2010 North Carolina Tax Law Changes
Article Date: Monday, February 28, 2011
Written By: Keith A. Wood
This article reviews certain legislative developments during this past summer legislative session.
Individual Income Taxes
I. New Individual Income Tax Surtax Will Also Apply for 2010.
Under N.C.G.S. 105-134.2A, the temporary personal income tax surtax, enacted by the 2009 General Assembly, is also effective for the 2010 taxable year, but this surtax is set to expire for taxable years beginning on or after January 1, 2011.
II. North Carolina Partially Conforms to the Federal 5 Year Carryback of 2008 and 2009 Net Operating Loss (NOL) Rules.
A. Overview of 2009 NOL Federal Legislation.
1. The Federal ARRA: 5 Year Carryback for 2008 NOLs for Small Businesses. Under the American Recovery and Reinvestment Act ("ARRA"), an eligible small business ("ESB") could elect to carry back an NOL from the 2008 tax year for three, four or five years rather than the standard two years. An ESB is a corporation or partnership with less than $15 million in gross receipts for the loss tax year.
2. The Federal WHBAA: Five Year Carryback for 2008 and 2009 NOLs For All Businesses. The Worker, Homeownership, and Business Assistance Act of 2009 (WHBAA) modified ARRA by allowing businesses of every size (and not just an ESB) to carry back 2008 or 2009 NOLs for up to five years. Congress not only extended the benefit of the five year NOL for an additional year but also extended the scope of the benefit by removing the ESB small business limitation. In other words, the WHBAA allows all taxpayers, whether an ESB or not, to carry back 2008 and 2009 NOLs three, four, or five years (subject to a 50% federal taxable income limit on NOL carrybacks to the fifth year). However, the expanded election under the WHBAA is available for NOLs incurred during either 2008 or 2009 but not for both years, unless the carryback election is made by an ESB. This means that an ESB that elected to carry back its 2008 NOL under the ARRA may also make the election available under WHBAA for a 2009 NOL, enabling the ESB to carry back NOLs from both 2008 in 2009 for up to five years.
B. New 2009 N.C. Legislation Allows 5 Year Carryback of 2008 NOLs For ESBs.
Last year Senate Bill 202 updated the N.C. tax references to the IRS Code enacted as of May 1, 2009. Therefore, N.C. law adopted the five year net operating loss carry back provisions for 2008 net operating losses for an ESB as allowed by ARRA. A N.C. taxpayer is required to carry back a 2008 NOL to the same year for federal and state income tax purposes.
C. New 2010 North Carolina Legislation.
Senate Bill 897 updates the N.C. references to the IRS Tax Code as of May 1, 2010. However, Senate Bill 897 also requires certain adjustments to federal taxable income. Under new N.C.G.S. 105-135.6(d)(7), a N.C. taxpayer (other than an ESB) is required to add back, to federal taxable income, the amount of any 2008 or 2009 NOL claimed under WHBAA beyond the standard two year carryback period. However, no addition to federal taxable income is required for the portion of a NOL that is attributable to an ESB as defined by § 172(B)(1)(H) of the IRC. Thus, only N.C. ESBs can utilize the benefits of 2008 NOLs and 2009 NOLs more than two years. A N.C. taxpayer is required to carryback a 2009 N.C. NOL to the same year for both federal and N.C. tax purposes.
D. Other Adjustments to 2011-2013 North Carolina Taxable Income.
N.C.G.S. 105-134.6(d)(8) was amended to provide that, for taxable years 2011 through 2013, any taxpayer who made an addition to taxable income under (d)(7), can then deduct one third of the NOL add back required on their 2003, 2004, 2005, 2006 tax returns for tax years 2011, 2012 and 2013. There are future deductions from the NOL addition required under NCGS 104-134.6(d)(7). Under the new rules, a deduction of one-third of the 2008 NOL or the 2009 NOL is allowed for tax years 2011, 2012, and 2013. SB 897, effective June 30, 2010.
