NCCBI News

Waging a Defensive Battle on Taxes

After taking stock of developments from this year’s rancorous session of the General Assembly, NCCBI can finally assess the job it did representing business interests during one of the most difficult legislative sessions ever. To use a football analogy, NCCBI was forced to play defense during an exceptionally tough budget year. We gave up a few points but stopped several big plays. We lost on one big play — session limits — but managed to keep our opponents from scoring on several occasions, particularly on tax increases. Below are brief items explaining the revenue laws changes:

Expanded definition of business income: As part of the package to “close loopholes” the legislature approved a provision to expand the definition of business income to include all income that is apportionable under federal tax law. This change in effect repeals the N.C. Supreme Court’s Lennox v Tolson decision and subjects to North Carolina tax such things as rents, royalties, the gain or loss from the sale of property, interest on dividends and such one-time events as the sale of a subsidiary. Advocates for the provision contended that this will “eliminate the vagueness and narrowness, which allow it to be used by corporations to create ‘nowhere’ income that should otherwise be taxable in North Carolina.”

Clarifying tax liability of LLCs: During the 2001 session of the General Assembly, legislation was enacted which was intended to close a loophole that allowed corporations to avoid franchise taxes on their assets by transferring their assets to a controlled limited liability company. Corporations pay franchise tax on their assets but LLCs do not. The provision passed last year required corporations to pay tax on assets owned by the LLC if the corporation, including its affiliate entities, indirectly owned at least 70 percent of the LLC’s assets. The change enacted this year attempts to further clarify the intent of the 2001 legislation.

Revision to subsidiary dividends: During the 2001 session of the General Assembly, legislation was enacted that made changes to state law as it related to tax treatment of subsidiary dividends. When the original law was enacted, it was perceived to conform to federal law and North Carolina businesses were not expecting to experience any major new tax burden. However, once the N.C. Department of Revenue published its bulletin on implementation of this change, it became clear that the new law had the unintended affect of dramatically increasing taxes related to subsidiary dividends. NCCBI, the N.C. Bankers Association and others worked tirelessly throughout the session on this issue to provide clarity to businesses affected by the change and limit the potential exposure for affected companies. As a result of this change in the law, there is now greater clarity to the expense attribution law as it applies to deductible dividends and the potential tax liability of affected companies is also limited. The new law provides clarity through a formula based on type of company and sets a cap of $11 million per corporate family. The provisions adopted this session affect taxable years 2001 and 2002 and directs the Revenue Laws Study Commission to review the issue and recommend a permanent solution. The change affects the nontaxable dividends that companies receive from wholly or partly owned subsidiaries and what expenses they can write off related to that nontaxable income.

Conformity on EGTRRA: As part of the federal Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), Congress raised the limits that individuals are allowed to save in tax deferred retirement plans such as IRAs, 401(k)s and 457 deferred compensation plans. Even in tough economic times for the state, the General Assembly agreed to conform to the increased federal limits. Adoption of these conformity provisions will reduce money going into the state’s General Fund by about $22 million for fiscal 2002-03. NCCBI strongly supported this change because nonconformity would have created significant record keeping problems for businesses and individuals and would have complicated the administration of pension plans. The conforming changes will encourage individuals to save for their retirement and their children’s education and will make it less complicated for individuals to consolidate retirement plans if they change jobs.

Change in depreciation treatment: Legislation enacted this session attempts to make it easier for companies to take advantage of the new federal law on depreciation. Whereas many states did not conform on this federal provision, North Carolina lawmakers crafted a measure to help business and industry and at the same time not take too big of a bite out of anticipated state revenues. Now, a taxpayer will be able to use the same basis in assets for federal and state purposes, but will be required to add back a percentage to cover any advantage in state calculations on depreciation. In a complex formula worked out in negotiations between the House and Senate, over a period of years the net effect to NC companies will be conformity to the federal provision.

Passage of “throw-out” rule avoided: In looking for ways to close the budget gap, the House approved legislation in its finance package making changes in what is referred to as the “throw-out rule.” Advocates of the legislative change described this as closing a loophole. NCCBI made a case on behalf of the business community that this was not a loophole closing but was a major change in state tax policy. If enacted, the provision would have limited the throw-out rule for corporate apportionment by subjecting to state tax a part of the corporation’s “nowhere” income that is not currently being taxed by any state. Under the proposal, sales to the federal government or to a buyer in a state that cannot tax the corporation would have been excluded from the sales factor formula and thus would not reduce the ratio that determines how much of the corporation’s business income is subject to North Carolina tax. The net effect would have been a major tax increase for many companies operating in North Carolina.

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