North Carolina Makes Changes to its Pass-Through Entity Tax; Clarifies the Franchise Tax Cap

On May 16, 2024, North Carolina issued revisions to Directive TA-23-1, originally issued October 4, 2023.  This directive made important changes to its pass-through entity tax (PTET), also known as electing to be a “taxed partnership.”  Prior to the enactment of North Carolina Session Law 2023-134, partnerships could only make the tax partnership election if (during the entire year) all partners were:

1. individuals;
2. estates;
3. trusts described in IRC Sec. 1361(c)(2);
4. Organizations described in IRC Sec. 1361(c)(6); or
5. partnerships or North Carolina S corporations.

Session Law 2023-134 added as an eligible member trusts that do not have as beneficiaries any persons other than individuals, estate, trusts or IRC Sec. 1361(c)(6) organizations.  Thus, certain trusts that previously precluded the taxed partnership election are now permitted partners. Additionally, entities that are treated as corporations for federal income tax purposes are also permitted partners, as opposed to only S corporations being permitted to be partners.  Note that while C corporations are permitted to be partners for purposes of the taxed partnership election, the income attributable to C corporations is not included in the taxed partnership’s tax calculation.¹

Partnerships that were disqualified from making the tax partnership election for tax year 2022, and who now qualify because of these changes, have until July 1, 2024 to amend their 2022 return to make the election, as long as the original 2022 return was timely filed.  Amended 2022 returns filed after July 1, 2024 are invalid.

In addition, Senate Bill No. 508 clarified the franchise tax base cap on the first $1 million of a C corporation’s net worth tax base for years beginning January 1, 2025. Historically the franchise tax has been calculated using a tax rate of $1.50 per $1,000 (0.15%) of a company’s total net worth, with a minimum amount of $200 being applied to all businesses.  

Effective January 1, 2025 (2025 franchise taxes filed on the 2024 income tax return), C corporations and holding companies will now apply a maximum franchise tax of $500 on the first $1 million of the corporation’s net worth.  Any net worth exceeding $1 million will be taxed at 0.15 %. 

For an S corporation, the tax rate will remain $200 for the first $1 million of the corporation’s tax base.  

Taxpayers who think they may be impacted by these changes should consult with a trusted tax advisor.

¹The tax calculation of tax partnerships only includes the distributive shares of partners listed in Sections 105-154.1(a)(1) – (4); C corporations are listed under section 105-154.1(a)(5).