New Jersey Becomes Latest State to Adopt an Elective Pass-Through Entity Tax

On January 13, 2020, New Jersey Senate Bill 3246 was signed into law. Also known as the Pass-Through Business Alternative Income Tax (or “BAIT”) Act, NJ S3246 creates a new elective pass-through business income tax with a corresponding income tax credit for members. The election takes effect immediately and applies retroactively to taxable years of pass-through entities (“PTE”) beginning on or after January 1, 2019.

The new legislation allows PTEs to report and pay tax at the entity level. In order for the election to be available, at least one member of a partnership, S corporation or LLC must be liable for New Jersey gross income tax on distributive proceeds. Additionally, members of the PTE must execute consent under penalties of perjury at the time the election is filed and are allowed to revoke the election until the due date of the return for that tax year. 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, sixth and ninth month of the taxable year, and by the 15th day of the first month following the close of the tax year.

The elective tax is imposed on a tax base equal to the sum of each member’s share of the PTE’s “distributive proceeds,” which 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 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

A PTE making this election will be included in a combined group and file a combined New Jersey Corporate Business Tax Act return unless the PTE meets the following: (1) all of the members of the PTE are taxpayers otherwise liable for the tax under the New Jersey Gross Income Tax Act; and (2) no business entity taxed as a corporation under the CBTA has a direct, indirect, beneficial or constructive ownership or control of the PTE.

Pass-through entities under common ownership by an individual, estate or trust, or a group of related individuals, estates or trusts, are not precluded from filing a composite or consolidated PTE tax return. To determine if the PTE is under common ownership, the individual, estates or trust, or a group of related individuals, estates or trusts, must own 50 percent of the direct or indirect voting control of each pass-through entity. IRC Code 318, however, still applies for determining voting control.

Under subsection 5 of the new legislation, a refundable tax credit is allowed if the taxpayer is a member of a pass-through entity that elects the PTE alternative income tax. For each pass-through entity where the taxpayer is a member, the credit is equal to the member’s pro rata share of the PTE tax for that period. Section 5(c) specifies that “if the credit exceeds the amount of tax otherwise due, the amount of excess shall be an overpayment.” Lastly, when a trust or estate receives a credit, it may be allocated to beneficiaries.

For PTEs owned by both corporate and non-corporate members, the corporate member is allowed a tax credit against surtax, but the credit may not reduce tax liability below the statutory minimum for nonexempt corporations. Corporate members may carry forward the excess credit for up to 20 privilege periods.

The process of states enacting elective pass-through entity taxes is a growing trend in SALT cap workarounds. New Jersey becomes the sixth – joining Connecticut, Wisconsin, Oklahoma, Louisiana and Rhode Island – in enacting mandatory/elective PTE entity tax legislation to combat the federal limitation on SALT deductions. States continue to monitor whether these SALT cap workarounds could survive scrutiny by the IRS and, if successful, whether state legislatures may continue to enact similar elective taxes.

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