On January 13, 2020, Gov. Phil Murphy signed the Pass-Through Business Alternative Income Tax Act (A-4807/S-3246). The new law allows flow-through businesses in New Jersey, such as sub-S corporations, partnerships or limited liability companies (LLCs), to elect to pay income taxes at the entity level rather than the personal income tax level. The intent of the law is to help New Jersey small business owners impacted by the state and local tax deduction cap imposed under the Tax Cuts and Jobs Act of 2017 (2017 Tax Law).
2017 Tax Law SALT Cap
The TCJA reduced the amount of state and local taxes (SALT) that an individual can deduct in a calendar year to $10,000. To help lessen the impact of the SALT cap, states like New Jersey have worked to blunt the impact via state regulations.
In 2018, New Jersey enacted a law authorizing municipalities, counties, and school districts to establish one or more charitable funds, donations to which could be credited toward the donor’s property tax obligation. In response, the Internal Revenue Service (IRS) enacted regulations prohibiting such workarounds. A legal challenge brought by New Jersey and several other states is still ongoing.
Pass-Through Business Alternative Income Tax Act
The Pass-Through Business Alternative Income Tax Act (Act) aims to help small business owners by allowing pass-through entities — those in which taxes typically “pass-through” to individual business owners — to shift the obligation to pay state tax on the businesses’ New Jersey income from the members of the business to the business. Since there is no limit on federal tax deductions for state and local taxes paid by businesses, the tax change is expected to save New Jersey business owners an estimated $400 million annually, according to the New Jersey Society of Certified Public Accountants (NJCPA).
The Act essentially amends New Jersey’s tax laws for pass-through entities so that they return to the way they were in the early 1990s. In doing so, it establishes two instruments to affect the optional shift of the New Jersey income tax payment obligation from members of a pass-through business to the business, an optional entity-level tax on pass-through businesses and an offsetting gross income tax credit for members of pass-through businesses making that election.
For tax years starting on or after January 1, 2020, pass-through entities may elect to pay an entity-level income tax based on the sum of the distributive shares of the partners. The election is available to partnerships, S corporations, and LLCs with at least two members. In addition, at least one of the partners must owe New Jersey gross income tax on income, dividends, and gain received from the pass-through business, and sourced to the State, in the tax year, which the Act refers to as the “distributive proceeds.”
To calculate the amount of tax due, the pass-through business is first required to determine the amount of distributive proceeds that each member receives from the business in the tax year. Then, each member’s pro-rata share of the distributive proceeds is multiplied by: A tax rate of 5.675% on income totaling up to $250,000 in the tax year; 6.52% on income totaling more than $250,000 but less than $1 million; 9.12% on income totaling more than $1 million but less than $5 million; and 10.9% on any income above $5 million.
Next, the pass-through business adds together each member’s taxed share to determine the business’s pass-through business alternative income tax liability for the tax year. However, if a member does not owe gross income tax in a tax year on distributive proceeds, or the liability is less than $1, then that member’s amount of distributive proceeds is disregarded for purposes of calculating the pass-through tax liability for the tax year.
For a business that opts to pay the pass-through business alternative income tax, the Act provides a refundable gross income tax credit that is available to taxpayers who are members of the pass-through business. In the case of a corporation that owns a pass-through business opting to pay the pass-through business alternative income tax, the Act provides a corporation business tax credit which, if unused, may be carried forward for up to 20 years.
The Act took effect immediately and applies to taxable years of pass-through entities beginning on or after January 1, 2020. The Division of Taxation must now promulgate rules, regulations, procedures, and forms for the administration of the tax and tax credit.
In order for LLCs operating in New Jersey to avail themselves of the opportunities presented by this law, they should consult with an attorney to amend and operate their LLC Operating Agreements.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Jeff Cassin, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.