trust described in Internal Revenue Code (IRC) Sec. 1361(c)(2).7 This provision now also includes a trust that solely has individuals, estates, trusts, or organizations described in IRC Sec. 1361(c)(6) as beneficiaries.8 Existing law permits an eligible partner to be a partnership, including an entity that is classified as a partnership for federal income tax purposes, or an S corporation.9 The statute was amended to replace the “S corporation” language with “an entity that is classified as a corporation for federal income tax purposes.”10 For the 2022 tax year, a partnership that could not make the PTE election on its timely filed tax return may make the election by filing an amended return by Oct. 15, 2023.11
Tax imposed on for-hire ground transportation services
Effective July 1, 2025, North Carolina is imposing an excise tax on the gross receipts derived from each for-hire ground transport service12 if the passenger boards the vehicle in North Carolina, regardless of whether the service is completed.13 The tax is imposed at a rate of 1.5% for an exclusive-ride service and 1% for a shared-ride service.14 The statute clarifies that the tax is intended to be passed on to the purchaser of the for-hire ground transport service.15 The for-hire service provider, rather than the vehicle driver, must collect the tax due. The tax must be stated and charged separately on any documentation provided to the purchaser by the for-hire ground transportation service provider at the time of the transaction. The tax is collected and administered in the same manner as the state sales and use tax.16
Commentary
North Carolina’s budget legislation follows the state’s recent trend of reducing income taxes. In 2021, the state enacted legislation phasing out the corporate income tax beginning in 2025.17 This year’s budget legislation implements the lower individual income tax rates earlier than originally planned and provides for three further possible rate reductions contingent on certain state revenue “triggers” being satisfied. If the contingencies are met, the individual income tax rate will be reduced to 2.49%. From an income tax rate perspective, in comparison to neighboring states, North Carolina should be attractive to businesses. The contingency language in the future rate reductions was a compromise between the North Carolina Senate and House of Representatives. As reported, the House wanted to enact the lower tax rates without the contingencies.
While the state’s relatively complex corporate franchise tax remains in place, the corporate franchise tax cap on the first $1 million of the tax base for C corporations should provide a minor degree of tax relief. Under existing law, a C corporation with a tax base of $1 million would be taxed $1,500. As amended, the franchise tax on the first $1 million will be reduced to $500.
The retroactive changes to the PTE tax should make the election available to a broader range of PTEs owned by more diverse interests. The extension of the deadline for making the election for the 2022 tax year formalizes the position taken by the North Carolina Department of Revenue. There is some concern that the changes may not allow all taxpayers to amend returns by Oct. 15, 2023. Further relief may be considered in the future.
Finally, the new tax on for-hire ground transportation services will affect many taxpayers because it will broadly apply to transportation reserved through major rideshare apps as well as taxi services. Because this new tax is not effective until July 1, 2025, the transportation service providers will have an opportunity to implement systems to collect this tax. The legislation expressly provides that this tax will be administered in the same way as the state sales and use tax. Given the growing popularity of rideshare services, it is not surprising to see that this new tax is being enacted as a means to generate additional tax revenue.
1 S.L. 2023-134 (H.B. 259), Laws 2023.
2 N.C. GEN. STAT. § 105-153.7(a).
3 N.C. GEN. STAT. § 105-153.7(a1).
4 N.C. GEN. STAT. §§ 105-120.2(b); 105-122(d2).
5 The same tax rates and caps currently apply for S corporations, except the first $1 million of the S corporation’s tax base is taxed at $200. N.C. GEN. STAT. §§ 105-120.2(b); 105-122(d2).
6 N.C. GEN. STAT. § 105-154.1. For further information on the PTE tax changes, see Directive TA-23-1, North Carolina Department of Revenue, Oct. 4, 2023. As originally enacted, the partnership election is available for tax years beginning on or after Jan. 1, 2022.
7 N.C. GEN. STAT. § 105-154.1(a)(3). The list of trusts described in this IRC provision includes trusts treated as owned by U.S. individual citizens or residents, electing small business trusts, and several other specified trusts.
8 Id. IRC Sec. 1361(c)(6) permits certain exempt organizations to be shareholders of an S corporation.
9 N.C. GEN. STAT. § 105-154.1(a)(5).
10 Id.
11 N.C. GEN. STAT. § 105-154.1(a1).
12 A for-hire ground transport service” is ground transportation in a passenger vehicle provided by a for-hire ground transport service provider for which a passenger is charged a fee. N.C. GEN. STAT. § 105-187.90(5). The statute defines a “for-hire ground transport service provider” as a transportation network company under N.C. GEN. STAT. § 20-280.1 or a taxi service. N.C. GEN. STAT. § 105-187.90(6). A “transportation network company” is any person that uses an online-enabled application or platform to connect passengers with drivers who provide prearranged transportation services. N.C. GEN. STAT. § 20-280.1(6).
13 N.C. GEN. STAT. § 105-187.91(a).
14 An “exclusive-ride service” is a for-hire ground transport service requested by a passenger who wants exclusive use of the vehicle. N.C. GEN. STAT. § 105-187.90(3). A “shared for-hire ground transport service” is a for-hire ground transport service for which an individual has been matched with another individual by a for-hire ground transport service provider. N.C. GEN. STAT. § 105-187.90(9).
15 N.C. GEN. STAT. § 105-187.91(b).
16 N.C. GEN. STAT. § 105-187.93.
17 N.C. GEN. STAT. § 105-130.3. The corporate income tax is scheduled to be entirely phased out by the 2029 tax year.
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