N.C. Court of Appeals Addresses a Dispute Over Local Sales and Use Tax Distributions: Town of Boone v. Watauga County
In an unpublished decision released on November 15 (Town of Boone v. Watauga County, 2022-NCCOA-778 (Nov. 15, 2022)), the North Carolina Court of Appeals rejected the Town of Boone’s challenge to the manner in which the proceeds of local option sales and use taxes are distributed in Watauga County.
This blog post describes how the proceeds of local sales and use taxes are distributed to North Carolina’s counties and municipalities, addresses the Court of Appeals’ decision in Town of Boone, and explains how the ruling might impact counties and municipalities across the State.
Distributions of Local Option Sales and Use Taxes to North Carolina Counties and Municipalities
North Carolina law permits counties to levy “local option” sales and use taxes. See G.S. Chapter 105, Art. 39 (1 cent), Art. 40 (0.5 cents), Art. 42 (0.5 cents), Art. 43 (0.5 cents or 0.25 cents, depending on the jurisdiction), and Art. 46 (0.25 cents). As of this writing, every county has levied the Article 39, Article 40, and Article 42 taxes, four counties have levied Article 43 tax, and 47 counties have levied Article 46 tax. In the November 2022 general election, Bladen, Cleveland, Macon, and Wayne county voters each rejected attempts in those counties to levy Article 46 tax, while voters in New Hanover County rejected an attempt to levy Article 43 tax.
The North Carolina Department of Revenue (“NCDOR”)—not individual counties—collects, allocates, and distributes the proceeds of local option sales taxes. After collecting these taxes from retailers or consumers, NCDOR allocates the proceeds of each tax according to a process prescribed in each of the “Articles” of Chapter 105 authorizing the imposition of the tax. After that allocation process occurs, NCDOR distributes the net proceeds of three of the local option taxes—those levied under Art. 39, 40, and 42—directly to (1) counties, and (2) incorporated municipalities within those counties.[1] See G.S. 105-472(b).
At the direction of the board of commissioners of each taxing county, NCDOR must follow one of two possible methods when distributing the net proceeds of Art. 39, 40, and 42 taxes to counties and municipalities: (1) a per capita method; or (2) an ad valorem method.[2] Under the per capita method, the taxing county and each municipality within the county receives a share of allocated local option sales and use taxes based upon the proportion of its population to the total population of the county and all of its municipalities. See G.S. 105-472(b)(1). Under the ad valorem method, the taxing county and each municipality within the county receives a share of allocated local option sales and use taxes based upon the ratio of the ad valorem (i.e., property) taxes that the specific jurisdiction levies to all ad valorem taxes levied by the county and all municipalities within the county (including the amounts of any ad valorem taxes levied by the county or municipality on behalf of a special taxing district (e.g., a service district)). In each case, NCDOR distributes funds directly to the county and each incorporated municipality.
The ad valorem method requires that counties and incorporated municipalities that collect ad valorem tax on behalf of a special taxing district “immediately share” with that district the proceeds of any distribution from NCDOR in an amount equal to the proportion of ad valorem taxes levied by the district to the total levy of the county or municipality that collects the ad valorem tax. See G.S. 105-472(b)(2). Counties and municipalities in which a county has elected to follow the per capita method need not reserve any portion of local option sales tax revenues for special taxing districts.
As of August 1, 2022, 51 counties have elected a per capita distribution method and 49 counties have elected an ad valorem distribution method.
Town of Boone v. Watauga County – Facts and Background
The dispute in Town of Boone v. Watauga County originated when the Watauga County Board of Commissioners changed its local sales tax distribution method from per capita to ad valorem in 2013. Prior to the change, three of the County’s four incorporated municipalities—Beech Mountain (pop. 675), Blowing Rock (pop. 1,376), and Seven Devils (pop. 313)—each held a share of the combined ad valorem levy of the County and its municipalities that was higher relative to its share of the combined total population of the County and its municipalities.
At that time, Beech Mountain contained 0.42% of the total population, but held 7.7% of the total ad valorem levy; Blowing Rock contained 1.70% of the total population, but held 6.89% of the total ad valorem levy; Seven Devils contained 1.36% of the total population, but held 1.13% of the total ad valorem levy. Meanwhile, the statistics were reversed for the Town of Boone and Watauga County itself: the Town of Boone (pop. 19,092) contained 24.49% of the total population, but only 12.32% of the total ad valorem levy, and the County (pop. 54,086) contained 73.14% of the total population, but only 71.70% of the total ad valorem levy. Unsurprisingly, then, the change from a per capita method to ad valorem method increased the amount of local sales tax revenues distributed to Beech Mountain, Blowing Rock, and Seven Devils (the “Smaller Towns”), but decreased the amount of local sales tax proceeds to the Town of Boone and Watauga County.
