July 2, 2018
Overnight, New Jersey completely overhauls its Corporation Business Tax Act
On July 1, 2018, New Jersey Governor Phil Murphy signed into law Assembly Bill 4202 / Senate Bill 2746 (the Law) which makes sweeping changes to the state's Corporation Business Tax (CBT) Act and results in possibly the most significant overhaul of the CBT since its first enactment in 1945. New Jersey no longer is a separate return state. The Law mandates water's edge combined reporting (with a taxpayer option for a worldwide election), overhauls the state's net operating loss (NOL) carryforward rules to include a conversion of pre-Law NOLs to a new combined reporting regime, imposes a temporary surtax that results in the one of the highest corporate tax rates in the US at 11.5%, imposes limitations on the deductibility of dividends (affecting the state's dividend received deduction (DRD) rules), adopts market-based sourcing for services for its allocation provisions, decouples the CBT from certain provisions of the federal Tax Cuts and Jobs Act (P.L. 115-97) (TCJA), and makes other changes to the CBT. The changes wrought by the Law have various effective dates, some of which will have retroactive effect.
DUE TO THE LAW CHANGES, THE 2017 CBT-100 FORMS ARE OBSOLETE AND ANY 2017 CBT-100 FILINGS ALREADY SUBMITTED WILL LIKELY REQUIRE AMENDMENT TO CONFORM TO THE LAW'S MANY CHANGES TO THE CBT ACT.
In separate legislative action, New Jersey enacted a tax amnesty program, imposed sales and use tax on certain transient accommodations, taxes ride sharing, and increases the gross income tax rate on high wage earners to 10.75%. The legislature also approved a bill that would adopt marketplace provider provisions for sales and use tax purposes. Changes to these other taxes will be discussed in separate, forthcoming Tax Alerts.
Set forth below is a summary of the changes made to the CBT Act.
The Law requires combined filing for unitary members of an affiliated group for tax years beginning on or after January 1, 2019.1 The combined filing definitions and requirements follow:
— New Jersey "affiliated group": Includes companies that are members of the federal affiliated group (pursuant to IRC Section 1504), as well as corporations included in more than one federal consolidated return, engaged in one or more unitary businesses, or not engaged in a unitary business with any other member of the affiliated group (note: this expansive definition can also include non-US corporations)
— Combinable captive insurance company: Includable in a CBT combined group is an entity taxable as a corporation under the IRC, that is commonly owned, licensed as a captive insurance company, whose business includes covering the risks of its parent, members of its affiliated group, or both, and 50% or less of its gross income consist of premiums from arrangements that constitute insurance for federal income tax purposes
— Common ownership: means that more than 50% of the voting control of each member of a combined group is directly or indirectly owned by a common owner or owners, either corporate or non-corporate, whether or not the owner or owners are members of the combined group
— Unitary business: Construed to the broadest extent permitted under the U.S. Constitution.
— A New Jersey taxpayer or group of taxpayers will be required to file a water's edge combined return, although a worldwide filing election will be available. A worldwide group election is generally binding for six years
— Apportionment is calculated pursuant to the "Joyce method" (i.e., inclusion of all members' total receipts in the sales factor denominator, and taxable member New Jersey receipts in the sales factor numerator)
a. The "Joyce method" does not apply to an affiliated group election
— Intercompany gains/losses are generally deferred
— The distributive share of unitary pass-through (i.e., partnership) income is included in entire net income (ENI)
— Generally, the common parent of a New Jersey affiliated group will be the managerial member unless it is itself not a New Jersey taxpayer. In the absence of a qualified common parent to serve as the managerial member, the group can elect (or the Director of the New Jersey Division of Taxation (Director) can appoint) any taxpayer as the managerial member. The combined group's year-end must conform to the managerial member's year end
— Combined group dividends are eliminated
— The charitable deduction is computed as a group deduction
— New rules are enacted regarding the application of NOL carryforwards (see section below)
— New rules are enacted regarding the application of credit carryforwards
— All taxable members are jointly and severally liable for the combined New Jersey CBT tax
The following members must be included in a water's edge combined return
— US-incorporated commonly owned unitary members with at least 20% of both their payroll and property located in the US
— Commonly owned unitary members, incorporated anywhere, with at least 20% of both their payroll and property located in the US
— Commonly owned unitary members that earn more than 20% of their income, directly or indirectly, from intangible property or related service activities that are deductible against the income of other members of the combined group (note that many overseas entities may be brought into a New Jersey combined return through this provision)
— Commonly owned unitary members with New Jersey nexus (note: the CBT has an economic nexus rule)
— Combinable captive insurance companies
All commonly owned unitary group members must be included in an elective worldwide combined return. Foreign member income and factors are included in the combined return as follows:
— Prepare a profit and loss statement (P&L) for each foreign branch or corporation in the currency in which the books of account of the branch or corporation are regularly maintained
— Adjust to conform the P&L to the accounting principles generally accepted in the US (i.e., US GAAP) for the presentation of those statements
— Further adjust the P&L to take into account any book-tax differences required by federal or state law
— Translate the P&L and apportionment factors into US dollars
(Note: the Director may allow taxpayers to forgo this requirement and use "reasonable approximation" to compute the taxable income of non-US members.)
