New Jersey Removes Requirement to Affirmatively Make Separate State S Corporation Election; Provides Opt-Out

New Jersey enacted a new tax law (A.B. 4295) on December 22, 2022, that accomplishes three things: (1) eliminates the requirement to affirmatively elect New Jersey S corporation status, while including an opt-out provision; (2) adopts the federal centralized partnership audit regime, with certain modifications; and (3) ends certain COVID-related extensions.

S Corporation Elections

Most states recognize the federal S corporation election, and a separate state S corporation election is not required.  New Jersey, however, was one of the few states (including New York) that required eligible taxpayers to affirmatively elect to be treated as a state S corporation by submitting a separate New Jersey S corporation election form, including for qualified S corporation subsidiaries (QSubs).  Before the enactment of A.B. 4295, failure to make the separate state S corporation election resulted in the taxpayer being subject to New Jersey’s Corporation Business Tax (CBT) as a C corporation.  A.B. 4295 eliminated that requirement.

Effective December 22, 2022, New Jersey no longer requires eligible taxpayers to affirmatively elect S corporation treatment.  To accomplish the change, New Jersey amended the definition of “New Jersey S Corporation” to mean a taxpayer that has made a valid election to be an S corporation for federal tax purposes.  Therefore, if a taxpayer is treated as an S corporation for federal tax purposes, then the taxpayer is automatically treated as a S corporation for New Jersey CBT and Gross Income Tax purposes.

Notably, the new law provides an opt-out provision.  A federal S corporation may elect not to be taxed as a New Jersey S corporation. This election must have the consent of 100% of the shareholders. The election may be made for any tax year at any time during the preceding tax year or at any time on or before the due date or extended due date of the S corporation’s tax return.  An election to opt out is effective for the tax year for which the election is made and for each succeeding tax year until revoked.  An election to not be taxed as a New Jersey S corporation may be revoked if shareholders holding more than 50% of the shares of stock of the S corporation on the day on which the revocation is made consent to the revocation.

New Jersey’s changes to S corporation status are effective December 22, 2022, and apply to tax years and privilege periods beginning after December 22, 2022.

Adoption of Federal Partnership Audit Regime

A.B. 4295 also adapts New Jersey’s Gross Income Tax to the new federal centralized partnership audit regime enacted as part of the federal 2015 Bipartisan Budget Act.  The federal partnership audit regime was changed to create efficiencies so that partnerships are the focus of an audit, instead of individual partners.  According to the bill’s legislative analysis, New Jersey adopts the Multistate Tax Commission’s (MTC’s) “Model Uniform Statute for Reporting Adjustments to Federal Taxable Income and Federal Partnership Audit Adjustments” for purposes of the New Jersey Gross Income Tax Act and CBT Act.  

Generally speaking, this will require a partnership to report any federal partnership audit adjustments made by the IRS to the Division of Taxation.  The partners are then required to pay any New Jersey Gross Income Tax liability resulting from the federal partnership audit adjustments reported on the Federal Adjustments Report.  The partnership does have the option to elect to pay any additional New Jersey tax on the partner’s behalf.

These provisions apply to any adjustments to a taxpayer’s federal taxable income on or after January 1, 2020.

Ending COVID-Related Extensions

Finally, A.B. 4295 ends the extension enacted in response to the COVID-19 pandemic for the statute of limitations on tax due.  It also ends the extension for the provisions regarding New Jersey’s payment of interest on a taxpayer’s overpayment of tax.  Both of the extensions’ end dates are December 22, 2022.

BDO Insights

  • The elimination of New Jersey’s separate S corporation election is welcome news to businesses and tax practitioners alike, as the change simplifies compliance and eliminates a possible trap for the unwary. 
  • As New Jersey must be aware, there are instances when taxpayers benefit by not being treated as an S corporation for New Jersey tax purposes. A.B. 4295 preserves such benefits, but now taxpayers will need to affirmatively elect out of New Jersey S corporation treatment.  
  • Both the election to opt out of S corporation treatment, as well as the revocation of that election, must be made in a form and manner prescribed by the Director of the Division of Taxation.  At this time, those forms have not been released.  
  • Federal S corporations that have historically filed as New Jersey C corporations, as well as any other federal S corporations that will file prospectively with New Jersey, should carefully consider the total tax impact that the state’s new opt-out/opt-in regime will have at the entity and shareholder level.