Wednesday, November 29, 2023

Proposed NC franchise tax cut wouldn’t affect most businesses

Both the House and Senate are in agreement on a plan that would reduce the franchise taxes on businesses by about 25%, but the majority of businesses wouldn’t see a change.

The proposal that appears in both chambers’ budgets would change how the complicated franchise tax is calculated. It stops short of eliminating the tax entirely, which has been a goal of the N.C. Chamber and some Republicans. 

Current law requires companies to calculate three different formulas – known as “bases” – and pay taxes on whichever of the three amounts is largest. Republican legislators want to simplify that and make every company use the same formula: $1.50 for every $1,000 of the company’s net worth in North Carolina. 

The vast majority of companies already use that formula. Those that don’t typically have major real-estate and equipment assets in North Carolina, which triggers one of the other calculations and a higher tax bill. Those calculations are based on the tax value of buildings, land and equipment the company owns in North Carolina, as well as the debt owed on those assets.

Sen. Paul Newton, R-Cabarrus, says the current system “punishes companies for making capital investment in North Carolina.” Brian Balfour of the conservative John Locke Foundation says that “the more you invest in North Carolina, the more you’re punished by the franchise tax.”

The N.C. Chamber supports the proposal in the budget, but it’s making a big push to kill the franchise tax entirely. Chamber President and CEO Gary Salamido says it’s an even higher priority for his group than reducing the corporate income tax rate.

He notes that North Carolina is one of only 16 states that still has a franchise tax (most of them are our neighbors in the Southeast), and four are in the process of phasing it out. In talking with business leaders around the country, Salamido said, “the two issues we hear are about talent and about the franchise tax. … For us, it’s a competitiveness issue.”

But Michael Mazerov of the Center on Budget and Policy Priorities argues that states without a franchise tax simply use other business taxes instead. “One particular tax does not determine the relative tax liability of a company investing in one place or another,” he says. North Carolina already has one of the lowest corporate income tax rates in the country.

Mazerov says that the franchise tax functions as an “alternative minimum tax” because most companies pay something, while some companies can avoid the corporate income tax thanks to incentives and loopholes. In North Carolina, companies (with the exception of LLCs) must pay a minimum franchise tax of $200 annually. 

The argument for North Carolina’s complicated franchise tax calculation is that companies with major real-estate and equipment assets should pay a higher share, because they typically use more government services. But Salamido says it amounts to “double taxation” because those companies are already paying hefty property tax bills. “Capital-intensive manufacturers are hit disproportionately,” he said.

Exactly which companies will benefit the most from the proposed franchise tax change isn’t clear. Corporate tax returns generally aren’t public records, so there are no lists of who pays the most franchise tax and who uses which calculation.

Alexandra Sirota of the left-leaning N.C. Budget and Tax Center says the proposed change would help companies with “very high property values in this state,” such as technology companies with big data centers and utility companies with major infrastructure. 

“While every business is contributing in, the vast majority of franchise tax collections are coming from very high net-worth companies with more than $20 million in assets,” Sirota said. “The idea of this being a tax break for smaller businesses is not entirely accurate.”

The franchise tax change would decrease state revenues by $150 million in fiscal year 2022-23, with the drop increasing to $170 million two years later, according to a fiscal memo from legislative staff. The state collected about $870 million in franchise taxes during the fiscal year that ended June 30.

For comparison, the corporate income tax – which legislators also want to cut – brought in $1.5 billion during the same time period. Both franchise and corporate income receipts make up about 6% of the state’s overall tax revenue, with the majority coming from personal income taxes and sales taxes. 

Republicans tried to make a similar change to the franchise tax in 2019, including it in the vetoed state budget and then again as a separate bill. Cooper vetoed that measure, saying it “prioritizes corporate tax cuts over investments in education and would further erode state revenue.” A similar debate could ensue soon as negotiators seek a budget compromise that Cooper won’t veto.

The franchise tax has been on the books in North Carolina in some form for more than a century, but few seem to know much about its origins. The complex three-formula calculation was already around in the 1970s, when legislators approved a request from the R.J. Reynolds Tobacco Company to cap the tax for holding companies at $75,000 (that cap is now set at $150,000), according to a 1975 News & Observer article. References to the franchise tax appear in news stories as far back as the 1910s.

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