New Jersey Issues Guidance on Entities Included In A Combined Group and Clarifies the Minimum Tax on Combined Group Members
New Jersey Issues Guidance on Entities Included In A Combined Group and Clarifies the Minimum Tax on Combined Group Members
On January 3, the New Jersey Division of Taxation (Division) issued a technical bulletin, TB-86, which defines the entities included in a New Jersey unitary combined group and clarifies when those entities are also subject to the $2,000 corporation business tax (CBT) minimum tax. However, TB-86 could present other nexus and apportionment questions for New Jersey combined group members.
As part of its comprehensive tax reform legislation enacted on July 1 (A. 4202), New Jersey now requires mandatory water’s-edge-style unitary combined reporting (with a worldwide election). Pursuant to N.J.S.A. section 54:10A-4.8.a., the “managerial member” with New Jersey nexus of the combined group will be required to file a unitary combined tax return on behalf of itself and the other members of the combined group that are engaged in a unitary business. Based on N.J.S.A. section 54:10A-4.7.a., each “taxable member” of the New Jersey combined group is treated as a separate taxpayer for purposes of computing a taxable member’s New Jersey sales factor numerator (the so-called “Joyce rule”).
On October 4, 2018, New Jersey enacted a technical corrections bill (A. 4495). Among other clarifications and technical corrections, A. 4495 accelerated the effective date of New Jersey’s mandatory unitary combined reporting to taxable periods ending on or after July 31, 2019. As a result, New Jersey taxpayers with taxable periods ending on or after that date, will be required to file a New Jersey unitary combined report beginning with that tax period.
Pursuant to N.J.S.A. section 54:10A-5(e), New Jersey imposes a minimum tax on a corporation that is based on the corporation’s New Jersey gross receipts. Those corporations with New Jersey gross receipts of $1 million or more are subject to a $2,000 minimum tax ($1,500 in the case of an S corporation). In addition, New Jersey’s 2018 tax legislation amended section 54:10A-5(e) to provide that for tax periods ending on or after July 31, 2019, “the minimum tax of each member of a combined group filing a mandatory or elective New Jersey combined return shall be $2,000 for the group privilege period.”
There was some concern that the minimum tax could apply to each member of a New Jersey combined group, whether a member had New Jersey nexus or not. While TB-86 may have clarified and alleviated this concern by limiting the applicability of the minimum tax to members with nexus, the Division may have raised new nexus and apportionment concerns that should be evaluated by New Jersey combined groups.
Composition of a New Jersey Combined Group
Under N.J.S.A. section 54:10A-4(z), a New Jersey “combined group” is a group of companies having common ownership that are engaged in a unitary business where at least one of the companies is subject to New Jersey CBT. TB-86 provides a list of 14 “included entity types.” The list includes:
- U.S. corporations
- Foreign corporations
- Banking corporations and financial corporations
- “Combinable captive insurance companies”
- Professional corporations
- New Jersey and foreign limited liability companies that are not treated as partnerships or disregarded entities for federal tax purposes
- Federal S corporations and qualified S corporation subsidiaries that have not made a New Jersey S corporation election
- New Jersey S corporations and qualified S corporation subsidiaries that have elected to be included in the combined group
- Any other business entity, regardless of place of organization, which is treated as a corporation for federal tax purposes
Under N.J.S.A. section 54:10A-2, a U.S. corporation with 80 percent or more of its property and payroll located overseas is excluded from a New Jersey water’s-edge combined group. Similarly, a foreign corporation with less than 20 percent of its property and payroll assigned to U.S. locations is excluded from a New Jersey water’s-edge combined group. However, a foreign corporation that earns more than 20 percent of its income from intangible property or related service activities that are deductible against the income of New Jersey combined group members is included in a water’s-edge group.
Although disregarded entities and partnerships (including LLCs that are treated as partnerships for federal tax purposes) are not treated as “included entity types,” their income (or loss) and apportionment factors flow to corporate partners or members that are members of a New Jersey combined group. In determining whether an entity is included in a New Jersey water’s-edge group, a disregarded entity’s factors are used to determine whether its owner is included in the water’s-edge group (i.e., a U.S. incorporated “80/20 company” or a foreign incorporated entity).
The following entities are “statutorily excluded entities” from a New Jersey combined group:
- New Jersey S corporations (and “QSubs”) that have not elected to be included in the combined group
- Captive insurance companies that are not “combinable captive insurance companies”
- All other insurance companies
- Corporations exempt from the CBT
- Corporations regulated, in whole or in part, by the Federal Energy Regulatory Commission, the New Jersey Board of Public Utilities, or a similar regulatory body of another state with respect to electric, natural gas, or water and wastewater services
A “combinable captive insurance company” is generally a licensed captive insurance company, which is owned more than 50 percent by a single corporation, which covers risks of its parent and/or other affiliates, and earns 50 percent or less of its gross receipts for the tax period from premiums on arrangements that constitute “insurance” for federal tax purposes.
TB-86 also indicates that the Division is still considering whether REITs, RICs, and investment companies will be treated as included or excluded entities for New Jersey combined report purposes.
