North Carolina Budget Includes Package of Tax Reductions

On November 18, 2021, Governor Roy Cooper of North Carolina signed into law S.B. 105, a budget bill that enacts more than $52 billion in spending over two years and includes a significant package of tax reductions for businesses and individuals. The law begins a phase-out of the corporate income tax in 2025, implements an elective pass-through entity tax as a workaround of the federal limit on state and local tax (SALT) deductions, simplifies the state’s franchise tax base, and reduces individual income tax rates and increases individual deductions.

Corporate Income Tax Phased Out

North Carolina has the lowest corporate income tax rate in the country at 2.5 percent, and the budget begins a phase out of the tax for tax years beginning after January 1, 2025. The law reduces the rate to 2.25 percent in 2025, 2 percent in 2026, 1 percent in 2028, and eliminates it after 2029. With the phase-out, North Carolina will join South Dakota and Wyoming as the only states without a corporate income tax.

Implements SALT Cap Workaround

The budget implements a workaround of the $10,000 federal limit on SALT deductions implemented under the Tax Cuts and Jobs Act (TCJA). The law allows S corporations and partnerships to elect to be taxed as an entity in an amount equal to each shareholder’s pro rata share of the taxed pass-through's income or loss. The shareholders or partners of the pass-through S Corporation are then allowed a deduction on their state taxes equal to the tax paid.

Simplifies Franchise Tax

The law also makes changes to the state’s franchise tax base. It simplifies the franchise tax base to the proportion of a corporation’s net worth apportioned to the state. Previously, the franchise tax base was the greater of net worth, 55 percent of the appraised value of all real and tangible personal property in the state, or a corporation’s total investment in tangible property in the state. The law also simplifies the assessment of the tax to $1.50 for every $1,000 of the tax base, with a limit of $150,000 and a minimum of $200. The changes are effective for tax years beginning on or after January 1, 2023, and are applicable to the franchise tax reported on the 2022 corporate income tax returns from 2022 and after.

Reduces Individual Taxes

The budget makes significant individual tax changes through both rate reductions and increased deductions. North Carolina has one of the lowest individual income tax rates in the country at 5.25 percent, and the law reduces the rate to 4.99 percent in 2022, 4.75 percent in 2023, 4.6 percent in 2024, 4.5 percent in 2025, 4.25 percent in 2026, and 3.99 percent after 2026. The law also excludes military pension income from taxation for tax years beginning on or after January 1, 2021.

The budget also increases the state’s standard deduction and child deduction. The law increases the standard deduction from $21,500 to $25,500 for married, filing jointly; from $16,125 to $19,125 for head of household; from $10,750 to $12,750 for single filers, and from $10,750 to $12,750 for married filers filing separately.

The law increases the child deduction amounts by $500 per qualifying child, bringing the largest deduction to $3,000 per child for married taxpayers with an adjusted gross income of up to $40,000. The bill also expands eligibility for the child deduction by raising the top bracket for single filers and married taxpayers filing separately from $60,000 to $70,000; for heads of household from $90,000 to $105,000; and for married taxpayers filing jointly from $120,000 to $140,000.

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