North Carolina Gov. Pat McCrory has signed a major tax reform bill that replaces the graduated personal income tax rates with a flat tax, lowers the corporate income tax rate, limits the adjustments to federal adjusted gross income for purposes of calculating North Carolina personal income tax liability, extends the research and development credit, and repeals numerous credits against personal and corporate income taxes. Other substantial changes were made to sales and use taxes and motor fuel and estate taxes.
Income Tax Changes
Personal Income Tax Rate
The graduated personal income tax rates are replaced with a flat tax of 5.8% during the 2014 tax year and 5.75% for post-2014 tax years. Currently the personal income tax rates range from 6% to 7.75%.
Corporate Income Tax Rate
The corporate income tax rate is reduced from 6.9% to 6% in 2014 and to 5% in 2015. The rate will be further reduced to 4% during the 2016 tax year and to 3% for post-2016 tax years provided that specified revenue growth targets are reached. The rates will be decreased in 2016 if net general fund tax collections for fiscal year 2014-2015 exceed $20.2 billion. The rate will be decreased for post-2016 tax years if the net general fund tax collections for fiscal year 2015-2016 exceed $20.975 billion.
Personal Income Tax Computation
Beginning with the 2014 tax year, the computation of personal income tax is changed significantly. The personal exemptions are repealed, but the standard deduction is increased to $15,000 for joint filers (currently $6,000), $12,000 for heads of household (currently, $4,400), and $7,500 for single taxpayers and married taxpayers filing separately (currently $3,000). Itemized deductions are limited to deductions for charitable contributions, personal residence interest, and real property taxes. The deduction amounts for personal residence interest and real property taxes are capped at $20,000. However, there are no limits on the charitable deduction amount.
Furthermore, addition adjustments are limited to the following:
- interest on other states’ (including political subdivisions and agencies of those states) obligations;
- the reduction in an S corporation shareholder’s income from the corporation attributable to any built-in gains tax imposed on the S corporation;
- the amount by which the federal basis of property exceeds the state basis of the property in the year the taxpayer disposes of the property;
- the amount excluded from federal gross income under the IRC §199 domestic production activity deduction; and
- the amount required to be added back when North Carolina decouples from federal bonus depreciation and IRC §179 asset expensing (currently 85% of the amount deducted on the federal return).
Subtraction adjustments are limited to the following:
- interest on U.S. obligations and, to the extend included in federal adjusted gross income (AGI), interest on North Carolina obligations and obligations of North Carolina nonprofit educational institutions;
- gain from the disposition of obligations issued before July 1, 1995, to the extent that the gain is exempt under North Carolina law;
- Social Security benefits and qualified railroad retirement benefits;
- refunds of state, local, and foreign income taxes included in the taxpayer's gross income;
- federal, state, or local government retirement benefits exempt pursuant to specified court settlements;
- Native American income earned or received by an enrolled member of a federally recognized Indian tribe provided the income is derived from activities on a federally recognized Indian reservation while the member resides on the reservation;
- the amount by which the state basis of property exceeds the federal basis of property in the year the taxpayer disposes of the property; and
- the amount allowed as a deduction as a result of an addback for federal bonus depreciation or IRC §179 asset expense deductions (currently 20% of the amount added back per year for five years following the year of the addback).
Numerous other deductions are repealed, including deductions for net business income, severance wages, certain retirement benefits, contributions to the Parental Savings Trust Fund of the State Education Assistance Authority, fire fighters, rescue squad workers, educator expenses, and compensation for erroneous conviction and imprisonment.
The technology development credit is renamed the research and development credit, and the credit is extended for two years (through 2015). In addition, the bill increases the personal income tax child care credit from $100 to $125 for joint filers making up to $40,000, but repeals the following credits:
- construction of dwelling units for handicapped persons credit;
- child care and certain employment-related expenses credit;
- certain real property donations credit;
- charitable credit for nonitemizers;
- conservation tillage equipment credit;
- gleaned crops credit;
- disabled persons credit;
- credit for tax paid on certain federal retirement benefits (credit or partial refund);
- credit for property taxes paid on farm machinery;
- poultry composting facility construction credit;
- interactive digital media credit;
- education expenses credit;
- savings association supervisory fee credit; and
- credit for reduced telephone charges for low-income users.
Sales and Use Tax Changes
Manufactured and Modular Homes
Effective January 1, 2014, and applicable to sales made on or after that date, the sales and use tax rate on manufactured homes is increased from 2% to the general rate of 4.75%, and the rate on modular homes is increased from 2.5% to the general rate as well. Moreover, the sale of both manufactured and modular homes is excluded from the 1% local sales and use tax.
Effective January 1, 2014, and applicable to sales made on or after that date, the following sales and use tax exemptions are repealed:
- nutritional supplements sold by a chiropractic physician at his office to a patient as part of the patient’s treatment plan;
- meals and food products served to students in dining rooms regularly operated by state or private educational institutions or student organizations; and
- sales of newspapers by newspaper street vendors, newspaper carriers making door-to-door deliveries, and in vending machines.
Effective July 1, 2014, and applicable to purchases made on or after that date, the following sales and use tax exemptions are repealed:
- bread, rolls, and buns sold at a bakery thrift store;
- back-to-school sales tax holiday; and
- Energy Star sales tax holiday.
Sunset of Certain Refunds Extended
Effective July 23, 2013, the sunset dates for sales and use tax refunds available to passenger air carriers, motorsports teams or sanctioning bodies, and professional motorsports teams are extended from January 1, 2014, to January 1, 2016.
Combined General Rate of Tax Applicable to Electricity and Piped Natural Gas
Effective July 1, 2014, and applicable to gross receipts billed on or after that date, the combined general rate applies to the gross receipts derived from sales of electricity and piped natural gas.
Changes to Admission Charges to Entertainment Activities
The 3% privilege tax on live entertainment and ticket resales is repealed. Also repealed is the 1% privilege tax on motion picture shows (i.e., movies). The exemption for certain exhibitions, performances, and entertainment is likewise repealed. In addition, the general rate of tax is imposed on:
- a live performance or other live event of any kind;
- a motion picture or film; and
- a museum, cultural site, garden, exhibit, show, or similar attraction, or a guided tour at any of these attractions.
Exemptions are enacted for admission charges to any of the following entertainment activities:
- an event held at an elementary or secondary school that is sponsored by the school;
- a commercial agricultural fair, as provided;
- a festival or other recreational or entertainment activity that lasts no more than seven consecutive days and is sponsored by a nonprofit entity that is exempt from tax, as provided, and that uses the entire proceeds of the activity exclusively for the entity’s nonprofit purposes (applicable to the first two activities sponsored by the entity during a calendar year); and
- a youth athletic contest (i.e., a contest in which each participating athlete is less than 20 years of age at the time of enrollment) sponsored by a nonprofit entity.
These provisions are effective January 1, 2014, and applicable to admissions purchased on or after that date.
Effective January 1, 2014, and applicable to sales made on or after that date, the general rate of tax of 4.75% applies to the sales price of a service contract. "Service contract" is defined as a warranty agreement, maintenance agreement, repair contract, or similar agreement or contract by which the seller agrees to maintain or repair tangible personal property.
Estate Tax and Other Tax Changes
The tax reform legislation also repeals the state estate tax, applicable to the estates of decedents dying on or after January 1, 2013; caps the motor fuel tax rate at 37.5 cents per gallon for the period October 1, 2013, through June 30, 2015; and repeals the annual franchise or privilege tax imposed on electric power, water, and public sewerage companies effective July 1, 2014, and applicable to gross receipts billed on or after that date.
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