North Carolina Amends PTE Election, IRC Conformity, and Personal Income Tax Rules

On April 3, North Carolina Gov. Roy Cooper signed S.B. 174 into law to effect numerous tax law changes, including revisions to the state’s elective pass-through entity (PTE) tax, many of which are retroactive, and an update to the state's Internal Revenue Code conformity date.

PTE Tax Election Revisions

Retroactive Changes Effective for Tax Years Beginning on or After January 1, 2022:

• Permissible Owners: Partnerships and S corporations are now permissible owners of an electing partnership. Under prior law, a partnership was eligible to make the North Carolina PTE tax election only if it was 100% owned by individuals, estates, trusts, and some tax-exempt organizations.
• Nonresident Withholding Requirement for Tiered Partnerships: Although a partnership having a partnership as a partner — that is, a tiered partnership – is now eligible to make the election, the electing partnership cannot include the distributive share of North Carolina taxable income of pass-through partners when computing its North Carolina PTE tax base. However, the electing partnership must still comply with the requirements of N.C. Gen. Stat. §105-154(d) regarding a nonresident pass-through partner and must pass the pass-through partner’s distributive share of North Carolina taxable income to the pass-through partner.
• The North Carolina Department of Revenue (DOR) references section VI.8 of the 2022 personal taxes bulletin for additional guidance on nonresident partners.
• Credit for Taxes Paid to Another State:
• PTE Election Not Made: North Carolina-resident partners are now allowed a credit for income taxes paid by the partnership to another state if the partnership elected to pay entity-level tax in the other state but did not make the PTE tax election in North Carolina. Pre-S.B. 174, only S corporation owners were allowed a credit for their pro rata share of income tax imposed directly on the S corporation by another state if the S corporation did not make a PTE tax election in North Carolina.
• PTE Election Made: Resident owners of a partnership or S corporation that made the North Carolina PTE tax election are not allowed to claim a credit for their distributive share of entity-level income tax paid by the respective entity to any other state. Rather, a credit against the PTE tax may be claimed by the electing PTE. The resident owners may deduct their share of income to the extent it was included in the electing PTE’s North Carolina taxable income.

Updates for Tax Year 2023 and Beyond:

• Effective for tax years beginning on or after January 1, 2023, S.B. 174 modifies the calculation of the PTE tax in North Carolina by excluding non-North Carolina-sourced income from the entity’s taxable income.
• There are now two deductions available to the owners of an entity that makes the North Carolina PTE tax election: (1) a deduction for the North Carolina income taxed at the PTE level; and (2) a deduction for income taxed by another state at the PTE level. Accordingly, resident owners of an electing PTE may not claim the credit for their share of entity-level income tax paid by the respective PTE to another state.
• Beginning on or after January 1, 2023, the PTE tax election is an annual election for the tax year covered by the return and may not be revoked after the return is filed.

IRC Conformity Update

S.B. 174 updates North Carolina’s corporate and individual income tax conformity date with the IRC from April 1, 2021, to the IRC “as enacted as of January 1, 2023, including any provisions enacted as of that date that become effective either before or after that date.”

Personal Income Tax Changes

• Sole Proprietorships: North Carolina law now requires multistate sole proprietorships to follow the same allocation and apportionment rules as corporations and multistate PTEs when determining North Carolina taxable income.
• Other State Tax Credits: S.B. 174 clarifies that tax credits claimed for income taxes paid to other states by individuals are not refundable; North Carolina law already provided that any excess credits cannot be carried over.
• Administrative and Miscellaneous Provisions:
• Penalty Waivers: S.B 174 adds the penalty for failure to timely file an informational return to the list of penalties that may be waived because of a presidentially declared disaster.
• Bad Check/EFT Penalty: The new law clarifies that the bad check or electronic funds transfer (EFT) penalties apply to a garnishee who issues a bad check or bad EFT. Previously, it was unclear which party would be assessed the penalty in the context of a garnishment.
• Request for Review: S.B. 174 allows the DOR to accept requests for review on forms other than Form NC-242, provided that the taxpayer includes a written statement clearly indicating that it requests review of a proposed denial of a refund or a proposed assessment of tax.
• Statute of Limitation on Collections: North Carolina now has a 10-year limitations period to collect delinquent taxes, commencing on the date the respective taxes become collectible by the DOR. Previously, the limitations period on collections did not commence until the date the DOR recorded the certificate of tax liability.

Insights

• The North Carolina DOR has issued a notice that includes guidance for preparing and filing 2022 partnership returns, as well as guidance on amending a 2022 tax return.
• Partnerships that could not make a North Carolina PTE tax election for tax year 2022 because they had partnership or corporate partners should consult with their tax advisors to consider the potential benefit of making a retroactive election. If a partnership has already filed a North Carolina partnership return for tax year 2022 and is now eligible under S.B. 174 to make the PTE tax election, it must file an amended Form D-403 by the due date of the North Carolina partnership return.
• Similarly, individuals who have filed a 2022 North Carolina income tax return and are now eligible to claim a tax credit paid to another state should consider filing an amended return.
• Because the PTE tax election is irrevocable for tax years beginning on or after January 1, 2023, taxpayers should ensure that they and their tax advisors are carefully considering the costs and benefits of making the election.

Written  by Angela Acosta and Jonathan Espinola. Copyright © 2023 BDO USA, LLP. All rights reserved. www.bdo.com