January 16, 2020 New Jersey enacts elective business alternative income tax for pass-through entities to address SALT deduction cap On January 13, 2020, Governor Phil Murphy signed into law Senate Bill 3246 (S. 3246 or bill) establishing the "business alternative income tax" (BAIT), an elective New Jersey business tax regime for pass-through entities (PTEs). Under the bill, New Jersey PTEs (defined as partnerships, limited liability companies, or S corporations) can elect to pay an entity-level tax. In addition, a proportionate share of the BAIT paid by a PTE can be credited to the PTE owners' Gross Income Tax (GIT) or Corporation Business Tax (CBT) liability. The BAIT applies to PTE tax years beginning on or after January 1, 2020. New Jersey becomes the latest state to enact such a state tax at the entity level. The BAIT is intended to give New Jersey individual income taxpayers a work-around of the $10,000 annual limitation on the deductibility of state taxes imposed by the federal Tax Cuts and Jobs Act (TCJA) (commonly referred to as the SALT deduction cap). This benefit is ostensibly accomplished by treating the BAIT paid at the entity level as an "above the line" deduction by the trade or business rather as an itemized deduction at the individual partner level, which would be subject to the SALT deduction cap. Neither the Treasury Department nor the IRS have issued specific guidance on whether any deduction flowing through to individual PTE owners would not be subject to the SALT deduction cap for federal income tax purposes. The BAIT statute is quite complex. Key features of the new law are summarized below (as are some of the open questions raised by the new tax): General member and election requirements Under the bill, only a PTE with at least one owner subject to the GIT can elect to pay the BAIT. The election into the BAIT regime must be made annually by the PTE on or before the original due date (without extensions) of the PTE's return and must have the consent of (i) all members or (ii) an officer, manager or member authorized by the PTE to consent to the election (such as a "tax matters partner"). A retroactive BAIT election cannot be made after the return's original due date (without extensions) and any revocation of the BAIT election must be made before the original due date of the PTE's return. Tax rates The BAIT is imposed at the following rates based on the collective sum of all the PTE's members' shares of distributive proceeds1 for the tax year:
Return filing and estimated payments A group of PTEs commonly owned by a related group of individuals, estates or trusts (consisting of direct or indirect ownership of more than 50% of voting control of each PTE, as determined under IRC Section 318) may file a combined BAIT return. Electing PTEs must:
PTE tax credits for GIT taxpayers PTE members may claim a "refundable" GIT credit equal to 100% of the member's pro rata share of the BAIT paid by the PTE. The credit applies against the member's GIT liability in the same tax year after all other credits available to the member have been applied. Excess credit is treated as an overpayment, but without the accrual of any overpayment interest. Any credit allowed to an estate or trust may be allocated to its beneficiaries or used against the estate or trust's tax liability, subject to the rules and regulations adopted by the director of the New Jersey Division of Taxation (DOT). A New Jersey-resident member may claim a credit for taxes paid to another US state or political subdivision on income subject to the BAIT. The credit may "not exceed the proportion of the tax otherwise due under [the bill] that the amount of the taxpayer's income subject to tax by the other jurisdiction bears to the member's entire New Jersey net income." A credit is not allowed for income or wage tax imposed on New Jersey-allocated S corporation income, or for any income or profits tax imposed or paid on behalf of a person other than the member. In addition, a resident taxpayer may claim a credit for a tax paid to another US state or political subdivision that the Director determines to be substantially similar to the BAIT, not to exceed what would have been allowed if the income were taxed at the individual level. S corporations All initial shareholders of a federal S corporation must consent to New Jersey S corporation treatment for that entity to elect to pay the BAIT. The state may collect a tax from the S corporation on behalf of any subsequent non-consenting shareholders, consisting of the New Jersey-sourced income allocated to the nonconsenting shareholders, multiplied by the maximum GIT tax bracket. The S corporation may recover such payments from the non-consenting shareholders and will not be liable for BAIT relative to collections made for non-consenting members. An S corporation may revoke its BAIT election on or before the last day of its tax year. Lastly, the requirement to further allocate S corporation income for part-year residents, in accordance with the number of days of residency, also applies for purposes of determining income under the BAIT. CBT filing and credit The BAIT is exclusive of any other tax due and paid by the PTE under the CBT. PTEs electing to file the BAIT must be included in a combined CBT return, unless:
