When a corporation buys equity in a qualified North Carolina small business and takes the 25% qualified business investments tax credit, why does the state make the corporation reduce its tax basis AND add the credit back into taxable income, partially canceling the benefit?

Plain-English summary

The Qualified Business Investments (QBI) credit in N.C.G.S. § 105-163.011 was designed to incentivize investment in small NC businesses. The statute allows a credit equal to 25% of the amount invested in qualifying equity or subordinated debt.

The Securities Regulator at the Secretary of State's office wrote to the AG with a complaint from a constituent: the Department of Revenue was effectively "taxing the credit" at 6% to 7.75%, depending on the filing status, which the constituent thought frustrated the legislative purpose of the credit.

Senior Deputy AG Reginald L. Watkins and Special Deputy AG George W. Boylan explained that the Department of Revenue was not exercising discretion. Two separate statutes operate in tandem to reduce the net benefit:

Basis reduction (applies to both individuals and corporations). N.C.G.S. § 105-163.012(d) requires the taxpayer to reduce basis in the equity securities or subordinated debt by the amount of the credit. So when the investor later sells the security, the gain is larger by the amount of the credit. The credit is recouped at the capital gains rate.

Article 4 add-back (applies only to corporations). N.C.G.S. § 105-130.5(a)(10) requires corporations to add back to taxable income all credits allowed by Article 4 of Chapter 105 (which includes the QBI credit). So in the year the credit is claimed, the corporation also pays tax on an amount equal to the credit at the corporate income tax rate.

Result for an individual taxpayer: a single adjustment (the basis reduction) recoups the credit when the investment is sold. Result for a corporate taxpayer: two adjustments operate, partly canceling the benefit of the credit in the year claimed and again at sale.

The AG noted that the Revenue Laws Study Committee was aware of the double-adjustment issue for corporations and was considering a proposal to eliminate the basis-reduction requirement for corporations. The AG closed with a polite institutional point: the legislature would welcome constructive suggestions on the design of the credit; the Department of Revenue lacked statutory discretion to alter the result.

This is a quintessential "statute says what it says" opinion. The constituent's complaint had a legitimate policy basis (the corporate double-adjustment may discourage the very behavior the credit is designed to encourage), but the remedy lay with the legislature, not the agency or the AG.

Currency note

This opinion was issued in 1994. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here. The QBI credit has been amended on several occasions since 1994. North Carolina's general corporate income tax rate has also changed materially over the past three decades. Anyone currently considering a QBI investment or claim should check the current statutes (N.C.G.S. § 105-130.5 and the current Article 4 credit provisions, or any successor provisions) and consult a tax advisor familiar with the current Revenue Department guidance.

Background and statutory framework

The qualified business investments credit was part of a broader 1980s and 1990s push in many states to provide tax incentives for in-state small business investment. The economic theory was that small businesses were starved for capital that the existing credit and venture markets did not adequately supply, and a state-level credit could fill the gap.

The double-adjustment issue is a structural problem with how the credit interacts with the rest of the corporate tax base. The legislature wrote the credit broadly and then wrote the add-back broadly. The legislative drafting attention apparently did not focus on the interaction.

The basis-reduction rule is conceptually defensible. It treats the credit as a partial return of the investment, so when the security is sold, the investor's taxable gain reflects the actual net out-of-pocket cost. Without basis reduction, an investor could effectively monetize the credit twice: once by reducing current tax liability via the credit, and again by reducing gain on sale.

The Article 4 add-back is harder to justify on first principles. It is essentially a state-level claw-back on tax credits, applied only to corporations and only to credits in Article 4. The mechanism is unusual. Most state tax codes either provide a credit (and let it stand) or do not. The simultaneous add-back partially defeats the credit's incentive purpose.

The AG's deference to legislative remedy reflects an institutional principle. Tax administrators must apply the statutes as written. If the statutes produce a counter-intuitive result, the fix is legislative. The Revenue Laws Study Committee was the right body to address it. The AG's choice to point the constituent to the legislative process was both legally and pragmatically correct.

Common questions

What changed for individual investors versus corporate investors?

Individuals were not subject to the Article 4 add-back. They got the full credit in the year claimed, with a basis reduction that delayed full recoupment until sale. Corporations were subject to both: basis reduction AND add-back. The two adjustments together substantially reduced the corporate credit's net benefit.

Did the proposed legislative fix happen?

The AG noted only that the Revenue Laws Study Committee was reviewing a proposal. The opinion does not say whether the proposal became law. Anyone researching whether the corporate double-adjustment was later fixed should check the legislative history of Article 4 credits during the mid-1990s.

Could the constituent challenge the Department of Revenue's interpretation in court?

In theory yes, by paying the tax and suing for refund. But the AG's analysis is straightforward statutory reading. A court would almost certainly conclude, as the AG did, that both statutes apply by their plain terms. The remedy is legislative, not judicial.

Why did the legislature write the credit and the add-back as parallel statutes?

The opinion does not address this directly. One plausible explanation is that the add-back in § 105-130.5(a)(10) predated the QBI credit and was a generic rule covering all Article 4 credits, originally aimed at credits that were structured as outright tax-rate reductions rather than as investment incentives. The QBI credit was layered onto a pre-existing framework that did not anticipate this kind of credit. That is speculation, but it matches the policy mismatch the constituent identified.

Source

• Landing page: https://ncdoj.gov/opinions/addition-of-qualified-business-investments-credits-to-taxable-income/

Citations

• N.C.G.S. § 105-130.5(a)(10)
• N.C.G.S. § 105-163.011
• N.C.G.S. § 105-163.012(d)

Original opinion text

February 22, 1994

Ed Gillespie
Securities Regulator
Department of the Secretary of State
300 N. Salisbury Street
Raleigh, North Carolina 27611

Re: Addition of qualified business investments credits to taxable income; G.S. § 105-130.5(a)10; G.S. §§ 105-163.011, –163.012(d)

Dear Mr. Gillespie:

In your recent letter you request that we review the scope of the credit granted in G.S. § 105-163.011 for certain business investments. Section 163.011 in essence allows as a credit for the taxable year 25% of the invested sum. You state that the Department of Revenue taxes "the credit at a rate of 6% to 7.75% depending on the individuals' filing status." You believe such taxation frustrates legislative purposes underlying the credit, and request that we review the department's treatment of this preference item.

Recognition of the credit varies between individuals and corporations. For both types of taxpayers, G.S. § 105-163.012(d) requires that the credit reduce the purchaser's "basis in the equity securities or subordinated debt" so acquired. However, G.S. § 105-130.5(a)(10) further directs corporations to add to taxable income all credits allowed by Article 4 of Chapter 105. Qualified business investments credits fall within Article 4.

The Revenue Laws Study Committee is aware of the double adjustments required for corporations utilizing these credits. It is reviewing a proposal that would eliminate for corporations the basis reduction presently imposed by G.S. § 105-163.012(d). All of these adjustments stem from substantive features of The Revenue Act; none rests upon any discretion or administrative powers delegated to the revenue department. I am sure the legislature would be delighted to receive any constructive suggestions to better achieve the goals underlying these unusual tax preferences.

We hope you find the foregoing helpful.

Reginald L. Watkins
Senior Deputy Attorney General

George W. Boylan
Special Deputy Attorney General