As the New Jersey Legislature works its way through its budget, the New Jersey Senate and Assembly passed Senate Bill 2795 (SB 2795) / Assembly Bill 4262 (AB 4262), respectively, on June 25, 2018, as a replacement for SB 2746 / AB 4202 — a bill that would have made significant changes to the corporation business tax (CBT) (see Tax Alert 2018-1256). If the new bill, SB 2795 / AB 4262, is enacted, it also would make significant changes to New Jersey's tax laws.

Specifically, SB 2795 / AB 4262 would make the following changes to New Jersey's current CBT:

— Impose a temporary "surtax" on CBT liability (effectively, an incremental increase in the nominal CBT rate) for the tax year ending on or after January 1, 2018, and the succeeding tax year, of:

a. 2.5% for taxpayers with "allocated net income" of over $1 million but under $25 million (effective 11.5% rate)

b. 4% for taxpayers with "allocated net income" over $25 million (effective 13% rate)

(This "surtax" would not apply to public utilities. In addition, taxpayers could not apply credits against the surtax (except for actual estimated payments made and overpayments))

— Reduce the dividends received deduction (DRD) for dividends received by CBT taxpayers that owned 80% or more of the stock of a subsidiary from 100% to 90% for the tax year beginning after December 31, 2016, and to 95% for tax years beginning on or after January 1, 2018

— Decouple the CBT law from IRC Section 199A, which permits a special deduction of 20% for qualified business income from the individual owners of a pass-through entity (PTE) (the decoupling would apply to income under both the CBT and the Gross Income Tax (GIT) Acts essentially disallowing the special federal 20% PTE deduction for New Jersey CBT and GIT purposes)

— Conform to the IRC Section 163(j) 30% business interest expense deduction limitation but require it to apply for NJ CBT purposes on a "pro rata" basis, excluding intercompany interest required to be added back to entire net income from the pro rata calculation (the current legislative language is unclear as to what "pro rata" means)

Perhaps more importantly, SB 2795 / AB 4262 removes the following CBT changes that were present in SB 2746 / AB 4202, including:

— Decoupling from IRC Section 965(c) (the transition tax participation exemption)

— The special 9% tax on dividends received or deemed to have been received in tax year 2017, which would have been sourced to New Jersey and subject to tax not based upon the recipient's or payer's apportionment to the state but on the basis of New Jersey gross domestic product (GDP) divided by federal GDP

— The inclusion of income effectively connected to a United States trade or business without regard to a US international tax treaty

— The treaty exemption to the New Jersey CBT addback of intercompany interest and royalty deductions statute

Implications

If enacted, SB 2746 / AB 4202 would likely result in significant changes for certain taxpayers to their New Jersey CBT liabilities. The rate increase in the bill would significantly increase the New Jersey CBT obligations of many taxpayers and make New Jersey's corporate tax rate the highest nominal state corporate tax rate in the nation. The bill would also decouple from sections of the TCJA that provide relief to taxpayers, while reducing the DRD and applying the federal interest limitation on a "pro rata" basis (without any clear guidance as to what the state has in mind). Combined with substantial, immediate conformity to the base-broadening provisions of the TCJA, these proposed changes to the New Jersey CBT tax base would result in a large (albeit temporary) increase in corporate tax revenue to the state beyond original, preliminary projections.

The reduction of the DRD for 2017 from 100% to 90% may result in a dramatic increase in overall New Jersey CBT liability for groups of related taxpayers that issued substantial dividends through layers of affiliates subject to the New Jersey CBT.

The "good news" for corporate taxpayers is that the most disconcerting aspects of SB 2746 / AB 4202, including the special dividend tax and the excision of the treaty exemption, have been removed in the replacement bills.

It is unclear at this time whether this revised bill will be signed or vetoed by Governor Murphy (who has publicly stated his opposition) or subject to further negotiations among the Legislature and the Governor.

EY is closely monitoring this development and will issue additional Alerts as warranted.

———————————————