By: Richard Feldman
On January 13, 2020, Governor Phil Murphy signed into law Senate Bill 3246 (S. 3246 or bill) establishing the “business alternative income tax” (BAIT), an elective New Jersey business tax regime for pass-through entities (PTEs). The BAIT program is intended to give New Jersey individual income taxpayers a work-around of the $10,000 annual limitation on the deductibility of state taxes imposed by the federal Tax Cuts and Jobs Act (TCJA) (commonly referred to as the SALT deduction cap).
Essentially, a pass-through entity with at least one member who is liable for New Jersey gross income tax (GIT) may elect to be liable for, and pay, a pass-through business alternative income tax in the tax year. The election must be made each year by all owners of the pass-through entity or by an officer or member who is designated under the law or the entity’s organizational documents with the authority to make the election for all members. In other words if your client has a LLC with an operating agreement that allows a representative to make tax elections on behalf of the members then only the representative would need to sign the election for BAIT, if this language does not exist in the operating agreement then each of the members of the LLC would need to sign this election.
This program would also potentially apply to Schedule C and Schedule E filer so long as it is beneficial and makes business sense to reorganize as a partnership, S-Corp, or other pass-through entity. This would not apply to a single member LLC which would not be able to participate in the NJ BAIT program.
This election 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 (DOT). This election may not be made retroactively.
If the members decide to revoke an election, that revocation must occur on or before the due date of the entity’s return.
Under the new legislation, the tax imposed on a pass-through entity will be equal to each member’s share of distributive proceeds attributable to the pass-through entity for the tax year, multiplied by the applicable tax rates, designed to mirror what the member’s individual tax rate would have been.
Pass-through entities whose members have made the BAIT election must file an entity tax return and make payments on or before the 15th day of the third month following the close of each entity’s taxable year for federal income tax purposes. Because businesses pay estimated taxes during the tax year, ideally, to avoid the underpayment of estimated taxes, the decision of whether to elect into the BAIT should be made early in the tax year.
The BAIT is imposed at the following rates based on the collective sum of all the PTE’s members’ shares of distributive proceeds for the tax year:
|If the sum of each member’s share of distributive proceeds attributable to the pass-through entity is:||The BAIT is:|
||$14,187.50 + 6.52% over $250,000|
||$63,087.50 + 9.12% over $1,000,000|
||$427,887.50 + 10.9% over $5,000,000|
Credits – Non-Corporate Members:
Each non-corporate member of the pass-through entity will receive a credit that is equal to the member’s pro rata share of the tax paid by the pass-through entity. If the credit exceeds the amount due, the excess is refundable. Corporate members will be allowed a tax credit against both the corporate business tax and the surtax. However, the credit for corporate members may not reduce the corporate member’s tax liability below the statutory minimum tax. Any excess credit may be carried over for a period of up to 20 privilege periods. A resident taxpayer will be allowed a credit against the gross income tax due for the amount of any tax that the New Jersey DOT determines is substantially similar to this tax by another state of the United States or political subdivision of such state, or by the District of Columbia, with respect to the direct and indirect distributive proceeds from a pass-through entity, which distributive proceeds are also subject to tax. A credit allowed may not exceed what would have been allowed if the income was taxed at the individual level and not taxed at the entity level.
Two states had these pass-through rules in place for 2018 (Connecticut and Wisconsin) and since then three more states have followed suit (Louisiana, Oklahoma and Rhode Island). The IRS has not issued any formal guidance on these workarounds. Even if the IRS did take action through regulation or other guidance to disallow the federal PTE deduction for the NJ BAIT payments the partners / members / shareholders would still be allocated the state tax credit related to their allocable share of the NJ BAIT payment.
The 2020 New Jersey Business Alternative Income Tax may provide members, partners, and shareholders of pass-through entities (PTE’s) a valuable opportunity to lower their tax liability.
Please contact your tax professional at Janover LLC to discuss this program.