Important Change in NJ Pass-Through Law

New Jersey’s Elective Pass-Through Business Alternative Income Tax Effective January 1, 2020

On Jan. 13, 2020, New Jersey Governor Murphy signed the Pass-Through Business Alternative Income Tax ("NJ PBAIT") Act into law. This act allows pass-through businesses to elect to pay income taxes at the entity level, while owners of the electing pass-through businesses receive New Jersey income tax credits. This helps individual pass-through business owners mitigate the negative impact of the federal SALT deduction cap. It is estimated to save New Jersey business owners $200 to $400 million annually.

The NJ PBAIT Act establishes an elective entity-level tax on pass-through entities (“PTE’s”) in lieu of taxing the PTE’s owners. PTE’s are partnerships, S corporations, and limited liability companies taxed as partnerships or S corporations. A single member limited liability company, treated as a disregarded entity for federal income tax, is not eligible to make the new election.

Shareholders, members, and partners of an electing PTE, receive a New Jersey tax credit to be used to offset the gross income or corporation business tax resulting from the flow-through of New Jersey-source income from the PTE.

Individual shareholders, members, and partners of an electing PTE can avoid (for now) the $10,000 federal income tax limitation on deductions for state taxes paid relating to the PTE’s New Jersey sourced income. There is no limit on the deduction of state taxes paid at the PTE level under the federal Tax Cuts and Jobs Act (TCJA).

All previous rules for computing a PTE’s taxable gross income remain the same; however for purposes of determining taxable income, a 3-factor apportionment formula applies with receipts from services sourced based on where the service is performed. According to current guidance, this is the apportionment methodology which applies to S corporations as well.

The new PTE law is elective, with the election due on or before the due date (excluding extensions) of the PTE’s return. The return is due on or before the 15th day of the third month following the close of the pass-through entity’s tax year. Estimated payments will be due on or before the 15th day of each of the: (1) fourth month; (2) sixth month, and (3) ninth month of the taxable year; and, on or before the 15th day of the first month following the end of its tax year. The new law also permits an owner or group of related owners to file a composite or consolidated PTE return on behalf of a group of commonly-controlled PTE’s. Common control is based on 50% of the direct and indirect voting control of each PTE determined under Internal Revenue Code section 318.

The new PTE tax will be based on New Jersey-source income allocated to resident and non-resident shareholders, partners, and members. Taxable income is referred to as “distributive proceeds.” The applicable tax rates are based on the distributive proceeds of a pass-through entity as follows:

• Distributive Proceeds up to $250,000 – 5.675%;
• Distributive Proceeds of $250,001 - $1 million - $14,187.50 plus 6.52% of the excess over $250,000.00;
• Distributive Proceeds of $1,000,001 - $5 million - $63,087.50 plus 9.12% of the excess over $1 million;
• Distributive Proceeds over $5 million - $427,887.50 plus 10.9% of the excess over $5 million.

The new law also provides that the New Jersey resident credit for tax paid to another state includes similar taxes imposed by other states, where PTE’s are paying the tax on state-source income allocated to their owners or members.

Given that the new legislation is aimed at providing relief to individual New Jersey taxpayers who have been negatively affected by the limitation on deductions for state and local taxes paid for federal income tax purposes, there is a risk the Internal Revenue Service can challenge the deductions taken at the PTE level, thereby negating any potential benefit of the PTE election.

If you have any questions please contact Jaime Reichardt (215-545-4800 ext 4520) or one of our SALT team professionals.