Senate Bill S2265 – What’s In It for You?
The New Jersey legislature has been listening to the concerns of entrepreneurs, business owners, and investors. Some of these concerns include how best to spur investment in New Jersey businesses as well as attract and retain businesses in New Jersey, and the high income taxes that are imposed on New Jersey residents. To this end, the NJ Senate has introduced bill S2265 which, if passed, should provide incentives for investing in New Jersey businesses by providing tax breaks on the realized gains from those investments.
New Jersey Senate bill S2265 would allow taxpayers to deduct the gain on the sale or exchange of New Jersey qualified small business stock that has been held for more than five years from their New Jersey gross income. In simple terms, you would not pay New Jersey income tax on these qualifying gains.
This bill was introduced in March of 2018 and passed its first hurdle by making it out of the Senate Appropriations Committee in late September. It is now with the Assembly (identical bill A4393 is currently in review by the Assembly Appropriations Committee). This bill has strong bipartisan support and it is expected to be approved. If approved, then it’s off to the Governor for his signature. The bill is currently written so that it would take effect immediately upon Governor Murphy’s signing.
Assuming passage (think positive thoughts!), how do you reach the promised land of not paying New Jersey income tax on the realized gains from these types of investments? As always, the devil is in the details.
A “qualified small business” is any domestic corporation which is a C Corporation. The aggregate gross assets of the corporation cannot exceed $50,000,000 either prior or subsequent to passage of this legislation. The corporation must have fewer than 225 employees, with at least 80% of the corporation’s payroll attributable to employment within New Jersey. Corporations which are members of a controlled group are treated as one corporation when determining the above thresholds. As is the case with all tax legislation, additional guidance and rules apply when determining eligibility; this summation is to provide you with a fundamental understanding.
“Qualified small business stock” means any stock in a C corporation that is a qualified small business per the above definition. This stock must be issued after the effective date of the passage of this legislation. The stock can be acquired in exchange for money, property (other than stock), or as compensation for services provided to the corporation. In addition, the corporation must meet the “active business requirements.” Active business requirements are met if at least 80% of the corporate assets are used in a qualifying trade or business. Startup activities and activities resulting in research and development expenditures are qualifying activities. Businesses involving professional services (health, law, accounting, engineering, performing arts, etc.), hotels, restaurants, farming and several others are NOT qualifying activities. Another caveat: Stock that would otherwise qualify as small business stock will NOT be treated as such if at any time during the period of two years prior to or two years after the issuance date the corporation purchased back its stock from you or a related party. This has to be a “new” investment. Again, I must caution that additional rules will apply.
Stock in corporations that qualify as “specialized small business investment companies” ARE eligible. Specialized small business investment companies are created for the sole purpose of investing in and providing financial services to businesses owned by socially or economically disadvantaged persons.
If you have ownership in a pass-through entity, such as an S corporation, partnership or LLC, and the pass-through entity has gains on the sale of these qualifying investments held for more than five years, your proportionate share of these gains will not be subject to tax, just as if you had purchased the investment directly.
There are limits imposed on the maximum gain that can be excluded. In general, the eligible gain on disposition in any tax year on one or more qualifying stocks cannot exceed $10,000,000 reduced by the total eligible gains that have been taken by the taxpayer in previous years.
This proposal is modeled on the Internal Revenue Code which has a similar provision for Qualified Small Business Stock under section 1202.