At the time of the distribution method change (and presumably as a condition of making the change), the Smaller Towns agreed by resolution to remit to the County 60% of the increase that each would receive under the ad valorem method for “costs and expenditures as requested by Watauga County.” The County’s change in distribution method, combined with the Smaller Towns’ remission of a portion of the sales tax proceeds, effectuated an ultimate allocation of the County’s local sales tax proceeds that would not be possible solely under the ad valorem or per capita methods.
Off to Court – The Town of Boone Challenges the Distribution Scheme
The Town of Boone and an individual resident and taxpayer of Boone (Mr. Marshall Ashcraft) filed suit against Watauga County in February 2020, seeking a declaratory judgment that this “hybrid” method of sales tax distribution violated G.S. 105-472. Town of Boone, 2022-NCCOA-778 at ¶5. According to the plaintiffs, G.S. 105-472 provided only two sales tax distribution methods—per capita and ad valorem—and the County violated that statute when the Smaller Towns agreed to remit a portion of the proceeds that they received under the ad valorem method back to the County. After some procedural wrangling and the addition of the Smaller Towns as defendants in the case, a superior court judge granted a motion to dismiss the suit for lack of subject matter jurisdiction in March 2021, finding that (1) the plaintiffs failed to identify any “infringement of a legal right” that they held under G.S. 105-472, and (2) that the plaintiffs’ claims—that Watauga County violated G.S. 105-472 by changing its distribution method while simultaneously entering into an agreement to obtain some portion of the proceeds from the Smaller Towns—presented a political question that the court lacked authority to address. Id. at ¶¶6-8.
The Court of Appeals Weighs In: A Win for Watauga County
Judge Hampson, writing for a unanimous three-judge panel of the Court of Appeals, affirmed the trial court’s ruling, holding that the Town of Boone and Mr. Ashcraft lacked standing to challenge the manner in which Watauga County and the Smaller Towns effected the change in local sales tax distribution. The court rejected a claim that G.S. 1-254, which permits “[a]ny person . . . whose rights, status or other legal relations are affected by a statute . . . [to] have determined any question of construction or validity arising under the . . . statute . . . and obtain a declaration of rights, status, or other legal relations thereunder,” entitled the plaintiffs to a declaratory judgment that G.S. 105-472 prohibited Watauga County from entering into agreements with the Smaller Towns to receive a portion of the proceeds of local sales taxes that NCDOR provided to those entities.
G.S. 105-472, the court noted, addresses how counties select the method of distribution and how NCDOR is to effect the distribution—but “[i]t does not address how those funds may be used after distribution . . . [or] any relationship between the county and municipalities beyond . . . distribution[.]” Id. at ¶16. Because the plaintiffs could not demonstrate that they were parties whose “rights, status, or other legal relationships” were affected by G.S. 105-472, they were not entitled to bring a declaratory judgment action under G.S. 1-254. Id. at ¶¶16-17. As the court resolved the appeal on that ground, it did not address whether the case presented a nonjusticiable political question.
Implications for Counties and Municipalities
The Effect of an Unpublished Opinion. Because the Court of Appeals did not publish this opinion, it does not constitute binding legal authority. I am not aware that the parties or their counsel any parties of record have made a motion to publish the opinion. See N.C. R. App. Proc. 30(e)(4) (permitting motion to publish within ten days of filing of opinion). Nonetheless, Judge Hampson’s opinion may have precedential value in a future dispute involving G.S. 105-472. See N.C. R. App. P. 30(e)(3).
Counties Alone Determine The Distribution Method. The opinion confirms at least one thing that we already knew: counties—and counties alone—decide how NCDOR must distribute the proceeds of local sales taxes under G.S. 105-472. Municipalities, along with their governing boards and residents, can lobby boards of county commissioners to select a particular distribution method—but state law does not entitle a municipality or its residents to demand that counties choose one method over another.
