Reducing Your New Jersey Tax Liability with BAITAnchin AlertDecember 9, 2020
The $10,000 federal limitation on the deductibility of state and local taxes, known as the State and Local Tax (SALT) deduction, continues to be a major concern for many taxpayers, particularly those in high-tax jurisdictions. To circumvent this cap, several states have introduced entity-level taxes on pass-through entities (PTEs), which ostensibly treat the entity tax as a deduction by the trade or business rather than an itemized deduction at the individual partner level, which would be subject to the SALT limitation. Individual partners, in turn, receive a credit for the entity-level taxes paid. Questions loomed regarding whether the Internal Revenue Service would respect such deductions until it released Notice 2020-75 in November, indicating that the deductions of these tax payments are in fact permitted.
New Jersey joined the SALT workaround bandwagon this year by establishing its Business Alternative Income Tax (BAIT). Signed into law in January, the BAIT is a new elective business tax regime in which New Jersey PTEs – partnerships, limited liability companies and S corporations – can elect to pay an entity-level tax. In return, a proportionate share of the BAIT paid is credited to the PTE partners’, members’ or shareholders’ Gross Income Tax or Corporation Business Tax liability. Effectively, electing into the BAIT allows the PTE owners to reduce their respective federal income by the full amount of BAIT paid by the PTE because such amount is deducted from the owners’ taxable distributive share from the PTE. This provides the same result as what was previously a full deduction against federal income tax for the SALT paid on the PTE income passed through to the owner.
New Jersey’s law works by imposing an alternative income tax, at graduated rates, on a PTE owner’s “distributive proceeds.” Distributive proceeds do not refer to cash distributions, but rather is defined by statute to include net income, interest, dividends, rent, royalties, guaranteed payments and other gains derived from sources within New Jersey. For the 2020 tax year, the four tiers of income tax rates are as follows:
- 5.675% for distributive proceeds under $250,000;
- $14,187.50, plus 6.52% for distributive proceeds between $250,000 and $1,000,000;
- $63,087.50, plus 9.12% for distributive proceeds between $1,000,000 and $5,000,000; and
- $427,887.50, plus 10.9% for distributive proceeds over $5,000,000.
To elect the BAIT, each member of a PTE must consent to an annual election due on or before the original due date, without extensions, of the PTE’s New Jersey return (e.g., March 15th for calendar year filers). Alternatively, the election can be made by an officer, manager or member who is authorized to make the election on behalf of the PTE. Note, however, that the election cannot be made retroactively.
For New Jersey residents, electing the BAIT can be an especially viable workaround to the SALT limitation. Residents are allowed a refundable credit against their New Jersey income tax equal to 100% of their pro rata share of the BAIT paid. The BAIT credit is applied against the taxpayer’s state tax liability after all other credits available to the member have been applied.
Despite the benefit of New Jersey’s BAIT, PTE owners are cautioned that there are open questions and potential pitfalls in deciding to elect into the tax. First, New Jersey’s law does not change the existing non-resident withholding requirements for those PTEs that elect to pay the BAIT. Accordingly, duplicative payment requirements may be created if individual non-resident taxpayers are subject to both regimes. A second and highly impactful issue is whether a state, such as New York, will permit its resident partners a credit for BAIT paid to New Jersey by the PTE. Typically, states grant residents a credit for personal income taxes paid to other jurisdictions, but they may not necessarily allow a credit for an entity-level tax even if paid on the resident taxpayer’s behalf. Finally, further consideration is needed for fiscal year PTE filers, as their individual members generally file on a calendar-year basis. This can create timing difficulties in claiming individual income tax credits for the BAIT paid at the PTE level.
As is the case with many tax decisions, careful planning is needed to determine whether New Jersey’s BAIT is the right choice for you. If you have questions with regard to electing into the BAIT, please contact Alan Goldenberg, Leader of Anchin’s State and Local (SALT) group, at firstname.lastname@example.org or your Anchin Relationship Partner.