On July 2, 2026, North Carolina Governor Josh Stein signed Senate Bill 595 (SB 595) into law as Session Law 2026-31 (the Bill). Among its wide-ranging revenue provisions, the Bill updates North Carolina's static Internal Revenue Code (IRC or Code) conformity date from January 1, 2023, to July 5, 2025, thereby incorporating federal tax changes enacted through that date, including those under the One Big Beautiful Bill Act (OBBBA). The Bill also includes targeted decoupling from the OBBBA's full first-year expensing of domestic research and experimental (R&E) expenditures under new IRC Section 174A(a), a notable change to the franchise tax treatment of affiliated indebtedness, conformity with the federal centralized partnership audit regime, new withholding requirements for gaming operators and various other tax changes. The Bill is generally effective July 2, 2026, except as otherwise noted.

The updated conformity date is particularly significant since the North Carolina Department of Revenue (NCDOR) issued guidance on February 9, 2026 (updated February 27, 2026), that instructed taxpayers to compute adjusted gross income (AGI) for individuals and federal taxable income (FTI) for corporations under the Code as of January 1, 2023. That guidance required taxpayers to disregard the OBBBA's federal tax changes for North Carolina purposes and to attach a supplemental reconciliation schedule to their 2025 returns. With the enactment of SB 595, the treatment of several key items has changed materially from what the NCDOR's guidance contemplated. On July 23, 2026, the NCDOR issued new guidance to account for the enactment of SB 595.

IRC conformity update and corporate income tax impacts

Bonus depreciation (IRC Section 168(k)).

Because North Carolina conformed to the Code as of January 1, 2023, the NCDOR's prior guidance limited the bonus depreciation percentage for qualified property placed in service during tax year 2025 to 40% (reflecting the phase-down schedule in effect under the pre-OBBBA Code). As a result, corporations were required to compute FTI using 40% bonus depreciation and then apply the regular Modified Accelerated Cost Recovery System (MACRS) depreciation to the remaining basis.

With SB 595's update of the IRC conformity date to July 5, 2025, North Carolina now incorporates the OBBBA's restoration of 100% bonus depreciation for qualified property. This change represents a significant difference from the position outlined in the NCDOR's February 2026 guidance. Corporations that placed qualified property in service in 2025 must now compute their North Carolina FTI starting point based on the full 100% bonus depreciation deduction.

North Carolina's existing 85% bonus depreciation addback under N.C.G.S. Section 105-130.5(a)(2) and corresponding 20% deduction over the following five years under N.C.G.S. Section 105-130.5(b)(4), however, remain in effect. Accordingly, while the starting point for computing FTI now reflects 100% bonus depreciation, the addback and deduction provisions will continue to apply.

R&E expenditures (IRC Section 174A(a)).

While SB 595 generally conforms to the Code through July 5, 2025, it specifically decouples from IRC Section 174A(a). IRC Section 174A(a) allows full first-year expensing of domestic R&E expenditures, replacing the amortization requirement for domestic R&E expenditures that was present under IRC Section 174. As amended by the Tax Cuts and Jobs Act of 2017, IRS Section 174 required taxpayers to capitalize and amortize domestic R&E expenditures over five years.

Importantly, SB 595 requires an addback-and-deduction mechanism under N.C.G.S. Section 105-130.5C, which operates as follows:

• Addback (Year 1): A taxpayer that claims the federal immediate expensing deduction under IRC Section 174A must add back 80% of the amount deducted for federal purposes when computing North Carolina taxable income in the year the expenditures are incurred.
• Deduction (Years 2 through 5): The addback amount is then deducted ratably over the following four tax years, with the taxpayer claiming 25% of the original addback as a deduction in each of those four subsequent years.

This North Carolina adjustment, required under SB 595, is effective (1) for tax years beginning on or after January 1, 2022, for taxpayers that elect for federal income tax purposes the retroactive application of IRC section 174A(a) of the Code for a tax year beginning in 2022, 2023, and 2024; or (2) for tax years beginning on or after January 1, 2025, for taxpayers that do not make the election.

EY observes: This structure parallels North Carolina's existing bonus depreciation addback regime, discussed previously. By adopting a similar mechanism for R&E expenditures, the General Assembly has created a framework that defers, but does not permanently deny, the benefit of federal R&E expensing for North Carolina purposes. However, because of North Carolina's current corporate income tax rate phase out, in addition to a timing difference, there may be a rate difference between the addback and the subsequent deductions.

