The North Carolina Legislature, firmly controlled by the Republicans, continues to enact a series of tax cuts as the Senate and House both voted to override Governor Roy Cooper's (D) veto of Senate Bill 257 (Bill). Each chamber needed a 60% majority to override Cooper's veto and approve the Bill. The Senate voted to override the governor's veto with a vote of 34-14 on June 27, 2017, followed the next day by the House with a vote of 76-43. Thus, the Bill was enacted on June 28, 2017.

The Bill enacts the state's $23 billion general fund budget for the fiscal year July 1, 2017 – June 30, 2018. With most tax cuts taking effect after 2018, the budget outlines overall tax relief totaling around $1.1 billion annually.

Corporate income tax

The Bill lowers the corporate tax rate to 2.5% for tax years beginning on or after January 1, 2019.¹ The Bill also repeals N.C.G.S. Section 105-130.3C, which provided for a rate reduction if the General Fund tax collected in a fiscal year met a certain threshold. Accordingly, the tax rate for the 2017 and 2018 tax years will remain at 3%.

Corporate franchise tax

The Bill simplifies the language of the franchise tax calculation. The rate and calculation remain unchanged for C corporations. For S corporations, the calculation remains unchanged but the rate is reduced. C corporations will pay $1.50 per $1,000 of the corporation's tax base. S corporations will pay $200.00 for the first $1 million of the S corporation's tax base and then $1.50 per $1,000 of its tax base that exceeds $1 million. Both C corporations and S corporations are subject to a minimum tax of $200.00.

The franchise tax changes are effective for tax years beginning on or after January 1, 2019, and apply to the calculation of franchise tax reported on corporate income tax returns filed for 2018 and later tax years.

Personal income tax

The Bill lowers the personal income tax rate from 5.499% to 5.25% for tax years beginning on or after January 1, 2019. The Bill also increases the standard deduction effective for tax years beginning on or after January 1, 2019 as follows²:

The Bill also converts the child tax credit to a tax deduction. Taxpayers who are allowed a federal child tax credit under IRC Section 24 for the tax year are no longer allowed a credit, but may claim a deduction, in computing North Carolina income tax. The deduction amount for each child ranges from $0 to $2,500 and is based on the filing status and adjusted gross income of the taxpayer. The law change is effective for tax years beginning on or after January 1, 2018.

Sales and use tax

Exempting mill machinery and certain other sales from sales and use tax

The Bill eliminates the existing 1% privilege tax on certain purchases of manufacturing equipment and machinery. Previously, mill machinery and mill machinery parts and accessories were exempt from sales and use tax but subject to a privilege tax at the rate of 1% of the sales price, with a maximum tax of $80 per article. The Bill eliminates the privilege tax on such property by repealing article 5F of Chapter 105 of the North Carolina General Statues. The Bill adds the following to the list of sales that are specifically exempt from retail sales and use tax:

— Sales of mill machinery or mill machinery parts or accessories to a manufacturing industry or plant, or to certain contractors or subcontractors

— Sales of certain property to a major recycling facility

— Sales of certain property to a company located at a ports facility for waterborne commerce

— Sales of certain property to a "secondary metals recycler," which is a newly defined term

— Sales of repair or replacement parts for a ready-mix concrete mill, regardless of whether the mill is freestanding or affixed to a motor vehicle, to a company that primarily sells ready-mix concrete

— Sales of certain equipment, or an attachment or repair part for equipment, that are to companies in specific industries³

These changes are effective July 1, 2018, and apply to sales made on or after that date. To help clarify the new law, the Revenue Laws Study Committee has been directed to study and report on ways in which to clarify the scope of the sales and use tax exemption for mill machinery, as enacted by the Bill, for review during the 2018 Regular Session of the 2017 General Assembly.

