New Jersey enacts elective pass-through entity tax as workaround to federal SALT cap
A recently signed New Jersey law gives businesses an election to pay an entity-level tax on income rather than have each partner, member, or shareholder of the business pay their tax individually. The elective entity-level tax is intended to be a workaround to the $10,000 cap on state and local tax deductions for federal income tax purposes as enacted in 2018. This New Jersey legislation is similar to those passed in other states, including Connecticut, Louisiana, Oklahoma, Rhode Island, and Wisconsin, in order to provide relief to taxpayers affected by the cap on state income tax deductions. It also provides an offsetting refundable income tax credit for members who earn income from a pass-through entity.
What to know about the election
The Pass-Through Business Alternative Income Tax Act (the Act), effective for tax years beginning on or after Jan. 1, 2020, allows New Jersey pass-through entities (partnerships, LLCs with at least two members, and S corporations) with at least one member or shareholder who is liable for the New Jersey gross income tax to make an election to pay income taxes at the entity level. The election is only available if each member or shareholder consents. It must be made annually on or before the due date of the entity’s return and on forms prescribed by the New Jersey Division of Taxation.
Pursuant to the Act, taxpayers who earn income from pass-through entities and pay the elective entity-level tax receive a refundable income tax credit. Under the 2017 Tax Cuts and Jobs Act (TCJA), there is no limitation on deductions for state taxes paid at the entity level.
For business entities that choose to pay this entity-level tax, the tax imposed is equal to each member’s distributive share of proceeds attributable to the pass-through entity multiplied by four tax brackets. The four tiers of income tax rates assessed on a partner or member’s distributive proceeds are:
- 5.675% for the first $250,000 of distributive income;
- 6.52% for distributive income between $250,000 and $1 million;
- 9.12% for distributive income between $1 million and $5 million; and
- 10.9% for distributive income exceeding $5 million.
Partners and S corporation shareholders may be able to claim a refundable credit on their personal New Jersey income tax return for their share of the tax paid by the entity.
Corporate partners are also permitted to claim a tax credit against their New Jersey Corporation Business Tax (“CBT”) for taxes paid on their behalf by the pass-through entity. They cannot take so much credit so as to be below the state’s minimum tax, but any excess credits can be carried forward for 20 years.
What does CohnReznick think?
Because the election is made at the entity level and requires consent of all partners, members, or shareholders, taxpayers should discuss the potential outcomes of making this election with their tax advisor, including both benefits and any federal IRS risks, while being mindful of the due date for making the election.
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
InsightMassachusetts issues proposed regulations for the Angel Investor Tax CreditKevin MichaelanRead what counts as a qualifying investor, investment, and business for the life sciences investment program, and prepare to apply quickly.
InsightTreatment of carried interest: Treasury and IRS release long-awaited proposed regulationsJonathan R. Collett, Robert RichardtRead the latest guidance on Section 1061 and what types of assets and entities are subject to it, as well as what fund managers should do now.
InsightTreasury releases temporary regulations regarding waiving NOL carrybacks for certain consolidated groupsChris Wray, Cheryl JosephRead how consolidated groups can handle consolidated net operating losses (CNOLs) under the CARES Act with two additional split-waiver elections.
InsightCalifornia approves budget changes including NOL suspension, tax credit limitationsKrista Schipp, John OnCalifornia is suspending net operating losses (NOLs), limiting certain tax credits to $5 million, and taking other steps to help offset the impact of COVID-19.
InsightNew IRS guidance on CARES Act waiver of 2020 required minimum distributions includes rollover deadline extensionDana FriedNotice 2020-51 also has a sample plan amendment for letting certain retirement plan participants choose whether to receive a 2020 required minimum distribution.
InsightIRS issues proposed regulations on non-deductibility of certain transportation fringe, transportation, and commuting expenses, including employer-provided employee parkingDana FriedThe IRS has updated guidelines related to “qualified transportation fringe” (QTF) expenses, including employer-provided employee parking expenses. Read more.