We recently distributed a newsletter providing a summary of the newly enacted New York Pass-through Entity (PTE) tax. This letter is intended to reiterate that our neighboring state, New Jersey, has also enacted a PTE tax regime similar to the one in New York.
On January 13, 2020, New Jersey Governor Phil Murphy signed the NJ SB3246 “Pass-Through Business Alternative Income Tax Act” into law. This is an entity-level tax to work around the $10,000 cap on State and Local tax as a part of individuals’ itemized deductions. In November 2020, the Internal Revenue Service agreed with the States’ PTE tax regimes in Notice 2020-75 that PTE taxes are fully deductible as a business expense at entity level and are not subject to any limitation at the owners level.
The following summarizes key information regarding New Jersey’s Pass-Through Business Alternative Income Tax (“BAIT”).
Taxable years beginning on or after January 1, 2020
Who is Eligible:
Any partnerships, federal S corporations that have made the New Jersey S corporation election, or Limited Liability Companies that are classified as partnerships or S corporations for the purpose of federal income tax law, with at least one partner, shareholder, or member who is liable for tax on distributive proceeds pursuant to the “New Jersey Gross Income Tax Act,” N.J.S.54A:1-1 et. seq., in a taxable year (cumulatively “Pass-through Entity”). Single-member LLCs and sole proprietorships may not elect to pay NJ BAIT.
Each eligible pass-through entity can decide whether or not to make an election annually. The election can be revoked prior to the due date of the entity’s tax return. The election cannot be retroactive, and an election will not be needed in a year that the entity reports a net loss. The annual electronic election must be made prior to the original due date of the NJ BAIT annual return (PTE-100) . The election is available if consent is received from each partner, shareholder, or member of the electing pass-through entity who had ownership at the time the election was filed; or by any officer, manager, partner, shareholder, or other authorized personnel of the electing pass-through entity.
The tax is based on the sum of distributive proceeds of each partner, shareholder, or member, such as net income, dividends, royalties, interest, rents, guaranteed payments, and gains of an electing pass-through entity, derived from or connected with sources within New Jersey and upon which tax is imposed.
|Sum of each member’s share of distributive proceeds from PTE:||The BAIT is the following:|
|$250,000 or less||5.675%|
|$250,001 – $1,000,000||$14,187.50 plus 6.52% of excess over $250,000|
|$1,000,001 – $5,000,000||$63,087.50 plus 9.12% of excess over $1M|
|More than $5,000,000||$427,887.50 plus 10.9% of excess over $5M|
A direct partner, shareholder, or member of an elected pass-through entity is allowed to take their direct share of refundable credit against gross income tax liability for the taxable year. In addition, New Jersey resident taxpayers are allowed a credit against their New Jersey income tax due if a substantially similar tax to NJ BAIT was paid by a pass-through entity, to other states, to the extent of what would have been allowed if the income was taxed at the individual level and not taxed at the entity level. This credit is allowed regardless of whether or not the election is made for New Jersey purposes.
When an electing pass-through entity owned by both corporate and non-corporate partners, the corporate partners will be able to take the credit toward NJ surtax and corporate tax liability. Though it cannot reduce the corporate partners’ liability below the minimum tax. Any remaining credits can be carried forward for 20 years.
Estimated Tax Payments:
The four equal estimated tax payments must be made electronically (by e-check, electronic funds transfer (EFT), or credit card) on or before April 15, June 15, September 15, and January 15 (of the following tax year). Failure to make estimated payments or underpaying any installment, will result in the imposition of interest. The electing pass-through entity must remit estimated taxes of at least 80% of the total tax liability for the current year or 100% of the total tax liability reported on the prior year’s tax return to avoid interest.
Annual PTE Tax Return:
The NJ BAIT annual return is due on or before the 15th day of the third month following closing of the electing pass-through entity’s tax year (the due date is March 15 for calendar year taxpayer’s). Each electing pass-through entity must submit form PTE-100, a PTE-K1 for every owner and form NJ-NR-A (if the pass-through entity is conducting business both inside and outside NJ). An extension of time to file may also be requested by submitting form PTE-200-T and by paying at least 80% of the total tax for the taxable year by the original due date of the annual return. Penalties and Interest will be imposed for late filing or payment.
How Does the NJ BAIT work?
To explain how NJ BAIT works, we will give you an example:
Two NJ residents own an eligible partnership. Each has 50% ownership interest and the partnership earns taxable income of $800,000 of which $400,000 was sourced in New Jersey. Therefore, each partner would have distributive proceeds of $200,000. We are also assuming a 35% Federal income tax rate and a 6% New Jersey income tax rate. For simplicity, assume that each partner has a $10,000 state and local tax deduction which is derived from property taxes paid.
Calculation of NJ BAIT for $400K distributive proceeds by the partnership using the following tax bracket:
|Sum of each member’s share of distributive proceeds from PTE:||The NJ BAIT is the following:|
|$250,001 – $1,000,000||
$14,187.50 plus 6.52% of excess over $250,000
NJ BAIT: $14,187.50 + ($150,000 X 6.52%) = $23,967.50 (Round to $24K for simplicity)
The following summarizes comparison of a partner’s tax liabilities and credits:
|Without NJ BAIT||With NJ BAIT|
|Taxable Earnings||$400,000 (50% of $800K)||$388,000 (50% of $800K less $24K of NJ BAIT deducted at entity level)|
|Federal Income Tax||$140,000 ($400K x 35%)||$135,800 ($388K x 40%)|
|NJ Income Tax||$24,000 ($400K x 6%)||$24,000 ($400K x 6%) The NJ BAIT tax deducted at entity level would be added back to taxable earnings for the calculation of NJ income tax.|
|Total Tax Liabilities||$164,000||$159,800|
|BAIT Credit on NJ Tax Return||$0||$12,000 (50% of $24K NJ BAIT paid by PTE)|
|Payment Due by the Partner||$164,000||$147,800|
Based on the simplified calculation above, there is a potential Federal income tax savings of $4,200 by a partner (or $8,400 for both partners if both partners are in the same Federal income tax bracket).
Please note that the partner’s NJ income tax liability is $24K while the NJ BAIT credit will be $12K. Therefore, the resident partner will still have to make estimated tax payments for the remaining $12K at partner’s level.
Additional Information That May Help Decision Making:
- If you own a single member LLC or sole proprietorship, you are not eligible for the NJ BAIT. However, you can do tax planning to change your business to be taxed as a partnership or elect to be taxed as an S corporation so that your business may be qualified for the NJ BAIT.
- It is very possible that in the near future there will be fundamental tax law changes including the repeal of the SALT Cap and/or a cap on itemized deductions for individuals earning more than $400,000 annually; both need to be monitored for future development.
- Regardless of pass-through entity’s participation in the BAIT, pass-through entities are still responsible to remit withholding tax on the non-resident owners’ NJ income. Also, the BAIT tax rates are higher than NJ individual income tax rates. Therefore, participating in NJ BAIT could result in a significant overpayment on non-resident owners and there could be a strain on the cash flow by the pass-through entity.
As always, our goal is to assist you in any way we can. Please contact us if you have any questions or want to consider making the required election.
Sincerely, The Partners and Staff at LHF