Sales and use tax exemption for fulfillment centers

The Bill exempts from tax the sales of equipment, or an accessory, an attachment, or a repair part for equipment that meets all of the following requirements:

1. Is sold to a large fulfillment facility

2. Is used at the facility in the distribution process, which includes receiving, inventorying, sorting, repackaging, or distributing finished retail products

3. Is not electricity

The Bill also defines "large fulfillment facility" as a facility that satisfies both of the following conditions:

1. The facility is used primarily for receiving, inventorying, sorting, repackaging, and distributing finished retail products for the purpose of fulfilling customer orders.

2. The Secretary of Commerce has certified that an investment of private funds of at least $100 million has been or will be made in real and tangible personal property for the facility within five years after the date on which the first property investment is made and that the facility will achieve an employment level of at least 400 within five years after the date the facility is placed into service and maintain that minimum level of employment throughout its operation. ⁴

If the required levels of investment or employment are not timely made, achieved or maintained, then the sales and use tax exemption is forfeited.

The sales and use tax exemption for fulfillment centers is effective beginning July 1, 2017, and applies to sales made on or after that date.

Other changes

Sales tax refund for transformative projects

Effective beginning July 1, 2017 and applicable to sales made on or after that date, an owner or lessee of a business that receives a grant under the Job Development Investment Grant Program on or before June 30, 2019, for a transformative project as defined in N.C.G.S. Section 143B-437.51(9a) is allowed a refund of the sales and use tax that it paid on building materials, building supplies, fixtures, and equipment that become a part of the real property of the facility.

Renewable energy tax credit extension

The repeal of the renewable energy tax credit is extended from January 1, 2017 to May 5, 2017 for certain renewable energy property utilizing renewable biomass resources.

Implications

Companies should consider the implications of the Bill on income tax reporting requirements (e.g., ASC 740). The Bill became law on June 28, 2017, so the timing of its changes should be considered accordingly.

Among states that levy corporate income tax, North Carolina will continue to have the lowest tax rate. According to the North Carolina Office of State Budget and Management fiscal impact assessment, the law changes will have the following impact on the state's revenue:

— During the fiscal year starting July 1, 2017, the corporate tax changes will result in a state revenue loss of about $6.4 million. The personal tax changes will result in a state revenue loss of about $200,000.

— During the following fiscal year, the corporate tax changes will result in a state revenue loss of about $107 million. The personal tax changes will result in a state revenue loss of about $388.6 million.

— During subsequent years the corporate tax changes will result in a state revenue loss of more than $200 million. The personal tax changes will result in a state revenue loss of about $900 million.

In the out years, it is possible that those revenue losses could play into future legislative tax law changes, which are currently impossible to predict.

In addition to the income tax changes, businesses in North Carolina should consider the newly enacted sales and use tax exemptions targeted to eliminate the taxes on machinery purchases. Namely, the Bill repeals the 1% privilege tax on mill machinery and mill machinery parts and accessories and substitutes a sales and use tax exemption for the items. Further, in recognizing that the operational language for mill machinery has remained virtually unchanged for over 60 years and lacks clear guidance with regard to its application (i.e., Article 5F of Chapter 105 of the North Carolina General Statutes, and its predecessors, did not define "manufacturing industry or plant" or "mill machinery"), the Revenue Laws Study Committee has been directed to study and report on ways in which to clarify the scope of the sales and use tax exemption for mill machinery, as enacted by the Bill, for review during the 2018 Regular Session of the 2017 General Assembly. These changes will be effective July 1, 2018. Businesses will want to contribute their thoughts to the Committee as it considers clarifying these important definitional issues.

In addition to the replacement of the privilege tax on mill machinery purchases with a sales and use tax exemption, the Bill also creates a unique exemption, effective July 1, 2017, for large fulfillment facilities in hopes of benefiting fulfillment companies already located in the state as well as attracting new business to the state.

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ENDNOTES

¹ Bill, Section 38.5(b).

² Id. at Section 38.2(a).

³ Id. at Section 38.8(c).

⁴ Id. at Section 38.9(a).