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.
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.
Harry Golematis, Director, State and Local Tax Services
973.364.7891
Corey Rosenthal, Practice Leader, State and Local Tax Services
646.625.5729
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