Affiliated group election
A managerial member may elect to include affiliated group members in a combined filing. Similar to the worldwide election, the affiliated group election is generally binding for six tax years.
An affiliated group election requires calculation of apportionment pursuant to the Finnigan method (inclusion of all members' total receipts in the sales factor numerator and denominator).
The newly-established combined filing rules also result in the following changes
— Removal of the adjustment related to excess compensation paid to affiliated or controlled group members and forced consolidation provision, due to imposition of combined filing requirements
— Similar to those states which recently converted from separate to combined reporting (e.g., Massachusetts, the District of Columbia and Connecticut), publicly traded companies can deduct, pursuant to a formula, the net increase in deferred tax liabilities, or net decrease in deferred tax assets attributable to the conversion in the tax system. The deduction begins five years after the first combined filing period, and is deductible at 10% over 10 years. The deduction is calculated as the quotient of the change in deferred tax asset/liability, divided by the New Jersey tax rate applicable at the time of the Law, divided by group apportionment at the time of the deferred tax asset/liability calculation. In order to utilize the deduction, a taxpayer is required to file a statement with the Director on or before July 1 of the year subsequent to the first privilege period for which a combined return is required (i.e., July 1, 2020).
The Law imposes a temporary "surtax" on CBT liability (effectively, an incremental increase in the nominal CBT rate) for tax years 2018 through 2021, at the following rates:
— 2.5% for taxpayers with "allocated net income" of over $1 million (effective 11.5% rate) for the periods beginning on or after January 1, 2018 through December 31, 2019
— 1.5% for taxpayers with "allocated net income" of over $1 million (effective 10.5% rate) for the periods, beginning on or after January 1, 2020 through December 31, 2021
This "surtax" does not apply to public utilities.
Taxpayers are not be permitted to apply credits against the surtax (other than credits for amounts of estimated taxes previously paid and overpayments).
NOL carryforward overhaul
The Law completely overhauls New Jersey's NOL carryforward rules mimicking the provisions New York used in its dramatic 2015 tax reform to move that state from a separate to combined reporting state. The new rules:
— Convert pre-apportioned NOL carryforwards incurred prior to tax years beginning on or after January 1, 2019 to post-apportioned NOL carryforwards by multiplying all prior period NOL carryforwards by "base year" apportionment ("base year" is defined as the taxpayer's New Jersey apportionment for the tax year prior to tax year beginning on or after January 1, 2019)
a. The carryforward period for the converted NOLs (PNOLs) continues to be 20 years from the date that the taxpayer incurred such NOLs (meaning that the carryforward period does not restart)
— Imposes a 20-year carryforward on any post-apportioned NOL carryforwards incurred during tax years beginning on or after July 1, 2019
— Disallows the application of PNOLs and NOLs incurred on a separate company basis to combined group ENI
— No longer requires the utilization of NOL carryforwards prior to the application of the DRD
— Adjusts New Jersey's unique merged company survivor rule (akin to IRC Section 382 ownership limitations), allowing for survival of NOL carryforwards resulting from mergers among combined group members
DRD and IRC Section 965 (transition tax) changes
While requiring inclusion of the post-1986 earnings and profits of foreign subsidiaries required under IRC Section 965 (the so-called transition tax) in New Jersey ENI, the Law disallows all of the deductions, credits, and exemptions of that section. Moreover, the Law explicitly makes this IRC Section 965 decoupling retroactive to tax years beginning on or after January 1, 2017.
The Law reduces the DRD for dividends paid to (or deemed paid to2) CBT taxpayers which owned 80% or more of the stock of a subsidiary from 100% to 95% for the tax year beginning after December 31, 2016. In 2017 only, taxpayers are required to apportion the non-deductible portion of the dividend using either their three year average allocation factor (for the taxpayer's 2015 through 2017 tax years) or 3.5%, whichever is lower. For tax years after 2017, the 95% DRD continues for subsequent tax years, without the application of the aforementioned apportionment rule. The intention of the "deemed paid" language seems to be targeted at the IRC Section 965 transition tax inclusion amount such that taxpayers will be allowed to deduct 95% of the pre-apportioned amount and thus, only pay New Jersey CBT tax on 5% of such amounts. (This is in contrast to previously provided advice by the Division that owners of 80% or more of a foreign subsidiary would have had a 100% deduction such that none of the IRC Section 965 amounts would have been taxable in New Jersey under the CBT law prior to enactment of the Law.)