Sales and Use Tax Changes
III. New Sales and Use Tax Compliance Relief For Certain Small Retailers.
Before 2010, N.C.G.S. 105-164.16(b1) provided that any taxpayer, who was consistently liable for at least $100, but less than $10,000, a month in state and local sales and use taxes, could file a return and pay taxes on a monthly basis. In addition, under N.C.G.S. 105-164.16(b2), if a taxpayer was consistently liable for at least $10,000 a month in state and local sales and use taxes, the taxpayer was required to file and pay on a semi-monthly basis and to make a monthly prepayment of the next month’s tax liability equal to 65% of the tax due for the current month. This monthly sales tax was a great burden upon many small retailers. Thus, under these old rules, retailers were required to pay sales and use tax on one of three filing schedules:
1. A retailer who was consistently liable for less than $100 a month in sales and use taxes would file sales and use tax returns on a quarterly basis.
2. A retailer who was consistently liable for at least $100, but less than $10,000 a month in sales and use taxes would file a return and pay sales and use taxes due on a monthly basis.
3. A retailer who was consistently liable for at least $10,000 a month in sales and use taxes had to file and pay on a semi-monthly basis and to make a monthly prepayment of the next month’s tax liability equal to 65% of the current month’s sales and use tax liability.
B. 2010 Relief for Small Retailers.
1. New 2010 Minimum Threshold For Semi-Monthly Filers. Under revised N.C.G.S. 105-164.16(b1), the semi-monthly sales and use tax filing threshold for a retailer is now $15,000, which is increased from $10,000 a month. This change is effective Oct. 1, 2010.
2. New Minimum Thresholds for 65% Prepayments for 2010. Under new N.C.G.S. 105-164.16(b)(2), retailers only have to prepay 65% of the next month’s sales tax liability if their sales tax liabilities are consistently in excess of $15,000 per month, which is increased from $10,000 a month. This change is effective Oct. 1, 2010.
C. 2011 Relief for Small Retailers.
1. New 2011 Minimum Threshold for Semi-Monthly Filers. Beginning on Oct. 1, 2011, the semi-monthly sales tax filing requirements will only apply to retailers who consistently have sales tax liabilities of over $20,000 per month.
2. New 2011 Threshold for Prepayment Obligations. Likewise, beginning Oct. 1, 2011, the 65% monthly prepayment obligation will only apply to taxpayers who consistently have at least $20,000 per month in sales and use tax liabilities.
Corporate Income and Franchise Tax Changes
IV. New Reduced Corporate Franchise Tax Burden for Certain Construction Companies.
A. Background and Introduction.
The state franchise tax, assessed on C Corporations and S Corporations, is determined based upon a company’s capital stock, surplus and undivided profits. Under N.C.G.S. 105-122(b), the term “surplus and undivided profits” includes all liabilities, reserves and deferred credits, except to the extent that any of these items are specifically exempt. One of the specific exemptions from the definition of “surplus and undivided profits” is “definite and accrued legal liabilities." N.C.G.S. 105-122(b)(1). The NCDOR has defined a “definite and accrued legal liability” as a liability that is definite in amount (and not merely estimated).
B. Review of Percentage of Completion Accounting Method For Certain Construction Contractors.
Under GAAP, revenue is recorded when it is earned, regardless of when the work is billed for, or when payment is received. With construction contracts, billed revenue and earned revenue can occur at different times. Under GAAP, to alleviate this possible mismatch of billed and earned revenue, contractors may use the percentage of completion method of accounting in those cases where construction costs can be reasonably estimated. Under this method, construction revenue is recognized as production takes place. However, since revenue recognition and actual billing may occur at different times, the percentage of completion contract method may result in billings in excess of costs or costs in excess of billings. For balance sheet purposes, any amounts of billings in excess of costs is a liability because this figure represents income that is yet to be earned. On the other hand, any amount of costs in excess of billings is a balance sheet asset.
C. Prior N.C. Franchise Tax Law Required “Billings In Excess of Costs” To Be Included in Franchise Tax Base.
Under previous North Carolina law, for purposes of calculating a corporation’s franchise tax base, the NCDOR took the position that, under N.C.G.S. 105-122(b)(1), the balance sheet liability amount (represented by billings in excess of costs) was not considered to be a “definite and accrued legal liability” under the percentage of completion contract method of accounting since that amount was based upon future construction cost estimates. Therefore, the amount of billing in excess of costs was considered to be a part of “surplus and undivided profits” and thus was included in the corporation’s capital basis and was subject to N.C. franchise tax. Many members of the construction industry thought that was unfair because they would have to pay N.C. franchise tax on revenue that had not yet been earned by the contractor.
