December 21, 2021
Upon passage of NC Senate Bill 105 (the budget) on November 18, 2021, several significant tax changes were enacted. This alert summarizes the more important provisions.
Internal Revenue Code Conformity
Deductible Expenses: The bill updates NC tax law to conform to the Internal Revenue Code as of April 1, 2021, except for specific differences written into NC law. A significant result of this conformity is the allowance of a deduction for expenses related to forgiven Paycheck Protection Program (PPP) loans, forgiven Economic Injury Disaster (EIDL) loans, and Shuttered Venue Operator and Restaurant Revitalization grants for tax years 2020 – 2022. These expenses were previously required to be added back to NC taxable income.
Internal Revenue Code Differences
Charitable Contributions: For cash contributions to public charities, North Carolina will continue to allow deductions up to 60% of the taxpayer’s adjusted gross income. The Federal law allows a deduction up to 100% of adjusted gross income for such contributions through 2021.
Mortgage Insurance Premiums: Mortgage insurance premiums continue to be non-deductible in NC for individual taxpayers, regardless of their deductibility at the Federal level. Mortgage interest and property tax continue to be deductible on the NC return up to a cap of $20,000.
Food and Beverage Deductions: In NC, business-related food and beverage expense deductions will remain at a 50% limitation; a decoupling from the Federal 100% deduction aimed to help the pandemic’s hard-hit restaurant industry.
Unemployment Compensation: In NC, unemployment compensation remains fully taxable; a decoupling from the Federal allowance permitting a $10,200 exclusion for taxpayers with adjusted gross income of less than $150,000.
Individual Income Tax Changes
Personal Income Tax Rate: Personal income tax rates will be reduced incrementally over 6 years beginning in tax year 2022. Rates will reduce from the current rate of 5.25% gradually down to 3.99% for tax year 2027.
Medical Expenses: North Carolina now conforms to Federal law, allowing a deduction for medical expenses in excess of 7.5% of adjusted gross income, instead of the state’s previous 10% threshold.
Standard Deduction: Beginning in 2022, the NC standard deduction amounts will increase to closely resemble the Federal amounts.
Child Deduction Increase: Beginning in 2022, the maximum deduction amount will increase from $2,500 to $3,000 per qualifying child.
Net Operating Loss (NOL) Deductions: Beginning in 2022, individual taxpayers will no longer rely on their Federal NOL in computing their North Carolina taxable income. There will be a separate North Carolina NOL computation, which will help address inequities currently experienced by some taxpayers.
Corporate Income Tax Changes
Corporate Tax Phase-Out: The corporate income tax rate is slated to drop to 2.25% in 2025, 2% in 2026, 1% in 2028, and 0% in 2030.
Franchise Taxes: Beginning with franchise tax reported on the 2022 corporate tax return, the franchise tax base will be calculated from net worth only. The other two bases of tangible property and appraised county tax values will be eliminated.
Pass-through Entities Tax Changes
SALT Cap Workaround: Per Federal law, individual taxpayers are limited to a deduction of $10,000 for state and local taxes paid during the year ($5,000 for married taxpayers filing separately). This limitation came into play with the passing of the 2017 Tax Cuts and Jobs Act and is detrimental to many taxpayers. Senate Bill 105 allows for certain pass-through entities to annually elect to be subject to the state tax themselves, instead of the owners. The state tax paid at the entity level will be deducted from the entity’s Federal income, thus passing through the deduction to the owner, without being subject to the limitation on the owner’s individual tax return. This provision begins with the 2022 tax year.
Other Tax Items
Mill Rehabilitation Credit: The bill re-enacts this credit and delays the sunset until 2030.
Business Interest Expense: Due to differences in Federal and NC limitations on the deductibility of business interest, an addition to NC income is required in certain instances. When a taxpayer is required to make this add-back business, the bill now allows a taxpayer to deduct that amount over a five-year period.
Business Recovery Grant Program
This new recovery grant program, administered by the NCDOR, will issue a one-time payment to an eligible North Carolina business that experienced significant economic loss due to COVID-19. The application period closes January 31, 2022.
There are two types of grants in the program. A hospitality grant will be available to an eligible arts, entertainment, and recreation business, as well as eligible accommodation and food service business such as a hotel, restaurant, and bar (NAICS codes 71 and 72). A reimbursement grant will be available to an eligible business not classified in NAICS Code 71 and 72 that did not receive funding from other relief programs including Paycheck Protection Program, COVID-19 Job Retention Grant, and EIDL Advance.
To qualify for the grant, a business must have suffered an economic loss of at least 20%. Your economic loss is determined based on the amount your North Carolina gross receipts from March 1, 2020, through February 28, 2021 (“COVID Period”) were reduced compared to those from March 1, 2019 through February 29, 2020 (“Pre-COVID Period”).
The grant amount is a percentage of your economic loss and could be up to $500,000. Grant amounts will be determined at the conclusion of the application period and the NCDOR will reduce grant amounts if the total amount requested by all applicants exceeds the maximum amount authorized by the state.
Under current law, this grant may be taxed by the Federal government, but this bill makes it exempt from North Carolina tax.
In the coming months additional guidance may be released from the North Carolina Department of Revenue (NCDOR) so stay tuned to JPS to learn more.
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