Clarification needed for NC State for "addition to income in NC handled differently from Federal"

[Pip_12_mn]

There is a question on the NC return that is very confusing because if you enter income as stated in the "learn more" help topic, you end up getting taxed on NC income that is supposed to be exempt.

Its under "Addition to income in NC handled differently from Federal"

You are prompted to enter Expenses Allocable to Income Exempt or Excluded From Gross Income

but under the "Learn More" it says

Enter the amount of expenses allocable to income NOT SUBJECT to North Carolina income tax.

This makes absolutely no sense, why would I want to add income  that should not be taxed in NC? This flows directly to the NC taxable income!

[LenaH]

It is not prompting you to enter income exempt or excluded from gross income. It is prompting you to enter expenses allocable to income exempt or excluded from gross income. In other words, if an income source is exempt from NC tax, then the state does not want any deductions relating to that exempt income to be deducted (in addition to the income being exempt). Therefore, you'd have to add those deductions back when calculating your taxable income.

[Pip_12_mn]

@LenaH 

Thank you this kind of helps.

Can you please give an example of a specific  expense that would be pertinent to this question?

Sometimes an example is worth a thousand words!

[LenaH · Accepted solution]

An example that North Carolina gives here are expenses connected with Interest Income from United States Obligations - Under G.S. 105-130.5(b)(1), interest income from obligations of the United States or its possessions is excludable from North Carolina taxable income to the extent such income is included in federal taxable income. Expenses incurred in producing the exempt income must be determined and subtracted from the gross amount earned during a taxable period before the deduction is made in computing the state taxable income.

@crash12_mn 

[Pip_12_mn]

@LenaH 

It's starting to make sense.

So if you own a mutual fund which derives 100% of it's income from US Treasury Obligations, the expenses related to that NC tax exempt income  would have already been removed by the mutual fund (by the expense ratio), so there would be no need to add the expenses back in as "additions". I just can't see how this would work in real life but thank you for the example!

I actually called NC DOR for clarification of NC Form 400 Schedule S line 12 instructions and was told they hardly ever see it used and were confused by the wording themselves.