On January 13, 2020, New Jersey Governor Phil Murphy signed into law NJ SB3246, the Pass-Through Business Alternative Income Tax Act, effective for tax years beginning on or after January 1, 2020. With this legislation, New Jersey joins Connecticut, Louisiana, Oklahoma, Rhode Island and Wisconsin in enacting some type of entity-level tax on pass-through entities (“PTEs”) in an effort to work around the $10,000 federal cap on individuals’ itemized deductions for state income taxes.
For New Jersey purposes, income and losses of a pass-through entity are passed through to its owners. However, the new law allows pass-through entities to elect to pay tax due on the owner’s share of distributive proceeds. The owner(s) may then claim a refundable tax credit for the amount of tax paid by the pass-through entity on their share of distributive proceeds.
Pass-through entities included under the Act mean partnerships and federal S corporations that have made the NJ S corporation election, as well as limited liability companies, with at least one member who is liable for tax on their share of distributive proceeds pursuant to the New Jersey Gross Income Tax Act, N.J.S.A. 54A:1-1 et seq., in a taxable year. Single-member limited liability companies and sole proprietorships may not elect to pay the Pass-Through Business Alternative Income Tax. “Distributive proceeds” means the net income, dividends, royalties, interest, rents, guaranteed payments, and gains of a pass-through entity, derived from or connected with sources within the State.
Individuals, estates, and trusts receive a credit against their gross income tax equal to the member’s tax on the share of distributive proceeds paid by the pass-through entity. Nonresident members of a pass-through entity making the Pass-Through Business Alternative Income Tax election can still participate on a Form NJ-1080-C composite return and take a credit for taxes paid.
The tax rates under the Pass-Through Business Alternative Income Tax are as follows:
|Pass-Through Entity Income||Tax Rate|
|Amount between $250,000 and $1 million||6.52%|
|Amount between $1 million and $5 million||9.12%|
|Amount over $5 million||10.9%|
Corporate members are allowed a credit against the corporation’s business tax equal to the corporate member’s tax on the share of distributive proceeds paid by the pass-through entity. The credit may not reduce the tax liability below the statutory minimum tax. Excess credits may be carried forward for twenty years.
By way of illustration, assume a New Jersey resident is a 50% partner in a partnership that is doing business in New Jersey and which makes this election. Further assume the sum of the partners’ distributive proceeds are $200,000, and the partnership’s New Jersey allocation percentage is 10%. The PTE tax related to this entity is $200,000 * 10% * 5.675% = $1,135. The New Jersey resident will only get a credit of their proportionate share (50%) = $567.50. However, as a New Jersey resident, they will owe New Jersey income tax on their entire distributive share: $100,000 * 5.675% (assuming their New Jersey tax rate mirrors the PTE rate) = $5,675. This results in a net tax due (before credits for taxes paid to other states) of $5,107.50. Presumably, the credits for taxes paid to other states will at least partially offset this remaining liability.
The election must be made each year by all owners of the pass-through entity or by an officer or member who is designated under the law or the entity’s organizational documents with the authority to make the election for all members. The annual election will be made on or before the original due date of the entity’s return on forms prescribed by the Division of Taxation. The pass-through entity’s tax return is due on the 15th day of the third month after the close of the tax year; i.e. March 15. Estimated tax payments are due on April 15, June 15, and September 15 of the tax year and on or before January 15 of the succeeding tax year.
LLI is working diligently to determine which PTE clients will benefit from this new tax law as well as the implementation steps necessary to properly take full advantage of its benefits. If you are an LLI PTE client, one of the partners will be in touch with you to discuss the implementation process.