New Jersey: Pass-Through Businesses Can Elect to Be Taxed at the Entity Level Starting in 2020
Summary of New Jersey Pass Through Business Alternative Income Tax Act
On January 13, 2019, the New Jersey governor signed S. 3246 into law, referred to as the “Pass-Through Business Alternative Income Tax Act” or “BAIT” Act. The new law creates an election for pass-through entities (PTEs) to pay at the entity level, and creates a corresponding tax credit for its members. In response to federal tax reform enacted in December 2017, New Jersey was one of several states searching for workarounds to help its residents manage the federal $10,000 SALT deduction limitation and amended Internal Revenue Code (IRC) Section 164. The BAIT Act was one of those responses and was introduced over a year ago.
The BAIT Act is effective immediately, and the election for PTEs applies to tax years beginning on or after January 1, 2020.
Details
Pass-Through Business Alternative Income Tax
Effective for taxable years beginning on or after January 1, 2020, New Jersey will allow a PTE to elect to be taxed at the entity level. A PTE with at least one member who is liable for New Jersey gross income tax may elect to be liable for, and pay, the BAIT in a tax year. Eligible PTEs include partnerships, NJ S corporations, and limited liability companies (LLCs) with at least two members.
Filing the Election, Tax Returns, Payments, and Estimates
To make the election, each member of the PTE must consent at the time the election is filed. Alternatively, the election can be made by any officer, manager, or member who is authorized to make the election on behalf of the PTE. The election must be made annually on or before the original due date (without extensions) of the entity’s New Jersey return. The election cannot be made retroactively. Finally, if the members decide to revoke the election, that revocation must be made on or before the original due date of the PTE’s return for the tax year in which the revocation is to be effective.
Electing PTEs must file a BAIT tax return and pay the entity level income tax by the 15th day of the third month following the end of their tax year, or March 15 for calendar-year taxpayers. Estimated payments must be made by the 15th day of the fourth month, sixth month, and ninth month of the taxable year, and by the 15th day of the first month following the close of the tax year.
Tax Rates
The BAIT is imposed on a tax base that is equal to the sum of each member’s share of the PTE’s “distributive proceeds” attributable to the PTE for the tax year. “Distributive proceeds” are defined as the net income, dividends, royalties, interest, rents, guaranteed payments, and gains of the PTE derived from or connected with sources within New Jersey upon which the New Jersey gross income tax would be imposed if the PTE were an individual taxpayer. For tax years beginning on or after January 1, 2020, the four tiers of income tax rates are as follows:
- 5.675 percent for distributive proceeds under $250,000
- $14,187.50, plus 6.52 percent for distributive proceeds between $250,000 and $1,000,000;.
- $63,087.50, plus 9.12 percent for distributive proceeds between $1,000,000 and $5,000,000
- $427,887.50, plus 10.9 percent for distributive proceeds over $5,000,000
Combined Groups and Composite Returns
If a PTE makes the BAIT election and is also engaged in a unitary business with a corporate member that is also a member of a New Jersey combined group, then the PTE is also included in that combined group and the group’s New Jersey combined return. If all the members of the PTE are taxpayers otherwise liable for New Jersey gross income tax, and no entity subject to the New Jersey corporation business tax (CBT) has a direct, indirect, beneficial, or constructive ownership or control of the PTE, then the PTE cannot be a member of a New Jersey combined group.
The new bill does not prevent a group of PTEs under common ownership by individuals, estates, or trusts from filing a composite or consolidated pass-through business entity income tax return. “Common ownership” means a group of related individuals, estates, or trusts must own more than 50 percent of the direct or indirect voting control of each PTE, using IRC Section 318 to determine voting control.
Credits for Individual Members
Non-corporate members of a PTE making the BAIT election are allowed a refundable New Jersey gross income tax credit equal to their pro rata share of the BAIT tax paid by the PTE. The credit is applied against the gross income tax liability of the member in that tax year after all other credits available to the member have been applied. Any excess credit is treated as an overpayment, but without the accrual of interest. The credit allowed to a trust or estate can be allocated to beneficiaries, or it can be used against the gross income tax liability of the estate or trust.
New Jersey residents are allowed a credit against their New Jersey gross income tax due for the amount of any state PTE tax that the director determines is substantially similar to the New Jersey BAIT. The credit cannot exceed what would have been allowed if the income was taxed at the individual level and not taxed at the entity level.
Credits for Corporate Members
A corporation that owns an interest in a PTE making the BAIT election is allowed a credit against both the CBT and the temporary surtax. The amount of the credit equals the corporate member’s pro rata share of the BAIT tax paid by the PTE and applies to the corporate member’s CBT or surtax liability in that same tax year. The credit cannot reduce the corporation’s tax liability below the statutory minimum tax and any excess credit can be carried forward for up to 20 years.
If the PTE is unitary with both the corporate member and that corporate member’s combined group, then the credit is shareable and allowed to reduce the total tax liability of that combined group, but not below the aggregate statutory minimum tax of the taxable members of the group.
If, however, the PTE is only unitary with the corporate member, but not that corporate member’s combined group, then the credit is not shareable. In that case, the credit is only allowed to reduce the tax liability of the corporate member derived from the corporate member’s activities that are independent of the unitary business of its combined group.
A corporate member of the PTE that is exempt from taxation under the CBT Act is permitted to have its share of the BAIT refunded.
BDO Insights
- New Jersey is the most recent of a new state tax trend – PTE tax elections as workarounds to the federal SALT deduction limitation – and joins Louisiana, Oklahoma, Rhode Island, and Wisconsin. Similar PTE tax elections have been introduced in a number of other state legislatures.
- The New Jersey PTE election must be made annually. The New Jersey legislation does not create a binding election.
- An analysis should be completed on each PTE, along with its members, to determine the potential impact of making the election. Factors that will come into play include tax rates, residency issues, PTE tax base, and whether a member’s resident state will allow a credit on their individual returns for taxes paid at the entity level in New Jersey.
- Questions remain on how the New Jersey BAIT election will be applied to tiered partnership structures, including those having corporate partners in upper tier partnerships.
- The election forms, tax forms, and estimated vouchers have not been created. Stay tuned for future guidance issued by the New Jersey Division of Taxation on compliance issues and tax forms.
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