What You Need to Know About New Jersey’s Recent Tax Changes
The New Jersey budget (A.5323) that was signed on July 3, 2023, contains several corporate, pass-through entity and other tax changes as discussed below. The NJ Division of Taxation has already released its preliminary guidance regarding these changes: Changes to Corporation Business Tax, Gross Income Tax, and Other Requirements from P.L. 2023, c.96 (state.nj.us).
Interest Addbacks/Deduction Limitation
For tax years ending on and after July 31, 2023, the addbacks for interest paid to a related party and related-party intangible expenses are repealed. Further, regarding IRC Sec. 163(j), for tax years beginning after December 31, 2017, and ending on and after July 31, 2022, the law codified the currently existing rules.
The interest deduction limitation in subsection (j) of Section 163 of the Internal Revenue 41 Code (26 U.S.C. s.163) shall apply to a combined group as though the combined group filed a federal consolidated return. Affiliates that were members of the federal consolidated return but were not members of the combined group included in the New Jersey combined return, the combined group and the affiliates will also be treated as having filed one federal consolidated return.
Research and Development
For tax years beginning on and after January 1, 2022, a deduction for research and experimental expenditures is allowed during the same tax year for which a New Jersey research and development tax credit is claimed, notwithstanding the timing schedule required by the federal Internal Revenue Code of 1986, 26 U.S.C. s.174, for the deduction of specified research and experimental expenditures.
Observation: The NJ Division of Taxation’s recent interpretive guidance in TB-107 (July 11, 2023) limits the deduction to the “full value of the New Jersey qualified research expenditures.” For taxpayers that claim a New Jersey R&D credit in a tax year, the statute doesn’t appear to limit the deduction to only New Jersey expenditures.
Deferred Tax Deduction
New Jersey deferred tax deduction for tax years beginning or after January 1, 2023, but before January 1, 20301, a combined group that qualifies (see footnote) may deduct 1% of the amount necessary to recover the unfavorable deferred tax impact of New Jersey adopting combined reporting, per year. After 2030, 5% of the remaining balance can be deducted per year until fully utilized.
While not actually part of the legislation, it should be noted that NJ’s 2.5% surcharge was not extended and, thus, expires for years beginning on and after January 1, 2024.
The following corporate tax changes apply to corporations for tax years ending on and after July 31, 2023, unless otherwise indicated.
A corporation that derives in excess of $100,000 of receipts from New Jersey sources or that has 200 or more separate transactions delivered to New Jersey customers is deemed to have income tax nexus. A corporation that meets the new economic nexus test(s) but is otherwise protected from tax pursuant to federal law P.L. 86-272 is subject to New Jersey corporate minimum tax.
Observations: Corporate apportionment/sourcing rules are used to determine New Jersey receipts and transactions. Further, these economic nexus provisions are in addition to any other nexus activities which may be applicable, such as physical presence.
Due Date of New Jersey Corporate Tax Return
For tax years ending on after July 31, 2023, the original due date for a New Jersey corporate tax return is the 15th day of the month following the federal original due date. The extra month to file a New Jersey corporate return also applies to a taxpayer that receives a federal extension.
Dividend Received Exclusion
A 100% exclusion of dividends and deemed dividends is allowed if paid or deemed paid by an 80% or more owned affiliate. Previously, a 95% dividend received exclusion was allowed for taxpayers with 80% or more ownership of the payor/deemed payor.
Observation: There was no change to New Jersey’s 50% dividend received deduction for taxpayers with 50% or more, but less than 80% ownership.
The dividend exclusion is deducted from entire net income after state addition modifications but before state subtraction modifications. The New Jersey dividend and deemed dividend deduction must be reduced by 5% to account for expenses and deductions attributable to those dividends. This doesn’t apply to intercompany dividend (and deemed dividend) transactions between members of the same group filing a New Jersey combined return. IRC Sec. 951A income (“GILTI”) is considered a dividend for purposes of the New Jersey dividend received deduction.
Foreign Non-U.S. Corporations
For a corporation that is incorporated or formed in a foreign nation with a comprehensive tax treaty with the United States that is not a member of a New Jersey worldwide combined group2, entire net income excludes income that is excluded or exempted from federal taxable income pursuant to the treaty.
A non-U.S. corporation that files a federal tax return and is not a member of a New Jersey worldwide combined tax return shall only include its income/loss that is included in federal taxable income, which is limited only to the corporation’s effectively connected income/loss and applicable New Jersey modifications. The corporation’s New Jersey allocation/apportionment factor only includes receipts that are attributable to such items of income or loss reported.
Similarly, a corporation that is not incorporated in the U.S. that is a member of a water’s-edge group or affiliated group for purposes of filing a New Jersey combined return and that files a federal tax return shall only include the member’s effectively connected income/loss and New Jersey modifications. The corporation’s New Jersey allocation/apportionment factor only includes receipts that are attributable to such items of income or loss reported.
