How NC's new tax cuts will save taxpayers billions

The drop in the tax rate is in addition to an eventual phase-out of the state’s corporate income tax, and the North Carolina General Assembly also reworked the franchise tax businesses pay, simplifying it in a way expected to save companies hundreds of millions of dollars over the next few years.

“Thirteen billion dollars,” said Rep. Brandon Lofton, D-Mecklenburg, a public finance lawyer by trade. “That’s something we could put to use.”

13 things tucked away in NC budget

Pat Ryan, spokesman for Berger, R-Rockingham, called it a “philosophical difference.”

“We don’t view it as the government’s money in the first place,” he said Friday.

Ryan also pointed to the record $4.25 billion "rainy day" reserve fund sitting at the state budget’s bottom line, calling it a cushion and noting projections on the tax cuts don’t account for growth the cuts might engender, which would boost state revenues in turn.

Gov. Roy Cooper signed off on the cuts despite opposing some of them in the past, saying the two-year budget they’re baked into contains more good than bad.

“The governor believes tax breaks should be more targeted to middle-class and working people and that the General Assembly has more work to do in expanding health care coverage and making sure every child has access to the sound, basic education our constitution requires,” Jordan Monaghan, a Cooper spokesman, said in a statement last week.

Here’s an explanation of what’s going to change, when it’s going to change and how much it’s projected to cost the state:

North Carolina has a 5.25 percent state income tax rate at the moment.

That changes next year, dropping to 4.99 percent, then dropping a little more each year until it hits 3.99 percent in 2027. It’s a flat rate, so everyone who owes state income taxes pays on the same rate, regardless of income.

The budget also increases the standard deduction next year from $21,500 for a married couple filing jointly to $25,500. That means couples won’t pay any state taxes on their first $25,500 of income. For single people, the deduction increases to $12,750.

The budget also boosts the per-child deduction by $500 starting next year and, for the first time, will let couples making up to $140,000 a year claim at least some of this deduction. This further lowers a family’s tax bill, with tiered deductions based on adjusted gross income:

These deductions expand the state’s “zero bracket,” meaning more people won’t pay any state income taxes at all. That’s an estimated 1 million returns now, with the deduction increases adding another 215,000 returns.

The new tax code also conforms to federal changes on medical expense deductions, and it eliminates a state tax on military pension income – a change effective immediately, for the 2021 tax year. This will save military retirees in the state an estimated $30.8 million this fiscal year.

“Before the 2013 reforms, North Carolina had the highest individual and corporate income tax rates in the Southeast,” the Tax Foundation said in praising the cuts this month. “Today, North Carolina has the lowest corporate rate and among the more competitive individual rates. When the 2021 reforms are fully phased in, North Carolina’s individual income tax rate will have been cut nearly in half between 2013 and 2027.”

Some would rather the state invest the money.

“Reducing the flat personal income tax rate helps the wealthiest in North Carolina – 74 percent of the total tax cut goes to the top 20 percent of taxpayers,” said Alexandra Forter Sirota, director of the N.C. Budget and Tax Center at the North Carolina Justice Center.

This legislature can't keep a future one from changing policies, so a planned phase-out in the state’s corporate income tax could get sidetracked between now and a scheduled start in 2025.

There’s no sign of that on the horizon, though, unless Democrats take control of the General Assembly, something they haven’t been able to do for a decade.

Democrats have complained for years that Republicans cut corporate taxes at the expense of government services, and the current rate of 2.5 percent is already the lowest in the nation among states that have a corporate income tax. The plan is to take that down to 2.25 percent in 2025 and keep dropping it until the rate hits zero in 2030.

In the last fiscal year, the state’s corporate income tax raised about $1.5 billion, according to the state Department of Revenue, a significant source of government funding but far behind personal income taxes and sales taxes.

The franchise tax is a tax businesses pay on their net worth or on the value of property, including equipment, they own in the state.

At the moment, what a business owes is calculated one of three ways, depending on which produces the highest number. The new tax reforms eliminate two of those, and instead, businesses will just pay a percentage of their net worth in North Carolina. That should particularly benefit companies that have expensive equipment located in the state.

“Essentially, a business looks at its books, assets minus liabilities, and the franchise tax takes a very small slice of that,” Berger’s office said in an explainer.

“It’s still bad tax policy, and our goal remains to eliminate it altogether. The tax doesn’t account for profit or loss or anything like that – it’s a tax on a business’ mere existence.”

In addition to simplifying things, the change is expected to cut business taxes next year by $173 million and by $738 million over five years.

To keep businesses afloat and employees working during the pandemic, the federal government funded the Paycheck Protection Program, providing money to companies that agreed not to lay people off.

Normally, a forgiven loan would be taxed like income, but the federal government waived that for PPP loans and also allowed businesses to deduct from their taxes expenses covered by those loans. North Carolina had already agreed not to tax the loans themselves, but lawmakers went back and forth this year on the deductions issue, with some calling it an unfair double dip.

The fact that many lawmakers own businesses and received PPP loans themselves also entered the debate.

Nearly a quarter of NC House members have close ties to companies with PPP loans

Ultimately, the legislature decided to allow the tax break, and it’s not a small impact, costing the state $600 million over two years. Similar changes tied to other, smaller federal pandemic programs mean the state plans to forgo another $60 million, according to projections from the legislature’s Fiscal Research Division.

Because many of these loans came in 2020, businesses that got them will have to file amended returns to get the tax break. The Department of Revenue said last week that it couldn’t estimate how many entities would file amended returns, but that it may be enough to delay processing.

“However, NCDOR will work as expeditiously as possible to process the returns,” Donna-maria Harris, a department spokeswoman, said in an email.

There are a handful of other tax changes in the state budget, including extensions – out to 2030 – for mill, railroad and other historic rehabilitation tax credit programs.

Part of the thinking was to give projects delayed by the pandemic some cushion, and these programs have been popular with developers.

There’s also at least one tax increase in the budget, on cigars sold online. Right now, only cigars sold at brick-and-mortar stores get taxed, and the expansion should bring in an extra $25 million a year, according to the Fiscal Research Division.

The change should save premium cigar buyers money, though, because while the tax rate stays the same, there’s a new cap on the total tax per cigar.

Altogether, the budget lays out tobacco taxes like this: