The Pass-Through Business Alternative Income Tax Act
New Jersey’s newest workaround solution to the federal cap on the State and Local Tax (SALT) deductions.
On January 13, 2020, New Jersey enacted the “Pass-Through Business Alternative Tax Act” joining Connecticut, Louisiana, Oklahoma, Rhode Island and Wisconsin in establishing a new, voluntary tax for pass-through entities. The tax is designed to be a work around to the federal cap on individuals’ itemized deductions for state income taxes or better known as the SALT deductions. Pass-through entities are S Corporations, Partnerships, and LLCs taxed as a partnership.
The new law takes effect for tax years beginning on or after January 1, 2020. In order to qualify for the election to pay the pass-through business alternative income tax, the entity must have at least one member subject to New Jersey gross income tax. The advantage of electing to be subject to the New Jersey alternative pass-through tax is that the entity now receives a Federal deduction, while the business owner still receives a dollar for dollar credit on their New Jersey personal tax return for their share of taxes paid by the entity.
Why did New Jersey create the pass-through tax? The Tax Cuts and Jobs Act limited individuals to a $10,000 SALT deduction on their New Jersey taxes. Business entities are not subject to the $10,000 SALT limitation. The pass-through entity tax takes nondeductible New Jersey individual taxes and turns the payments into deductible business taxes (paid by the pass-through entity) by allowing a tax credit for the New Jersey individual taxes.
How do you elect to pay the tax? Entities can elect the new entity level tax on their New Jersey taxable income. An election is made annually on or before the due date of the entity’s return. Revocation of the election must occur on or before the due date of the return and on forms prescribed by the Division of Taxation. This election may not be made retroactively.
A pass-through entity is required to make estimated entity tax payments on or before the 15th day of each of the fourth, sixth and ninth month of the tax year and on or before the 15th day of the first month succeeding the close of the tax year.
The Alternative Income Tax Rate is based on each member’s share of the entity’s income [distributive proceeds] attributable to the pass-through entity for the tax year, multiplied by:
5.675% for the first $250,000 of distributive income;
6.52% for distributive income between $250,000 and $1 million;
9.12% for distributive income between $1 million and $5 million; and
10.9% for distributive income exceeding $5 million.
Example: John is the sole owner of an S Corporation that operates exclusively in New Jersey. The S Corporation, after expenses, has net income of $100,000 and could elect to pay $5,675 of New Jersey alternative income tax. The S Corporation would list John’s 100% share of the New Jersey pass-through tax paid on his K-1 and John would then report the alternative income tax credit on his New Jersey individual income tax return against his New Jersey personal tax liability. The above rules would apply to S Corporations, partnerships and LLCs with more than one owner taxed as a partnership. The calculation of the New Jersey alternative income tax credit allocation amongst the owners is based on each member’s percentage of income (distributive proceeds) and is also limited by the New Jersey apportionment percentage.
Downsides. The tax returns for the electing entities are due one month before those for the non-electing pass-through entities. Single member LLCs and sole proprietors are not eligible for the credit.
The IRS has not officially ruled on pass-through entity taxes, creating uncertainty as to whether the IRS will challenge the New Jersey SALT limitation work around.
Please contact your Nisivoccia tax professional at (973) 298-8500 to discuss whether electing to pay New Jersey Pass-Through Business Alternative Income Tax makes sense for you.