D. 2009 Franchise Tax Changes For Certain Construction Contractors Who Use the Percentage of Completion Accounting Method.
In 2009, N.C.G.S. 105-122(b)(1a) was revised to provide that billings in excess of costs under the percentage of completion accounting method are exempt from the definition of “surplus and undivided profits." Thus, this balance sheet liability will no longer be subject to the N.C. franchise tax. N.C. Sess. Laws 2009-422.
E. Effective Date and Possible Refund Claims for 2007, 2008 and 2009.
The new law is retroactive to 2007, which means that any taxpayer who paid franchise tax in 2007, 2008 or 2009 on billings in excess of costs can apply for a refund of those extra franchise taxes paid. N.C. Sess. Laws 2009-422, Sec. 31.9.(a). However, any requests for a refund for 2007, 2008 or 2009 franchise taxes must be made on or before Jan. 1, 2011; any refund request after that date will be barred. N.C. Sess. Laws 2009-422, Sec. 31.9.(b).
V. New Relief for Annual Report Compliance.
A. Background and Introduction.
N.C. corporations and LLCs are required to file annual reports each year and to pay the required annual report fee. For a business corporation annual report filed online, the corporate annual report fee is $18 plus a $2 electronic transaction fee. If filed in paper form with the DOR, the N.C. corporation annual report fee is $25. The LLC and LLP annual report fee is $200 plus the $2 electronic filing fee. If a corporation or LLC fails to file its annual report, the failure can be grounds for administrative dissolution.
B. In 2009 N.C. Secretary of State Advises of Numerous Annual Report Delinquencies.
In March 2009, the N.C. Secretary of State’s office mailed 270,000 notices to businesses stating that they were late in filing one or more annual reports. The Secretary of State found that many LLCs thought that their first annual reports were due the year after their formation. The Secretary of State, however, informed the LLCs that their first annual report was due on April 15 regardless of when the business was formed. This meant that if an LLC was formed on April 10, the LLC would have to file an annual report five days later on April 15. Many CPAs and attorneys were unaware of this annual report filing requirement.
C. New North Carolina Annual Report Compliance Changes.
SB 875 made the following changes to the annual report filing notice requirement:
1. Due Date for Corporate Annual Reports Is the Same Date For Filing the Corporate Income Tax Return. Under amended N.C.G.S. 55 16 22(c), the new due date for filing annual reports for a corporation will now be the same as the due date for filing corporate income tax returns - the 15th day of the fourth month following the corporation’s year end.
2. First Annual Report For An LLC Will Be Due April 15 of the Next Year. For newly formed LLCs, the first annual report will now be due by April 15 of the year following the calendar year in which the LLC files its articles of organization. Amended N.C.G.S. 57C-2-23(c).
3. New Retroactive Relief For LLC Annual Reports for LLCs Formed After Sept. 2001. An LLC is considered to have timely met its annual report filing obligations if (a) the LLC was formed after Sept. 1, 2001, and ( b) the LLC has filed its annual report for each year after the calendar year in which its articles of organization were filed. This retroactive relief will help LLCs formed during the first three months of a year after 2001 that failed to file an annual report by April 15 of the year of formation. N.C. Sess. Laws 2010-31, Section 31.4.(c), effective July 1, 2010.
N.C. Unemployment Insurance Taxes
VI. Temporary Small Business Refundable Tax Relief for Certain Payments to North Carolina
Unemployment Insurance Fund.
The N.C. Unemployment Insurance Tax is a tax on employer payrolls, which funds unemployment benefits to qualified unemployed workers. The unemployment insurance tax is not deducted from employee wages but instead is a direct tax against the business-employer.
B. New North Carolina UI Credit for 2010 and 2011 For Small Businesses.
New § N.C.G.S. 105-129.16J provides a new tax credit for small businesses that make contributions to the N.C. Unemployment Insurance Fund. The new tax credit is equal to 25% of the qualified contributions to the fund. This temporary credit only applies to taxable years 2010 and 2011. N.C.G.S. 105-129.16J(c).
