Directive TA-23-1

Session Law 2023-134 (House Bill 259) became law on October 3, 2023. This legislation included a provision that updates North Carolina’s pass-through entity (“PTE”) tax to allow certain trusts and corporations to be partners in a Taxed Partnership effective for taxable years beginning on or after January 1, 2022.1   The purpose of this directive is to provide an overview of this important retroactive change.

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  For more information on North Carolina’s pass-through entity tax, see the Department’s Important Notice dated April 14, 2022. Terms defined in that notice will also be used in this Directive.

Prior to the enactment of Session Law 2023-134, N.C. Gen. Stat. § 105-154.1(a)1  did not allow a partnership to make the Taxed Partnership Election if it had, at any time during the taxable year, a partner who was not one of the following:

• An individual.
• An estate.
• A trust described in section 1361(c)(2) of the Code.
• An organization described in section 1361(c)(6) of the Code.
• A partnership including an entity that is classified as a partnership for federal income tax purposes, or an S Corporation as defined in N.C. Gen. Stat. § 105-131(b).

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  See SB 174, s. 1.5.(b); S.L. 2023-12. See also the Department’s Important Notice dated April 4, 2023.

Session Law 2023-134 rewrote subdivision (3) of N.C. Gen. Stat. § 105-154.1(a) to read as follows:  

Any of the following:

• A trust described in section 1361(c)(2) of the Code. 
• A trust if such trust does not have as a beneficiary any person other than an individual, an estate, a trust, or an organization described in section 1361(c)(6) of the Code.  Emphasis added. 

Because of this modification, additional trusts now qualify as eligible partners for purposes of the Taxed Partnership Election. In particular, a partnership that includes a trust which is not described in Internal Revenue Code (“Code”) § 1361(c)(2) is eligible to make the Taxed Partnership Election if the trust does not have as a beneficiary any person other than an individual, an estate, a trust, or an organization described in Code § 1361(c)(6) (“Qualifying Trust Partner”).

Because the North Carolina taxable income of a Taxed Partnership is calculated based on the partners listed in N.C. Gen. Stat. §§ 105-154.1(a)(1) through 105-154.1(a)(4), a Taxed Partnership with a Qualifying Trust Partner will include that partner’s distributive share in its calculation of North Carolina’s PTE tax.1

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  See SB 174, s. 1.5.(c); S.L. 2023-12. See also the Department’s Important Notice dated April 4, 2023.

Session Law 2023-134 also rewrote subdivision (5) of N.C. Gen. Stat. § 105-154.1(a) to read as follows:

A partnership, including an entity that is classified as a partnership for federal income tax purposes, or an entity that is classified as a corporation for federal income tax purposes. Emphasis added.

This modification allows any entity classified as a corporation for federal income tax purposes to be an eligible partner for purposes of the Taxed Partnership Election (“Qualifying Corporate Partner”). Under prior law, only an S Corporation was considered an eligible partner.1

As mentioned earlier, the taxable income of a Taxed Partnership is calculated based on the partners listed in N.C. Gen. Stat. §§ 105-154.1(a)(1) through 105-154.1(a)(4). Because a Qualifying Corporate Partner is listed under N.C. Gen. Stat. § 105-154.1(a)(5), a Taxed Partnership with a Qualifying Corporate Partner will NOT include that partner’s distributive share in its calculation of North Carolina’s PTE tax.

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  See SB 174, s. 1.5.(b); S.L. 2023-12. See also the Department’s Important Notice dated April 4, 2023.

A partnership that could not make the Taxed Partnership Election for tax year 2022 because the partnership had a partner not listed under subsection (a) of N.C. Gen. Stat. § 105-154.1 as originally enacted1 can now make the Taxed Partnership Election if all of its partners are listed under N.C. Gen. Stat. § 105-154.1(a) as amended by Session Law 2023-134. Significantly, a partnership that previously filed a NC Partnership Tax Return (“Form D-403”) for tax year 2022 can only make the Taxed Partnership Election if:

• The partnership filed Form D-403 on or before the due date of the return, including extensions, and
• The partnership files an amended return making the Taxed Partnership Election on or before July 1, 2024.2   A Taxed Partnership Election made on an amended return for tax year 2022 filed after July 1, 2024, is NOT valid.

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  See SB 105, s. 42.5.(h); S.L. 2021-180.

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  See SB 508, s. 11.3.(a); S.L. 2024-1.

The amended return for a Taxed Partnership with a Qualifying Trust Partner must be completed in accordance with the instructions provided in Form D-403A for tax year 2022. However, the amended return for a Taxed Partnership with a Qualifying Corporate Partner must be completed in accordance with the instructions provided in the Department’s Important Notice dated April 4, 2023. Moreover, if a partnership files an amended Form D-403 to make the Taxed Partnership Election, the Taxed Partnership must furnish each partner with an updated Form NC K-1 for tax year 2022 if the information originally reported to the partner has changed.

In addition, a partnership that is eligible to make the Taxed Partnership Election for tax year 2022 but has not filed its NC Partnership Tax Return must make the election by the due date of the partnership’s return, including extensions. A Taxed Partnership Election on a late-filed NC Partnership Tax Return is not valid.1

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  See the Department’s Important Notice dated April 14, 2022.