The intangibles tax was enacted in 1937 and remained on the books until its repeal in 1995. Along with taxing accounts receivable, notes and bonds, and beneficial interests in foreign trusts, the intangibles tax stipulated that all shares of stock owned by a business or individual be taxed at a rate of 25 cents per $100 of total fair market value of the stock, regardless of whether the stock earned a dividend or not (cf. G.S. §105-203).The tax, however, did not apply to stock held in any company that paid the state corporate income tax on 100 percent of its income. All other shares of stock were taxed (thanks to a 1939 amendment) at a rate inversely proportional to the amount of corporate income tax paid by the business to North Carolina. As explained in the 1996 U.S. Supreme Court decision, Fulton Corp. v. Faulkner:
Thus, a corporation doing all of its business within the State would pay corporate income tax on 100% of its income, and the taxable percentage deduction allowed to resident owners of that corporation’s stock under the intangibles tax would likewise be 100%. Stock in a corporation doing no business in North Carolina, on the other hand, would be taxable on 100% of its value. For the intermediate cases, holders of stock were able to look up the taxable percentage for a large number of corporations as determined and published annually by the North Carolina Secretary of Revenue. In 1990, for example, the Secretary determined the appropriate taxable percentage of IBM stock to be 95%, meaning that IBM did 5% of its business in North Carolina, with its stock held by North Carolina residents being taxable on 95% of its value.
For many years, the business community, in particular, lobbied for the repeal of the intangibles tax. The tax was not eliminated, however, until the Fulton Corporation of Salisbury, N.C., challenged the law on constitutional grounds in a suit filed May 1, 1991. After the North Carolina Supreme Court upheld the tax (Fulton v. Justus (1994)), the U.S. Supreme Court heard the case on appeal in October 1995. In a unanimous decision, the high court determined that the law violated the (Interstate) Commerce Clause of the U.S. Constitution because the tax discriminated against corporations in other states “in the hopes of encouraging firms to do business” in North Carolina. Subsequently, the high court remanded the case back to the N.C. Court to determine, in effect, whether the tax should be repealed altogether or be applied equally to all shareholders.
Already, however, North Carolina lawmakers had decided in April 1995 to repeal the entire tax, effective for taxable years beginning January 1, 1995 (S.L. 1995-41). Contrary to media reports that the repeal was a “Grey Poupon bill” aimed at helping the wealthy, the Legislative Research Commission characterized the tax as “unfair” and detrimental to economic development. If the law were rewritten instead of repealed, concluded the commission, the result would be “a tax increase for many taxpayers, particularly individuals who own small, in-state businesses.”
Contrary to the General Assembly’s clear intentions, the North Carolina Supreme Court decided that the tax should be retroactively applied to stock held in all North Carolina corporations for the years 1990 to 1994 (Fulton v. Faulkner (1997)). In response, the General Assembly passed legislation preventing retroactive collection of the tax (S.L. 1997-17) and also (as prompted by the Wake Country Superior Court) refunded the tax for the years 1990 to 1994 to all those (Class A plaintiffs) who formally protested the tax in accordance with state regulations (S.L. 1997-318). (The tax was refunded only as far back as 1990 due to the five-year statute of limitations regarding refunds.) In Smith v. State (1998), the North Carolina Supreme Court also granted refunds to a second class of taxpayers (Class B plaintiffs) who had not filed timely protests with the Department of Revenue for taxes paid from 1991 to 1994. Finally, Shaver v. State (1998) brought an additional refund for taxes paid in 1990.
While the nullification of the intangibles tax is to be applauded, the elimination of the tax set the stage for even more regressive tax increases in other areas. To begin with, the repeal of the tax resulted in a significant loss of revenue – in particular, for local governments. For six years the state reimbursed local entities (at the 1994 level) for this lost stream of revenue. In 2001, however, the reimbursements stopped and were replaced by a one-half cent increase in the local-option sales tax that was passed with the 2001 Budget Act and went into effect December 1, 2002. Similarly, the refunds arising from the nullification of the tax partially contributed to the so-called budget crisis that precipitated the passage of several other new taxes, including a one-half cent increase in the state sales tax, a one-half percent tax increase for the top income earners, and a 6 percent sales tax on liquor.
All in all, the state was liable for $596 million in tax refunds (including interest) to more than 400,000 taxpayers—the second-largest tax settlement in state history. The first refund of $156 million was paid out in 1997 and taken from the General Fund. The second refund of $200 million was allocated in 1999 and taken from the Savings Reserve Account, which was supposed to have been reimbursed in FY2000-2001, but has never been repaid (cf. S.L. 1999- 327). A final refund of $240 million was allocated in 2000 and taken from money devoted to State Aid to Local School Administrative Units, which funds payroll accounts for teachers (S.L. 2000-67).The repeal of the intangibles tax also resulted in the loss of approximately $125 million in annual revenue for the state.