Interest Income

A taxpayer may take a deduction on the North Carolina income tax return for interest on bonds, notes, and other obligations of the state of North Carolina or any of its political subdivisions to the extent that this income has already been included in federal taxable income and adjusted gross income, as appropriate.

In addition, a taxpayer may take a deduction on the North Carolina tax return for the gain or loss realized on the sale or other disposition of obligations of the state of North Carolina or its political subdivisions issued before July 1, 1995, if North Carolina law under which the obligations were issued specifically exempts the interest or gain. With respect to North Carolina obligations issued after July 1, 1995, the income tax treatment of gains from the sale or disposition of such obligations is the same for federal and state purposes.

Example 1: Interest on bonds, notes, debentures or other evidence of the indebtedness issued under G.S. § 131E-28 by the North Carolina Hospital Authorities, including gain from the sale or exchanges of these obligations.  (Repealed by Session Laws 2016-5,s.5.3(a), effective May 11, 2016).

Example 2: Interest and gain derived from obligations issued by the North Carolina Housing Finance Agency under G.S. § 122A-19.

Example 3: Interest and gain derived from bonds issued under the Joint Municipal Electric Power and Energy Act under G.S. § 159B-26.

Example 4: Interest on bonds, notes, debentures, or other evidence of indebtedness issued by the North Carolina Medical Care Commission under the Health Care Facilities Finance Act under the provisions of G.S. § 131A-21. Gain from the sale or exchange of these obligations may also be excludible.

Example 5: Interest and gain on bonds issued by the North Carolina State Ports Authority under G.S. § 136-265(g).

Example 6: Interest on bonds, notes, debentures, and any other evidence of indebtedness issued by a North Carolina Housing Authority (including any corporate agent authorized by Article 1 of Chapter 157 of the General Statutes to exercise the powers of the authority) under the provisions of G.S. § 157-26. Gain from the sale or exchange of these obligations is not excludible.

Example 7: Interest on bonds issued by the authorities created under the Industrial and Pollution Control Facilities Financing Act, G.S. § 159C-14.

Example 8: Income from bonds issued by boards of trustees of State supported colleges and universities in North Carolina including any gain from the sale or exchange of such bonds under G.S. §§ 116-183 and 116-196.

Example 9: Interest and gain received from bonds and notes issued under the provision of the Higher Education Facilities Act by the North Carolina Educational Facilities Finance Agency under G.S. § 159D-55.

Example 10: Interest and gain received on obligations issued under Chapter 122D (the North Carolina Agriculture Finance Act) by the North Carolina Agriculture Finance Authority under G.S. § 122D-14.

A taxpayer may take a deduction on the North Carolina income tax return for interest received from direct obligations of the United States to the extent this interest has already been included in federal taxable income or adjusted gross income, as appropriate. The State does not tax this income; therefore, this deduction will reduce North Carolina taxable income.

The U.S. Supreme Court has listed four criteria that would exempt interest from state and local taxation based on the classification as interest from an obligation of the United States:

• Written documents;
• Interest bearing;
• Binding promise by the United States to pay specific amounts at specific dates; and
• Specific authorization by Congress

U.S. Treasury bonds, notes, bills, certificates, and savings bonds are primary examples of this exception. In addition, the following are other current examples of issuers of bonds, notes or other direct obligations from which interest received is deducted from either federal taxable income or adjusted gross income , as appropriate:

• Guam, Puerto Rico, or Virgin Islands
• A Federal Land Bank
• A Federal Home Loan Bank
• A Farm Credit Bank
• Export-Import Bank of the United States
• Tennessee Valley Authority
• Banks for Cooperatives
• Production Credit Associations
• Commodity Credit Corporation
• Federal Deposit Insurance Corporation
• Federal Financing Bank
• General Insurance Fund
• United State Post Office
• Resolution Funding Corporation
• Financing Corporation (chartered by the Federal Housing Finance Agency)

Previously, other agencies or entities that have subsequently been merged, dissolved, or changed the form of its operations issued obligations with interest payments that would qualify as a deduction. Examples include Federal Intermediate Banks, Farm Home Administration, Federal Savings and Loan Insurance Corporation, and Student Loan Marketing Association (prior to July 1, 2010).

However, interest paid on obligations where the United States is merely an insurer or guarantor is not deductable from federal taxable income or adjusted gross income, as appropriate. Examples include Federal Home Loan Mortgage Corporation ("Freddie Mac"), Federal National Mortgage Association ("Fannie Mae"), and the Government National Mortgage Association ("Ginnie Mae").

You cannot deduct distributions from United States obligations representing gain from the sale or other disposition of the securities, or interest paid in connection with repurchase agreements issued by banks and savings and loan associations. This deduction does not apply to any portion of a distribution from an Individual Retirement Account (IRA).

North Carolina's individual income tax return may require an adjustment for interest received on notes and bonds. All taxpayers who received interest on notes and bonds from states other than North Carolina must add this interest income to the North Carolina return because this interest income has not been included on your federal return. Notes and bonds issued by Guam, Puerto Rico, and the US Virgin Islands are not subject to this adjustment.

Mutual fund shareholders who receive exempt interest dividends on notes and bonds of other states must also make this adjustment. Unless you have a supporting statement from the mutual fund showing it is not taxable to North Carolina, you must add back all interest income which was exempt on your federal return.

Interest on notes and bonds from states other than North Carolina should be included on Form D-400 Schedule S, Part A – Additions to Federal Adjusted Gross Income.