Pass-Through Business Alternative Income Tax Act

Introduction

On January 13, 2020, New Jersey Governor Phil Murphy signed into law NJ SB3246, the “Pass-Through Business Alternative Income Tax Act.”  With this legislation, New Jersey joins Connecticut, Louisiana, Oklahoma, Rhode Island and Wisconsin in enacting some type of entity-level tax on pass-through entities (“PTEs”) in an effort to work around the $10,000 federal cap on individuals’ itemized deductions for state income taxes. 

Overview

For tax years starting on or after January 1, 2020, PTEs may elect to pay an entity-level income tax based on the sum of the distributive shares of the partners.  The tax is based on the sum of each partners’ “distributive proceeds” as follows (for purposes of this summary, the term “partner” includes a shareholder in an S corporation):

• First $250,000 – 5.675%
• $250,001 - $1 million – $14,187.50 + 6.52% of the excess over $250,000
• $1,000,001 - $5 million – $63,087.50 + 9.12% of the excess over $1 million
• Over $5 million – $427,887.50 + 10.9% of the excess over $5 million.

The partners can claim a refundable credit for their pro rata share of the tax paid on their personal return. 

The term “distributive proceeds” is defined as the PTE’s various classes of income subject to New Jersey’s Gross Income Tax “derived from or connected with sources within the State, and upon which tax is imposed and due . . . . For a nonresident, this means New Jersey source income . . . .”  Pending further guidance from the Division of Taxation to the contrary, this language may be problematic for New Jersey resident partners as the tax, and corresponding credit, are based on the distributive proceeds derived from New Jersey (presumably the distributive proceeds multiplied by the New Jersey allocation factor), as opposed to the distributive proceeds “taxed” by New Jersey (which for New Jersey resident partners would be the entire distributive proceeds). 

By way of illustration, assume a New Jersey resident is a 50% partner in a partnership which is doing business in New Jersey and which makes this election.  Further assume the sum of the partners’ distributive proceeds are $200,000, and the partnership’s New Jersey allocation percentage is 10%.  The PTE tax related to this entity is $200,000 * 10% * 5.675% = $1,135.  The New Jersey resident will only get a credit of their proportionate share (50%) = $567.50.  However, as a New Jersey resident, they will owe New Jersey income tax on their entire distributive share:  $100,000 * 5.675% (assuming their New Jersey tax rate mirrors the PTE rate) = $5,675.  This results in a net tax due (before credits for taxes paid to other states) of $5,107.50.  Presumably, the credits for taxes paid to other states will at least partially offset this remaining liability. 

The Election

The election is available to partnerships, S corporations, and LLCs with at least two members.  In order to make the election, at least one of the partners must have a liability for New Jersey Gross Income Tax on their distributive share of such entity’s income.  Thus, the election is not currently available for single-member LLCs (unless treated as an S corporation), PTEs with only corporate partners, or entities that do not have income. 

The election is made at the entity level, and is only available if each member of the entity consents, or if consent is made by any officer, manager or member of the entity who is authorized to make such an election.  The election is made on or before the due date of the entity’s return (it is unclear whether this is the extended due date or the original due date), and is made annually. 

Taxpayer Credits

If a PTE makes the election, its partners are allowed a refundable credit against their gross income tax.  The credit is equal to the partner’s pro rata share of the tax paid by the PTE.  The credit is taken after the application of all other credits.  In addition to the credit for taxes paid by the PTE to New Jersey, resident taxpayers are also allowed a credit against their New Jersey tax otherwise due for amounts that are paid by the PTE to other states, and which are determined to be “substantially similar” to the New Jersey PTE tax. (Note: It appears that this credit is allowed regardless of whether or not the election is made for New Jersey purposes.) 

Corporate partners are permitted to take the tax credit against the New Jersey surtax, as well as their corporate business tax liability.  However, the credit cannot reduce the corporate partner’s liability below the minimum tax.  Any excess credits can be carried forward for 20 tax years.  If a corporate partner is tax exempt, their pro rata share of the PTE tax shall be refunded. 

The Return and Payments

The PTE entity tax return is due on or before the 15th day of the third month following the close of the entity’s tax year.  Estimated payments are due on the 15th day of the 4th, 6th, and 9th months of the tax year, and the 1st month of the subsequent tax year. 

Misc.

1. There are special rules applicable when the PTE is a member of a unitary combined group, and PTEs that file composite returns.
2. New Jersey will be working on forms, regulations, etc. in the upcoming months. As such, the above guidance is subject to change.