North Carolina Senate Finance Committee Chairs Ralph Hise (R), Paul Newton (R), and Jerry W. Tillman (R) this month introduced Senate Bill 622, the Tax Reduction Act of 2019. This bill includes several tax changes, but the most notable proposed structural improvement is a provision to reduce and cap the state’s franchise tax. North Carolina has been a leader in good tax policy in recent years and reducing the franchise tax would make the state even more attractive as a destination for business investment.
Currently, North Carolina is one of 16 states with a franchise tax (also known as a capital stock tax). Unlike corporate income taxes levied on the net income of a corporation, franchise taxes are levied on a business’s wealth, usually defined as net worth (with some adjustments). Capital stock taxes are essentially a tax on investing in a state, which makes them more economically harmful than many other tax types. By taxing businesses on their net worth, capital stock taxes discourage in-state investment and the accumulation of assets, favoring profit-taking over business investment and growth. Franchise taxes can be especially burdensome to new businesses, capital-intensive businesses, and struggling businesses because they are owed even when businesses post losses or barely break even. As a result, many businesses have to reach into their valuable cash flow to pay the tax.
Under current law, North Carolina’s franchise tax is levied on the largest of three base options: (1) the company’s North Carolina-apportioned net worth, (2) 55 percent of the appraised value of all real and tangible personal property in the state, or (3) the business’s total investment in tangible property in the state.
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Under the net worth calculation, the franchise tax captures intangible property (like trademarks and patents), as well as tangible property (like machinery and equipment), real assets (like land and buildings), and cash and investment assets, apportioned in the same way as the corporate income tax. The tax applies to C corporations, S corporations, and those limited liability companies (LLCs) that elect to be taxed as corporations for federal income tax purposes. Under all three bases, the tax is levied at a rate of $1.50 for every $1,000 of the tax base, with a $200 minimum to ensure franchise tax payment even by businesses with low net worth.
Among the states that levy a franchise tax, eight cap the tax to limit its impact, but North Carolina’s franchise tax is unlimited (except for qualified holding companies), resulting in a high tax burden on high-valued companies. Further, some states with both a corporate income tax and a franchise tax allow businesses to pay one or the other, whichever amount is higher. But North Carolina is among the states requiring businesses to pay both, which increases tax burdens and compliance costs and applies duplicative layers of taxes on the same income.
Senate Bill 622 would make several positive changes to North Carolina’s franchise tax by reducing its rate, adjusting its base, and introducing a cap to prevent excessive tax liability. Specifically, for C corporations, this bill would reduce the rate to $1.30 per $1,000 in tax year 2020, and to $1.00 per $1,000 starting in tax year 2021. For S corporations, the tax would be levied at a flat $200 on the first $1 million in the tax base, plus $1.30 (reduced to $1.00 starting in tax year 2021) on net worth in excess of $1 million.
Senate Bill 622 would also consolidate the base to the greater of either the company’s net worth or total investment in tangible property in the state. In addition to changing the rate and base, this legislation also seeks to limit the tax owed by any one company by capping the tax at $150,000 (while retaining the existing $200 minimum).
All in all, Senate Bill 622 reduces reliance on the franchise tax, which is another step in the right direction for North Carolina, a state that has led the way in enacting pro-growth tax reforms in recent years and currently has the 12th best overall tax structure on our State Business Tax Climate Index. Reducing, and eventually eliminating, the antiquated franchise tax would make North Carolina even more attractive as a destination for business investment, further solidifying the state’s standing as a leader in sound tax policy in the region and nation.