C. Refundable Credit Can Only Be Claimed Against Income Taxes.
This new UI credit may be claimed only against corporate and individual income taxes (and not sales or property taxes). However, this credit is a refundable credit, which means that, if the amount of the 25% credit exceeds the amount of the corporate and individual income taxes for the year, the excess will be refunded to the taxpayer. New N.C.G.S. 105-129.16J(b)(2).
D. What is a Small Business?
A small business is a business whose cumulative gross receipts from business activities for the taxable year do not exceed $1 million. New N.C.G.S. 105-129.16J(a).
General Administrative Changes
VII. N.C. Officially Adopts the Mailbox Rule for Certain Filings, Refund Claims and Requests For Review of Proposed Assessments.
A. Background and Introduction.
The N.C. tax rules have been confusing in determining when the NCDOR was deemed to have received a taxpayer filing or refund claim. This issue has been especially troublesome for taxpayers filing a refund claim or filing a request for a departmental review of a proposed assessment. Also, clients have wondered whether a filed return, report, payment or a request for an extension of time for filing a report or return would be timely depending on when the return, payment or extension request was mailed or received by the NCDOR. Except with respect to filed requests for review of proposed assessments or denial of refund claim, the NCDOR in the past appeared to have informally adopted the federal mailbox rule.
B. New Mailbox Rule for Filing a Return, Report or Payment or Requesting Extensions.
The N.C. tax rules have now officially adopted the “mailbox rule." N.C.G.S. 105 -263 has now been amended to provide that, for purposes of determining whether a return, report or payment or other document is timely filed, Section 7502 of the IRS Code governs. Such provision is known as the “mailbox rule." Under the mailbox rule, the date the document is considered filed is the U.S. postmark date stamped on the mailing cover in which the return, report, payment or other document is mailed. Therefore, under the new N.C. rules, a report or return or payment is deemed filed when it is mailed rather than when it is received by the NCDOR. Effective July 17, 2010; Senate Bill 1177.
C. New Mailbox Rule for Requests for Review of a Proposed Tax Assessment or a Proposed Denial of Refund Claim.
N.C.G.S. 105-241.11(b) has also been revised to provide that a request for a departmental review of a proposed tax assessment or proposed denial of a refund claim is considered to be filed on the following dates:
(1) For a request delivered in person, the date of delivery;
(2) For a request that is mailed, the date determined in accordance with N.C.G.S. 105-263 (i.e., the “mailbox rule"); and
(3) For a request delivered by any other method, the date the Department receives it.
Effective July 17, 2010, SB 1177, Session Law 2010-95.
Tax Collection Procedure Changes
VIII. Attachment and Garnishment.
A. Now, North Carolina Garnishment Notices May Be Sent by Electronic Means.
New 2010 SB 897 amended N.C.G.S. 105-242.1 to permit the NCDOR to send notices to a garnishee by electronic means. This will speed up the process by which a garnishee has been provided notice of a taxpayer’s outstanding tax liability.
B. New Data Matches Between the NCDOR and Financial Institutions Will Speed Up Garnishment of Bank Accounts of Delinquent Taxpayers.
Effective Jan. 1, 2011, the NCDOR may submit a quarterly statement to any financial institution regarding information identifying taxpayers and the amount of debts owed by that taxpayer to the NCDOR. The financial institution will then search its records and will inform the NCDOR whether any taxpayers have accounts at that financial institution. This new matching program will increase the speed of garnishments on bank accounts held by taxpayers. New amended N.C.G.S. 105-242(b).
IX. NCDOR Will Increase Collections by Expanding the Use of the “Set Off Debt Collection Act”
For North Carolina Tax Refunds.
The Set Off Debt Collection Act, which was enacted in 1997, allows the NCDOR to “set off” an individual’s income tax refund against a debt that individual owes to N.C.. Under that Act, a claimant agency of N.C. sends the NCDOR notice of the debt owed by the individual taxpayer, and the NCDOR immediately sets off the debt the individual owes to North Carolina against any tax refunds that North Carolina owes to that individual taxpayer.
These rules have now been expanded to allow debts that a business or individual owes to a N.C. agency to be set off against that entity’s North Carolina tax refund. N.C.G.S. 147-86.25 and N.C.G.S. 105A-2.
The Set-off Debt Collection Act also was expanded to apply to any type of tax refund and not just an income tax refund. New N.C.G.S. 147-86.25(2). Subsections (d) through (g) of Section 31.8 of Session Law 2010-31.
X. Expansion of Statewide Accounts Receivable Program.
The Statewide Accounts Receivable Program was enacted in 1993. This Program requires the N.C. State Controller to monitor accounts receivable owed by N.C. taxpayers to N.C. state agencies. Subsections (a) through (c) of Section 31.8 of Session Law 2010-31 have modified the Statewide Accounts Receivable Program, and N.C.G.S. 147-86.20 through 147-86.25, to allow N.C. tax debts owed by a taxpayer to be set-off against payments that N.C. owes to that taxpayer, either for goods or services that the N.C. taxpayer previously provided to N.C..
For example, assume that a N.C. general contractor owes back taxes to the NCDOR and has provided services to the State of N.C.. Under the expanded Statewide Accounts Receivable Program, before the N.C. State Controller issues payment to that contractor, the Controller will check to see if the contractor owes any tax debts to the NCDOR. When the Controller determines that a tax deficiency is owed to the NCDOR, the account payable owed by N.C. to the contractor will be set-off by the amount of the tax debt the taxpayer owes to the NCDOR. Subsections (a) through (c) of Section 31.8 of Session Law 2010-31.
XI. New NCDOR Guidelines For Reviewing And Accepting Offers In Compromise.
A. Background and Introduction.
N.C.G.S. 105-237.1 provides the NCDOR with authority to entertain an offer in compromise under certain circumstances. The NCDOR may accept an offer in compromise if it determines that the offer is in the best interest of N.C. and makes one of the following findings:
(1) there is reasonable doubt as to the amount of the tax liability (doubt as to liability);
(2) the taxpayer is insolvent and the NCDOR probably could not otherwise collect an amount in excess of the offered amount (doubt as to collectability);
(3) collection of a greater amount than offered is improbable and the funds offered for the OIC come from sources from which the NCDOR could not otherwise collect;
(4) the IRS has already accepted an earlier OIC with respect to the same tax assessment, and the NCDOR could probably not collect an amount equal to or in excess of that amount offered by the N.C. taxpayer; or
(5) collection of a greater amount than offered in the OIC would produce an unjust result under the circumstances.
B. N.C. Taxpayer Frustration With the N.C. OIC Process.
Many N.C. taxpayers have submitted N.C. OICs over the last several years based upon the Section 105-237.1 guidelines, only to have those OICs rejected. In many cases N.C. practitioners have been frustrated with the lack of guidance offered by the NCDOR as to the specific amount that should be offered in a N.C. OIC.
C. New NCDOR OIC Guidelines.
The NCDOR issued its new “Offer in Compromise Instruction Booklet” on February 2010 setting forth the guidelines for taxpayers to follow in submitting an OIC to the NCDOR. Under these new guidelines, an OIC will be considered only if all of the following criteria are met:
1. The taxpayer must have filed all tax returns legally required to be filed prior to submitting the OIC;
2. All estimated tax payments must be paid to date for the current year;
3. The taxpayer must submit a Form OIC-100 and RO-1062 or RO-1063 setting forth certain financial information regarding the taxpayer and his or her business; and
4. The taxpayer must offer to pay 20% of the amount offered in compromise as a non-refundable deposit when the offer is submitted. This 20% downpayment will not be refunded to the taxpayer even if the OIC is rejected by the NCDOR, but this amount will be applied to reduce the taxpayer’s outstanding tax liability.
D. Determining the Amount of Taxpayer’s Offer and Required Downpayment.
The new guidelines require that the taxpayer submit an offer based on the reasonable collection potential, i.e. the taxpayer’s net equity in its assets plus estimated collection potential from future income. These guidelines are very similar to the guidelines currently used by the IRS in reviewing federal OIC offers.
Keith Wood is both a certified public accountant and an attorney. He is a shareholder and director at Carruthers & Roth, P.A. in Greensboro, N.C.
Views and opinions expressed in articles published herein are the authors' only and are not to be attributed to this newsletter, the section, or the NCBA unless expressly stated. Authors are responsible for the accuracy of all citations and quotations.