New Jersey Combined Group Members and the Minimum Tax
As noted, there was concern that the 2018 New Jersey legislation could be interpreted to mean that each member of a New Jersey combined group, whether each had nexus with New Jersey or not, could be subject to a $2,000 CBT minimum tax. TB-86 alleviates this concern, but in doing so may create different and far-reaching concerns.
TB-86 clarifies that only those New Jersey combined group members that have nexus with New Jersey based on N.J.S.A. section 54:10A-2 are subject to the minimum tax and states, “If a member does not have nexus with New Jersey, the member is not subject to the minimum tax.”
However, N.J.S.A. section 54:10A-2 not only asserts CBT taxing jurisdiction over corporations that are “doing business” in New Jersey or that own property, employ capital, or maintain an office in New Jersey (i.e., have a physical presence), the statute also asserts CBT taxing jurisdiction over corporations that derive receipts from New Jersey sources. In addition, the statute asserts CBT taxing jurisdiction based on any contact that is sufficient to give New Jersey jurisdiction to tax under the U.S. Constitution. After the U.S. Supreme Court’s June 2018 decision in South Dakota v. Wayfair, Inc., does this now include an economic presence? The 2007 New Jersey Supreme Court decision in Lanco, Inc. v. Director, Division of Taxation, had already ruled that a physical presence was not required for purposes of CBT taxing jurisdiction, but was that decision limited to corporations deriving receipts from intangible property used in New Jersey? Although TB-86 clarifies that a New Jersey combined group member must have New Jersey nexus before it must pay the $2,000 minimum tax, is New Jersey economic presence nexus sufficient for purposes of the CBT and the minimum tax? TB-86 does not explicitly answer these questions, but does at least imply that an economic presence may be sufficient.
Further, TB-86 also provides that if a member of a New Jersey combined group has New Jersey nexus “and sufficient activities in New Jersey to be taxed based on income, no member that has nexus with New Jersey may claim P.L. 86-272 protection.” In effect, does this mean that no member of a New Jersey combined group may claim P.L. 86-272 protection from the CBT or does it mean that members with New Jersey nexus, but that are protected from the CBT, are still subject to the minimum tax? TB-86 does not answer this question, but the former seems a highly questionable position for the Division.
Last, as also mentioned above, for New Jersey apportionment purposes each member of the combined group is treated as a separate taxpayer. Therefore, the New Jersey sales factor numerator of a “taxable member” only includes that member’s New Jersey source receipts. A “taxable member” is a New Jersey combined group member that is subject to the CBT. There are concerns that TB-86 also represents the Division’s position that New Jersey combined group members that have New Jersey nexus, but that are protected by P.L. 86-272 from a CBT liability, will still nonetheless be treated as a “taxable member” and their New Jersey source receipts included in a New Jersey sales factor numerator. If included, this would seem to be a highly questionable position for the Division as well.
While TB-86 clarifies one concern about the CBT minimum tax for New Jersey combined group members, it raises a number of other questions that could be raised on audit or the subject of litigation, and may not be resolved until New Jersey courts decide.
Disregarded Entities and Partnerships and the Minimum Tax
Entities that are treated as disregarded entities for federal tax purposes are not treated as members of a New Jersey combined group, but their tax attributes (income, loss, and apportionment factors) flow through to their corporate owner. However, disregarded entities are not treated as members of a New Jersey combined group. Partnerships, limited partnerships, and LLCs treated as partnerships for federal tax purposes are also not treated as members of a New Jersey combined group. If a partnership or LLC is unitary with a corporate partner or member, then the partner’s or member’s distributive share of income (or loss) and factors flow through to the partner or member.
Because disregarded entities, partnerships, and LLCs treated as partnerships for federal tax purposes are not treated as members of a New Jersey combined group, the minimum tax does not apply to these entities, but will apply to their corporate partners or members.
Statutorily Excluded Entities and the Minimum Tax
“Statutorily excluded entities,” such as S corporations that do not elect inclusion in a New Jersey combined group, insurance companies, and certain regulated entities described above, cannot be subject to the $2,000 minimum tax as members of a combined group. But if they are members of an “affiliated group,” as defined under Section 1504 of the Internal Revenue Code (IRC), or a “controlled group,” as defined under IRC Section 1563, which has a total payroll of $5 million, then such “statutorily excluded entity” is subject to the $2,000 minimum tax, even if a New Jersey S corporation. However, if such entity does not have New Jersey nexus or is exempt from the CBT under N.J.S.A. section 54:10A-3, it is not subject to the minimum tax.
- TB-86 provides guidance for the types of entities that will be included in a New Jersey combined group, if they otherwise satisfy common ownership, unitary business, and the other statutory requirements, as applicable. The guidance is important, because A. 4495 accelerated the effective date of New Jersey’s mandatory unitary combined reporting regime to tax periods that end on or after July 31, 2019.
- While TB-86 also clarifies that a New Jersey combined group member must have New Jersey nexus before it can be subject to the CBT minimum tax, the Division’s guidance raises additional questions with respect to the extent to which New Jersey may now assert nexus, the Division’s position on P.L. 86-272 protected entities, and even potential New Jersey sales factor implications for P.L. 86-272 protected entities.
- Taxpayers affected by TB-86 should consult with their financial statement auditor and tax advisor to evaluate and determine the potential financial statement implications under ASC 740, including the impact on current and deferred taxes, uncertain tax benefits, and disclosures.