(Please note that the bill provides an anti-pyramiding provision for the DRD, which allows an exclusion from taxable income of any dividends that were subjected to the CBT at a subsidiary level. The exclusion is limited to the amount effectively taxed at the subsidiary (i.e., net of apportionment)).
Other TCJA responses
The Law decouples the CBT from IRC Section199A, which permits a special deduction of 20% for qualified business income from the individual owners of a pass-through entity (PTE), effective for tax years beginning after December 31, 2017. The decoupling applies 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.
The Law conforms to the IRC Section 163(j) 30% business interest expense deduction limitation but requires that it apply for CBT purposes on a "pro rata" basis, including intercompany interest already required to be added back to ENI, effective for tax years beginning after December 31, 2017. The Law provides no guidance as to what "pro rata" means or is intended to mean.
Apportionment, ENI base and CBT credit changes
The Law adopts market-based sourcing for service income, effective January 1, 2019.
The Law adjusts the depreciable basis of assets for gas, electric, and gas and electric utilities for years that the utilities would have been subject to tax if doing business in the state, effective retroactive to January 1, 2017.
The Law narrows the treaty exemption for the addback of interest and intangible expenses to payments made to related members domiciled in nations with a comprehensive tax treaty with the United States, only to the extent that the related member was subject to tax in the foreign nation on a tax base that included the payment paid, accrued, or incurred and the related member's income received from the transaction was taxed at an effective tax rate equal to or greater than a rate of three percentage points less than the rate of tax applied to taxable interest by New Jersey. In regard to the addback on interest expense, the change is effective retroactive to January 1, 2017. For purposes of adding back intangible expenses, the change is effective January 1, 2018.
The Law makes the New Jersey research and development credit nonrefundable and decouples from any prospective termination of IRC Section 41, effective January 1, 2018.
The Law adjusts the Alternative Minimum Tax credit utilization, effective January 1, 2018.
Penalty and interest abatement provisions
Neither penalties nor interest will accrue for the underpayment of tax resulting from the retroactive changes applying to returns filed for tax years 2017 and 2018, provided, however, that the additional catch up payments must be made by either with the second next estimated payment subsequent to the enactment of the law (i.e., for a calendar year taxpayer, by December 31, 2018 for tax years beginning on or after January 1, 2017) or by the first estimated payment due after January 1, 2019 for tax years beginning on or after January 1, 2018.
In the first tax year that a mandatory combined return is due, no penalties or interest shall accrue due to underpayment that may result from the switch from separate return reporting to mandatory combined return reporting, and any overpayment by a member of the combined group from the prior tax year will be credited as an overpayment of the tax owed by the combined group, credited toward future estimated payments by the combined group.
Captive insurance company premiums tax
Effective January 1, 2018, the Law imposes a tax on non-combinable captive insurance companies (minimum of $7,500 and maximum of $200,000) as follows:
— 0.38 of 1% on the first $20,000,000 and 0.285 of 1% on the next $20,000,000 and 0.19 of 1% on the next $20,000,000 and 0.072 of 1% on each dollar thereafter on the direct premiums collected or contracted for
— 0.214 of 1% on the first $20,000,000 of assumed reinsurance premium, and 0.143 of 1% on the next $20,000,000 and 0.048 of 1% on the next $20,000,000 and 0.024 of 1% of each dollar thereafter.
The provisions of the new law are severable from each other, and the Director is empowered to adopt regulations related to the law.
The Law makes sweeping, comprehensive and dramatic changes to the CBT that affect all corporations, or are affiliated in a unitary relationship with other corporations, that do business in New Jersey. The Law effectively rewrites virtually every significant aspect of the CBT and in some cases, on a retroactive basis to tax year 2017. This Alert provides an overview of the most material changes. We caution that there are other changes in the Law that are not fully addressed in this Alert and that they also should be considered. Any corporation that does business in New Jersey or that is part of a unitary group that has even one member with business in New Jersey, must immediately consider these changes.
We plan to issue additional alerts as guidance becomes available and as a greater understanding of the Law's impact is addressed.
1 It is possible that taxpayers may elect combination for tax year 2018. It is unclear if the Legislature intended this outcome.
2 "Deemed paid" language did not exist in the DRD provision of the CBT prior to this Law.