EGTRRA changed federal law on these matters, but it did not change North Carolina law. North Carolina's individual income tax law is tied to the Internal Revenue Code as it exists on a certain date. That date is set in G.S. 105-228.90(b)(1b), and the date is currently January 1, 2001. Chapter 427 (House Bill 232) of the 2001 Session Laws sets the date at January 1, 2001. This date does not include the changes made by EGTRRA.

North Carolina's individual income tax law was revised in 1989 to use federal taxable income, as defined in the Internal Revenue Code as of the date set in G.S. 105-228.90, as the starting point for calculating State taxable income. Since 1989, the North Carolina General Assembly has reviewed the changes made to the Internal Revenue Code each year by federal legislation and has always changed the date set in G.S. 105-228.90 to a date that includes the federal changes.

North Carolina uses a fixed date as the reference date to the Internal Revenue Code for two reasons. One is a policy reason and one is a legal constraint. The policy reason for specifying a particular date is that, due to the many changes made to federal tax law from year to year, the State may not want to adopt all federal changes automatically, particularly when the changes result in large State revenue increases or decreases. More importantly, however, the North Carolina Constitution imposes a legal constraint. Section 2(1) of Article V of the North Carolina Constitution prohibits a delegation of the taxing power. The Attorney General's Office has advised that an automatic adoption of future federal tax changes would be invalidated as an unconstitutional delegation of legislative power.

As a result of the need for the General Assembly to review federal tax changes before adopting them for North Carolina purposes, the reference date of the Internal Revenue Code in G.S. 105-228.90 is almost always out of alignment with the most recent federal changes. This poses administrative problems of varying degrees for taxpayers as well as for the Department of Revenue. For example, tax returns for a tax year are sometimes due before the General Assembly has had a chance to review federal changes that affect the returns filed. The Department has always handled the federal and State income tax alignment problem by allowing taxpayers to file returns as if the State's reference date to the Internal Revenue Code included the most recent federal changes.

The dilemma posed by the lack of alignment in the EGTRRA retirement and pension provisions is substantial. If North Carolina law is not aligned with the federal on these matters, plan participants can make contributions under federal law that will have different consequences for federal tax purposes than for State tax purposes. For taxpayers to report the proper amount of State tax, the North Carolina individual income tax return would need to be revised to reflect these differences. Various add-backs would be needed to account for the differences on the "front end" when contributions are made and various deductions would be needed to account for the differences on the "back end" when contributions are withdrawn. Plan administrators would need to track the differences and tax practitioners would need to explain the differences to taxpayers who are likely to be totally confused.

The Department will recommend to the 2002 General Assembly that the State conform to these changes for both practical and policy reasons. The Department is quite mindful, however, of the problems created by a loss of revenue and recognizes that other changes may need to be made in the tax laws to avoid a revenue loss.

If the General Assembly chooses not to conform, the Department will modify its tax forms accordingly and will waive certain penalties. It will waive all penalties that might otherwise apply to plan administrators for failure to withhold tax on contributions that are exempt from federal tax but are subject to State tax. It will also waive estimated tax penalties that might otherwise apply to individuals who have more taxable income under State law than under federal because their contributions are subject to State tax. These waivers will apply for the 2002 tax year.

Last modified on: 10/31/07 03:36:07 PM.