NJ Adopts Market Sourcing for Corporate Service Providers

October 28, 2019

By William Gentilesco and Jeanne-Marie Waldman

For tax reporting purposes, law firms doing business in New Jersey have traditionally sourced their service revenue to the state according to where the firm’s professionals actually performed the services. This straightforward approach to revenue sourcing for New Jersey required only that the professionals record their time according to where they actually did the client work.

The New Rules

For tax years beginning on or after January 1, 2019, New Jersey changed the sourcing rules for services performed by corporate taxpayers. Thus, firms organized as corporations must now source their revenue from services to New Jersey using a market-based method. This new market-sourcing approach is client focused and can result in a shifting of a portion of the tax burden from in-state to out-of-state service providers.

Determining where the purchaser receives the benefit is not always as straightforward as it may seem. The NJ statute specifies certain default rules that taxpayers can use absent clear evidence as to where the recipient receives the benefit. Firms may presume that individual clients receive the benefit at their billing addresses. For non-individual clients, if the location where a client receives the benefit of a service cannot be reasonably determined, then a taxpayer can source that revenue to the location from which the client orders that service “in the customer’s regular course of operations.” If that information is unavailable, the statute permits using the client’s billing address.

If the benefit of a service is received both inside and outside of New Jersey, then the resulting revenue should be sourced to New Jersey in proportion to the relative value derived in the state. The statute does not define certain critical terms, and taxpayers could benefit from forthcoming clarifying regulations.

Which Law Firms Will Be Impacted?

The change only affects firms organized as C corporations and S corporations. Partnerships will continue to source service revenue to New Jersey to the extent the service was performed in the state.

It is worth noting that for resident shareholders of S corporations, the new rule will not change their New Jersey tax liabilities. As Garden State residents, they will continue to pay tax on 100% of their earnings and be eligible for a credit based on taxes on pass-through service income paid to other jurisdictions.

Depending upon several other factors—the most important of which are the firm’s location, tax classification and client composition—starting in 2019, firms taxed as C corporations and nonresident S corporate owners may see a reduction in their NJ tax liabilities.

Preparing for the 2019 Filing Season

To help prepare for the 2019 reporting season, administrators should categorize and track the revenue from each invoice to facilitate retrieval in time for tax reporting. Further, professional services firms with out-of-state clients should confirm that their tax advisors are projecting their 2019 New Jersey taxable income using the proper revenue-sourcing method.

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About William Gentilesco

William Gentilesco is a State and Local Tax Group Director focusing on state and local income taxation and sales and use tax consulting.

About Jeanne-Marie Waldman

Jeanne-Marie Waldman is a Senior Tax Manager with nearly 20 years of experience focusing on partnership and corporate taxation as well as state and local income tax compliance and consulting.

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