Other Avenues to Challenge the “Hybrid” Distribution of Local Sales Taxes? The court’s opinion in Town of Boone left open the possibility that the “agreements” between the Smaller Towns and Watauga County—and by extension, similar agreements in other jurisdictions—might be “otherwise ultra vires or impermissible.” Slip op. at ¶16. Although neither G.S. 105-472 nor any other statute requires that municipalities spend the proceeds of Article 39, 40, or 42 taxes for any particular purpose, municipalities still may only exercise the powers that the legislature has provided to them. See Myers v. Town of Plymouth, 135 N.C. App. 707, 711, 522 S.E.2d 122, 124 (1999). Municipal actions beyond the scope of those powers (e.g., entering into a contract and disbursing money for a non-authorized purpose) are void. See Bagwell v. Town of Brevard, 267 N.C. 604, 608, 148 S.E.2d 635, 638 (1966).
Neither the plaintiffs in Town of Boone nor the Court of Appeals identified the authority upon which each of the Smaller Towns relied in disbursing the proceeds of local sales taxes to “costs and expenditures as requested by [the] County.” The record in the case also did not reveal any formal, preaudited interlocal agreements between the Smaller Towns and Watauga County. Instead, the “agreements” seem to have been contained in resolutions adopted by the governing boards, each expressing a desire to appropriate a portion of the increased sales tax proceeds received under the ad valorem method back to the County.
A challenge to the validity of a municipality’s agreement to remit a portion of local sales tax proceeds to a county might be based upon (1) the general or specific legal authority upon which a municipality relied in paying for specific “costs or expenditures” requested by a county, or (2) the lack of a preaudit certificate affixed to the municipal resolution that obligated the municipality to pay sales tax proceeds to the county.
On the first ground, a municipality does not have general authority to provide municipal funds to another unit of local government for any reason. But it does have authority to enter into an interlocal agreement with another unit of local government (e.g., a county) to exercise any power or function that they each have authority to undertake. See G.S. 160A-461. For example, a municipality and a county could enter into an interlocal agreement pursuant to which a municipality appropriates funds to a county to carry out a parks and recreation program. See G.S. 160A-355 (“Any two or more units of local government may cooperate in establishing parks and recreation systems as authorized in Article 20, Part 1, of this Chapter.”); G.S. 160A-356 (“Each county and city is authorized to expend for its parks and recreation system any of its revenues not otherwise limited as to use by law.”). Identifying the source of a municipality’s legal authority to undertake a particular activity and appropriate funds to a third party would be crucial in a dispute over the legality of a disbursement of sales tax proceeds.
On the second ground, the Court of Appeals has previously held that a municipal resolution requiring the payment of municipal funds to a school board was void because, among other things, it lacked a valid preaudit certificate. See Watauga Cnty. Bd. of Educ. v. Town of Boone, 106 N.C. App. 270, 276, 416 S.E.2d 411, 415 (1992). Even if a municipality has legal authority to enter into a specific contract and appropriate funds for a specific purpose thereunder, its failure to properly preaudit a municipal resolution or contract obligating local sales tax proceeds for an otherwise authorized purpose may render an “agreement” between a municipality and a county void.
A resident of a municipality that has agreed to remit local sales tax proceeds may have legal standing to challenge the validity of an agreement between the municipality and the county. At least in the Town of Boone case, though, such a challenge would be unlikely as each of the Smaller Towns fares much better under an ad valorem method (even after remitting a portion of the proceeds to the County) than under a per capita distribution system.
The Future of “Hybrid” Distributions. Aggregate distributions of local option sales and use tax revenues to counties and municipalities have roughly doubled over the last ten fiscal years. In FY2013, NCDOR distributed $1.09 billion in Article 39 taxes, $548.6 million in Article 40 taxes, and $540.8 million in Article 42 taxes. In FY2022, NCDOR distributed a total of $2.11 billion in Article 39 taxes, $1.05 billion in Article 40 taxes, and $1.04 billion in Article 42 taxes. The decision in Town of Boone suggests that a “hybrid” distribution approach is permissible—and as the local sales tax “pie” grows, counties and municipalities may become more creative in dividing that pie.
The record in Town of Boone contained a document published by the League of Municipalities in 2012 that summarized the terms of several interlocal agreements between counties and municipalities concerning “hybrid” distributions of local sales taxes—but I am not aware of a current, similar document. If your county or municipality has adopted a “hybrid” arrangement, I would be interested to hear about its terms.
[1] The net proceeds of Article 43 tax, where levied by a county, are distributed to the taxing county and the units of local government in the county that operate a public transportation system on a per capita basis. See G.S. 105-507.3(a); G.S. 105-511.4(a). The net proceeds of Article 46 tax, where levied, are distributed only to the taxing county. See G.S. 105-538.
[2] A county’s selected distribution method for Art. 39, 40, and 42 also determines the distribution of sales tax revenue under G.S. 105-524(c). See G.S. 105-524(d).
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