On January 13, 2020, Governor Phil Murphy signed NJ SB3246, better known as, the “Pass-Through Business Alternative Income Tax Act” into law. The bill received bi-partisan support and was written in collaboration with the New Jersey Society of Certified Public Accountants.
In essence, this act allows pass-through businesses (PTEs) to pay income taxes at the entity level instead of the personal level. The Act is aimed to help business owners reduce the impact of the SALT deduction cap.
Who are the pass-through businesses?
Over 90 percent of businesses in the United States are pass-through businesses. They include: sub-S corporations, partnerships and limited liability companies. These businesses generate the majority of business income in the US, yet business owners are taxed at the individual level. Tax rates can be substantial, reaching above 40 percent at the federal level and 13.3 percent at the state and local levels.
How the new law affects businesses
New Jersey’s new law offers business owners the choice to pay income tax at the entity level rather than the personal income tax level. Taxpayers who earn income from a pass-through business, will have the option to pay the pass-through business alternative income tax and receive a refundable gross income tax credit on their individual New Jersey returns.
The act will allow business owners to circumvent the individual state income tax deduction limitations put in place with the 2017 Federal Tax Cuts and Jobs Act (TCJA). The TCJA doesn’t restrict deductions on state taxes for entities, but it does for individuals. Pass-through business owners are now limited to $10,000 in state and local income tax deductions, otherwise known as the SALT cap.
The New Jersey Pass-Through Business Alternative Income Tax Act doesn’t negate the deduction restriction but instead offers a provision to reclassify income tax payments as “elective entity-level tax” instead of personal income tax. This lets businesses write off income tax payments because the $10,000 cap doesn’t pertain to business taxes.
Going off of recent IRS statistics, the new law will extend protection to over 260,000 individuals and $23 billion in income in New Jersey. It’s estimated that pass-through businesses may save up to $400 million.
How will this impact state and local governments?
For taxpayers concerned about the impact this act will have on state and local funds, the structure of the act is designed to shield against tax loss. An analysis by the Office of Legislative Services projects that the impact of the legislation will be “revenue neutral,” meaning that the new policy shouldn’t affect the total amount of taxes collected from pass-through businesses and their owners.
The fine print
As discussed above, the option to pay at the entity level is available to partnerships, sub-S corporations, and LLCs with two or more members.
What are the criteria?
- At least one of the partners must be liable for New Jersey Gross Income Tax on their distributive share of such an entity’s income.
- The election is made at the entity level and is only available if each member consents, or if consent is made by any officer, manager or an authorized member of the entity.
- The election is made on or before the due date of the entity’s return
Breaking down the numbers
Effective after January 1, 2020, pass-through businesses may pay an entity-level tax using the following rate schedule, which is based on member shares of the proceeds attributable to the business:
- 675% of the sum of the proceeds not exceeding $250,000
- $14,187.50 plus 6.52% of the sum of the proceeds over $250,000 but not over $1,000,000
- $63,087.50 plus 9.12% of the sum of the proceeds over $1,000,000 but not over $5,000,000
- $427,887.50 plus 10.9% of the sum of the proceeds over $5,000,000
The reaction and what’s next
The New Jersey Society of Certified Public Accountants and the New Jersey Business & Industry Association were among the groups praising the legislation’s approval. “We are grateful to the Governor, the Legislature and all those who supported the bill,” said NJCPA CEO and executive director Ralph Thomas. “Their dedication to assisting small businesses in New Jersey does not go unrecognized.”
Since 2017, numerous high-tax states have been working to pass legislation to soften the impact of the $10,000 cap on state and local tax deductions in the 2017 tax overhaul. New Jersey itself has the highest average property taxes ($8,767) in the country and a rising income tax.
However, the U.S. Treasury Department and the Internal Revenue Service issued guidance in 2019 that prevents state-run charitable funds from being used to circumvent the state and local tax limits. Tax workarounds for businesses have not been barred.
Please contact Bederson with any questions or concerns regarding this new legislation. We are at your service.