On January 13, 2020, New Jersey Governor Phil Murphy signed into law a bill establishing an elective alternative business tax for pass-through businesses. New Jersey is the latest state to enact such legislation aimed at addressing the $10,000 federal cap on the state and local tax (SALT) deduction enacted as part of the Tax Cuts and Jobs Act (TCJA) of 2017.
The New Jersey law allows pass-through entities to elect to pay an entity level tax, which is creditable to an individual or corporate owner’s New Jersey Gross Income Tax or Corporate Business Tax, respectively.
The New Jersey legislation will take effect for tax years beginning on or after January 1, 2020 and is designed to provide an above the line deduction for the pass-through entity. The salient features of the law are as follows:
- An election must be made annually on or before the original due date of the pass-through entity’s return.
- The election must be made by the pass-through entity and must either have the consent of all the members of the pass-through entity or someone qualified and authorized by the pass-through entity to consent to the election.
- A combined business alternative income tax return can be filed for pass-through entities that are commonly owned.
- The rate of the alternative business income tax is a graduated rate and estimated payments are due on the 15th day of the 4th, 6th, and 9th months of the year, and on the 15th day of the first month following the close of the tax year.
- Retroactive elections are not permitted.
- The alternative tax paid by the pass-through entity can be credited to the member’s/shareholder’s/partner’s New Jersey tax liability.
Although New Jersey has joined select states in creating a “workaround” to the federal SALT limitation, the main question about these types of taxes is whether they will be respected by the IRS. The New Jersey law has features that appear to resemble a composite return filed by pass-through entities on behalf of all of the members that elected to join the composite filing. It is also an elective filing option that utilizes a graduated rate based on the aggregate income attributable to each member and provides a refundable credit to the members.
To date, the IRS has not issued any guidance on whether it will respect the pass-through entity level taxes enacted subsequent to the passage of the TCJA. The hope is that, if the IRS does challenge the pass-through entity level tax enacted by states as a workaround, any changes affecting the above the line deduction are prospective in nature and the elective nature of the pass-through entity tax does not invalidate the deductibility of the tax paid at the entity level.
If you’d like to discuss this new legislation and how it may impact you or your business, please contact a member of Kreischer Miller’s State and Local Tax group.
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