Corporate franchise tax: affiliated indebtedness modification

Creditor-side receivable deduction

SB 595 includes a change to the franchise tax treatment of affiliated indebtedness under N.C.G.S. Section 105-122 that warrants careful attention. Under North Carolina's franchise tax regime, a corporation is generally required to add affiliated indebtedness to its net worth tax base unless the indebtedness creates "qualified interest expense" for income tax purposes (i.e., interest expense paid to a related member that meets one of the statutory exceptions). Historically, the affiliated lender (creditor), assuming they were also a North Carolina filer, was permitted a corresponding deduction from its net worth tax base for the receivable to the extent the borrower (debtor) was required to include the related payable as an addition.

SB 595 modifies this framework by prohibiting a creditor from deducting the receivable from its net worth tax base if the debtor has added back the corresponding payable. The legislative history characterizes this as a technical or conforming change consistent with prior revisions to the franchise tax base. However, the practical implications of this change merit close scrutiny, particularly for affiliated groups with non-interest-bearing intercompany debt.

Significance for non-interest-bearing affiliated debt

Before the 2022 revisions (enacted by House Bill 83; see Tax Alert 2022-1492), a taxpayer could potentially avoid the affiliated indebtedness addition by structuring intercompany lending on a non-interest-bearing basis, since such debt would not "create net interest expense." The 2022 legislation closed that perceived gap by requiring the addition for affiliated indebtedness unless the indebtedness creates qualified interest expense. In doing so, non-interest-bearing intercompany debt became subject to the debtor-side addition. In practice, however, many affiliated creditors may have relied on the corresponding receivable deduction to offset the franchise tax impact at the group level.

Under SB 595's modification, that creditor-side offset is no longer available. For affiliated groups with significant non-interest-bearing intercompany balances, this change could result in a meaningful net increase to a group's overall franchise tax liability, since the debtor adds back the payable without a corresponding deduction at the creditor level.

EY observes: SB 595 applies this change retroactively to franchise tax year 2021 (filed on 2020 corporate income tax returns). Up until now, the statute as written permitted the creditor-side deduction, and taxpayers structured their intercompany transactions and prepared their returns accordingly. The retroactive elimination of that deduction raises questions about the extent to which taxpayers may have reasonably relied on the prior statutory text in filing franchise tax returns. While the General Assembly has characterized the change as a technical correction that conforms to original legislative intent, taxpayers that claimed the creditor-side deduction on prior-year returns may want to consider how this change might affect them and whether protective measures are appropriate.

Centralized partnership audit regime

SB 595 conforms North Carolina to the federal centralized partnership audit regime enacted under the Bipartisan Budget Act of 2015 (BBA). The Bill authorizes the assessment of tax at the partnership level for federal audit adjustments and allows refunds attributable to federal audit changes. This adoption of the BBA framework means that North Carolina will follow the federal push-out and imputed underpayment procedures, providing greater consistency for partnerships operating in the state.

Individual income tax considerations

With North Carolina now conforming to the Code as of July 5, 2025, individuals must compute AGI by incorporating OBBBA provisions that affect items included in AGI, such as the changes to bonus depreciation flowing through pass-through entities. However, certain OBBBA provisions that apply below the AGI line do not affect AGI and are, therefore, not automatically adopted for North Carolina purposes. OBBBA provisions that apply below the AGI line include new above-the-line deductions for tips, overtime pay, car loan interest, and the senior deduction, as well as the increased standard deduction and the expanded state and local tax (or SALT) deduction cap. The North Carolina General Assembly would need to enact separate legislation to provide for similar adjustments.

Consistent with the corporate income tax treatment, individual taxpayers are also subject to the R&E decoupling and must apply the 80% addback and subsequent four-year ratable deduction mechanism when computing North Carolina taxable income.

Other notable provisions of SB 595

In addition to the IRC conformity and franchise tax provisions previously discussed, SB 595 includes several other noteworthy tax changes:

• Withholding on gambling winnings - Effective for gambling winnings paid on or after January 1, 2027, gaming operators must withhold North Carolina income tax when the proceeds from a wagering transaction exceed $5,000 and are at least 300 times the amount wagered.
• Penny elimination rounding - The Bill provides retailers with a rounding procedure for cash transactions in connection with the elimination of the penny.
• Increased frivolous return penalty -The penalty for filing a frivolous tax return is increased from $500 to $2,000.
• Property tax refund changes - The Bill modifies procedures for obtaining refunds of improperly collected property taxes.
• Excise and privilege tax changes - Various provisions address fuels taxes, tobacco products taxes, and other excise and privilege taxes.