Corporate members may claim a BAIT credit against both the CBT and temporary surtax imposed by N.J.S.A. 54:10A-5.41 to the extent of the statutory minimum tax imposed under N.J.S.A. 54:10A-5. The BAIT credit available to corporate taxpayers equals the corporate member's share of PTE tax paid and applies against the corporate member's CBT or surtax liability in the same tax year applicable to the BAIT. Excess BAIT credit may be carried forward for 20 tax years. If the PTE is unitary with both the corporate member and its combined group, the BAIT credit is shareable among all combined group members. If the PTE is unitary with the corporate member, but not its combined group, the BAIT credit only applies against income derived from the corporate member's business activities, independent of the unitary business activities of the combined group. The bill permits a corporate member of the PTE that is exempt from the CBT to have its share of the BAIT refunded. Additional matters Under the bill, both the partners of a partnership and the partnership itself are jointly and severally liable for BAIT obligations, with two exceptions:
BAIT payments are to be deposited in the state's General Fund, rather than the state's Property Tax Relief Fund (PTRF), to which all GIT revenues are allocated. Implications The bill presents significant income tax implications for PTEs, as well as their individual and corporate owners. The bill differs significantly from similar legislation and PTE taxes enacted in other states (e.g., the Connecticut PTE tax) because the BAIT is elective rather than mandatory. It is unclear whether the elective nature of the BAIT affects its effectiveness as a workaround to the federal SALT deduction cap. For the workaround to achieve its intended purpose, the IRS would have to find that the voluntary nature of the election does not affect deductibility at the trade or business level as opposed to the individual level. Because the PTE will only pay tax on New Jersey-connected income, the credit that New Jersey residents (who must pay their GIT on their unapportioned (i.e., world-wide) taxable income) obtain from a PTE with income from both within and outside New Jersey may be less than their overall GIT liability.2 For example, if a PTE earns only 10% of its income from New Jersey sources, the PTE may pass on to its New Jersey resident partner a credit equal to 10% of the partner's GIT liability. For this reason, the BAIT may only provide effective federal tax relief to the resident members of PTEs with significant New Jersey presence. The bill does not change existing non-resident withholding requirements for those PTEs that elect to pay the BAIT. Accordingly, duplicative payment requirements may be created if individual non-resident taxpayers are subject to both regimes. Moreover, the PTE may be filing on a fiscal-year basis, while its individual members may be filing on a calendar-year basis. This could create difficulties in applying GIT credits for BAIT tax paid at the PTE level. While PTEs can elect to pay the BAIT after the end of the tax year, the requirement to make estimated payments commences during the tax year. Accordingly, to avoid the underpayment of estimated tax penalties, the decision of whether to elect into the BAIT should be made early in the tax year. For electing PTEs, the bill creates new reporting and payment requirements, including the need for BAIT compliance materials and associated guidance. For example, the BAIT's January 1, 2020, effective date would require the DOT to implement an estimated payment protocol by April 15, 2020. As DOT staff must already provide guidance and compliance materials for the 2018 CBT reform, and the substantial changes made to New Jersey's tax laws in response to the TCJA, it is unclear how quickly these materials and guidance will actually be provided. It is unclear for corporate PTE members how the CBT credit for BAIT paid by a PTE will apply if PTE income is included in the combined business tax base, but the PTE is unitary only with its member (that is otherwise unitary with its other combined group members). The implications of shifting of revenue from the PTRF to the General Fund are unclear and could result in future municipal property tax increases to compensate for possible PTRF reductions by the indirect conversion of GIT payments into BAIT payments. ———————————————
——————————————— 1 The bill defines "distributive proceeds" as "the net income, dividends, royalties, interest, rents, guaranteed payments, and gains of a PTE, derived from or connected with sources within the state, and upon which tax is imposed and due on a member of the PTE pursuant to the 'New Jersey Gross Income Tax Act' [ … ] in a [tax] year." 2 The definition of "distributive proceeds" in Section 2 of the bill appears unclear and may reflect a drafting error. "Distributive proceeds" is defined as the income " … of a pass-through entity, derived from or connected with sources within [New Jersey] [emphasis added]." This definition further provides that, "for a nonresident, [distributive proceeds] means New Jersey source income as set forth in N.J.S. 54A:5-8." Several interpretations are possible: (1) the special definition applicable to nonresidents may be superfluous; (2) by negative implication, the additional language suggests that resident members compute their New Jersey-source distributable proceeds in some other unspecified manner than non-resident partners do not; or (3) the Legislature may have intended to add 100% of the distributable proceeds of resident members to the apportioned distributable proceeds of non-resident members. Regardless, this provision would appear to require subsequent clarification and consistency. | |||||||||||||||
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