New Jersey Net Operating Loss Deduction
The net operating loss conversion carryover (NOLs earned in years ending prior to July 31, 2019, that were converted from pre-allocation to post allocation “PNOLS”) must be subtracted from entire net income allocated/apportioned to New Jersey after the state dividend received deduction.
Observation: Previously, New Jersey NOLs had to be used before the dividend-received deduction that resulted in taxpayers being forced to apply NOLs against income that otherwise could have been offset by the dividend-received deduction. It appears that the same “post-DRD” deduction applies to New Jersey NOLs earned in years ending after July 31, 2019.
New Jersey conforms to the NOL limitation set forth in IRC Sec. 172(a)(2) except that August 1, 2023, is substituted for the January 1, 2018, reference in the IRC and July 31, 2023, is substituted for the December 31, 2017, reference. Further, New Jersey doesn’t conform to the unlimited NOL carryover, which permits NOL’s to be carried forward for no more than 20 years.
Observation: For tax years ending after July 31, 2023, corporate taxpayers can deduct New Jersey NOLs generated in taxable years beginning before August 1, 2023, without limitation. NOLs generated in taxable years beginning after July 31, 2023, are subject to an 80% income limitation, which operates similarly to the federal limitation.
A current year net operating loss that can be carried over includes a taxpayer’s New Jersey dividend- received deduction for that year. A taxpayer and the director may adjust NOLs earned in tax years that are closed to assessment (limited to 10 years after a return was filed) to determine the correct tax liability in an open year.
Captive Investment Companies, Captive Real Estate Trusts and Captive Regulated Investment Companies Are Taxed as Regular C Corporations
The law adds definitions for each of these entities and provides certain exceptions. New Jersey’s favorable investment company and REIT tax provisions in N.J.S.A. Sec. 54:10A-5, including 40% apportionment, no longer apply. Deductions permitted for federal tax purposes solely because of being an investment company are not permitted. The above entities are members of New Jersey combined returns, assuming they meet the ownership and other unitary tests.
Combined Corporate Tax Returns for Tax Years Ending on or After July 31, 2023
A combined group’s entire net income includes a member’s direct and indirect distributive share of a partnership’s unitary business income. In such case, the partnership shall not be liable for withholding on income attributable to that member.
The remaining balance of a prior net operating loss carryover (“PNOLC”) for members of a combined group are pooled together and applied against allocated/apportioned entire net income of either (a) the combined group for which the corporation is a member; or (b) the corporation that created the loss provided the corporation departs the combined group before the corporation’s PNOLC is completely used.
- The law states that the NJ Director of Taxation shall provide regulations on pooling of NOLs and tracing members’ prior NOL conversion carryovers in the event a member departs the group before their prior NOL carryovers are used.
Observation: It’s unclear in the statute if a departing member must take its share of any remaining prior NOLs or if the combined group can choose to keep them. Our initial interpretation is that a departing member must take their remaining PNOLC, if any. Presumably, the regulations will address this.
Previously, NOLs generated prior to a member joining a combined group could only be used by the member or members that generated the loss. For tax years ending after July 31, 2023, such NOLs may be pooled with the combined group’s NOLs, or they can be used by the taxable member that generated the loss but only against “non-unitary” income generated by the member.
Observation: In most cases, it will be preferable to pool the NOLs with the rest of the group rather than limiting them to the member that generated the loss, particularly since that member can only apply those NOLs to non-unitary income.
A provision was added requiring each taxable member of a combined group to track their proportionate share of any combined NOL. Foreign corporations must be included in a New Jersey water’s-edge combined return to the extent of their effectively connected income. A combined group is treated as one taxpayer for purposes of the New Jersey sales factor numerator and denominator.
Observation: Previously, New Jersey followed the Joyce Rule for determining the sales factor numerator in a combined return. Under that rule, receipts of members without New Jersey nexus weren’t included in the sales factor numerator. With this change, New Jersey adopts the Finnigan Rule. Under this rule, New Jersey receipts of all combined group members are included in the receipts factor numerator irrespective of whether a member a New Jersey nexus.
A combined group’s designation as the managerial member is binding for five years. Previously, it was binding for 10 years.
New Jersey Gross Income Tax Change
For tax years ending on and after July 31, 2023, businesses, regardless of form (partnership, S corporation, etc.), that conduct business operations within and without New Jersey and, as a result or for other reasons, cannot determine readily or accurately their income from New Jersey sources must source their income to the state using New Jersey’s corporate apportionment rules (single-factor apportionment and market sourcing for services).
Observation: The requirement to use corporate apportionment rules appears to be triggered by a taxpayer not being able to readily or accurately ascertain their New Jersey source income. While it is unclear how this provision will be interpreted and applied by the NJ Director of Taxation, recent guidance implies that all pass-through entities will now be required to use a single-factor formula and market-based sourcing for services.
1This is for taxpayers whose net deferred tax liability increased or whose net deferred tax asset decreased as a result of New Jersey changing to unitary combined reporting beginning in 2019 and that completed and filed Form DT-1 “Statement of Net Deferred Tax Liability Deduction” with the NJ Division of Taxation on or before July 1, 2020.
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