NC market discount income from US govt bonds is not interest

Overview

On August 18, 2017, the North Carolina Supreme Court (Court) upheld the decision of the North Carolina Business Court and concluded that market discount income is not deductible in computing North Carolina taxable income.

Taxpayer purchased US government bonds at a discount and earned ‘market discount income,’ which is the difference between the purchase price of the bonds and the amount received from the bonds at maturity. Taxpayer took the position that market discount income qualified for North Carolina’s deduction for ‘interest’ from US obligations and deducted the income on its North Carolina income tax return. The North Carolina Department of Revenue (DOR) disallowed the deduction and issued an assessment.

The Court’s holding focused on the meaning of the term ‘interest.’ Market discount income qualifies as ‘interest’ under the Internal Revenue Code. However, the Court concluded that North Carolina does not adopt IRC definitions on a wholesale basis. The Court found that the word ‘interest’ is unambiguous and means “periodic payments received by the holder of a bond.”  The Court determined that market discount income is not included in the plain meaning of the term and, accordingly, that market discount income was not deductible for North Carolina purposes.