After weeks of negotiation and discussion regarding competing tax proposals in Trenton, a deal has been struck on the state budget and tax reform by Governor Phil Murphy and legislative leaders. The result is a host of business tax changes enacted as part of Assembly Bills A-3088, A-3438 and A-4202. Here is a summary of some of the major business tax changes set to take effect in New Jersey:
- A-3438 provides for a 90-day tax amnesty period to run through no later than January 15, 2019.
- Under the new amnesty, any taxpayer with liabilities for returns due on or after February 1, 2009, can pay the tax, plus half the interest due as of November 1, 2018 and avoid any penalties with the exception of criminal and civil fraud penalties.
- An eligible taxpayer cannot be notified of or be under criminal action or investigation.
- The new law also imposes a 5 percent non-participation penalty for liabilities eligible for amnesty that are subsequently discovered by the Division of Taxation.
Gross Income Tax
- A-3088 sets a new top income tax bracket in New Jersey of 10.75 percent for income exceeding $5 million.
- The new law also requires employers that are subject to the state’s income tax withholding requirements to withhold 15.6 percent on salaries and wages in excess of $5 million for tax year 2018.
- The bill also eliminates an exclusion from New Jersey source income (for nonresidents) for carried interest/income from providing investment management services and imposes a 17% surtax on such management income for Gross Income Tax and Corporation Business Tax purposes.
- The legislation changes the sourcing rule in the Corporation Business Tax used to apportion income for an S corporation providing investment management services to be based on where the service is performed, as opposed to the location of the customer.
- The carried interest or investment management services surtax and sourcing changes described above do not go into effect until Connecticut, Massachusetts and New York enact similar legislation.
- A-4202 eliminates the tax exemption provided to pass-through entities receiving and selling Grow New Jersey credits.
- A-4202 also decouples the gross income tax from providing any form of the new federal pass-through business income deduction pursuant to Internal Revenue code section 199A.
Corporation Business Tax
- A-4202 imposes a surtax under the Corporation Business Tax at the following rates: for tax years beginning on or after January 1, 2018 through December 31, 2019, 2.5 percent on taxpayers with New Jersey allocated income that exceeds $1 million; for tax years beginning on or after January 1, 2020 through December 31, 2021, 1.5 percent on taxpayers with New Jersey allocated income that exceeds $1 million.
- Although a special dividend tax and surcharge on repatriated income was discussed and part of the original bill, that measure did not make it into the final legislation to be enacted.
- The bill decouples the Corporation Business Tax from any deduction provided under the federal Tax Cuts and Jobs Act for income repatriated to the U.S. under Internal Revenue Code section 965. This change is applicable for tax years beginning on or after January 1, 2017.
- For tax years beginning on or after January 1, 2017, taxpayers seeking an exception to the interest and intangible expense add back rules based on the related payee having a comprehensive income tax treaty with the U.S. will also have to demonstrate that the corresponding income is subject to an effective tax rate in the foreign nation that is within 3 percentage points of the rate of tax applicable in New Jersey.
- The final legislation also clarifies that the pass-through business income deduction will not be available for corporation business tax purposes beginning on or after January 1, 2018.
- For tax years beginning on or after January 1, 2018, the interest deduction limitation of Internal Revenue Code section 163(j) shall be applied on a pro-rata basis to interest paid to related and unrelated parties.
- The dividends-received-deduction (“DRD”) provided in the Corporation Business Tax is modified for tax years beginning after December 31, 2016 by reducing the amount of the exclusion from 100 percent to 95 percent for 80 percent-owned subsidiaries. A 50 percent exclusion would still be available for dividends received from companies which are 50 percent or more owned by the taxpayer.
- Dividend income that is included in entire net income under the new DRD regime in tax years beginning on or after January 1, 2017 through December 31, 2017 should be apportioned using a 3-year average allocation factor for the taxpayer (2015-17 tax years) or 3.5 percent—whichever is lower. Dividend income for periods beginning on or after January 1, 2018 shall be apportioned under regular Corporation Business Tax sourcing rules if included in entire net income.
- If dividend income of the taxpayer is included in the subsidiary/payor’s income, the amount included in taxpayer’s entire net income should exclude those dividends to the extent of the subsidiary’s allocation (or apportionment) factor.
- For periods beginning on or after January 1, 2017, a Net Operating Loss (“NOL”) includes the dividend exclusion. The bill also provides the same treatment for a net operating loss carryforward. Accordingly, taxpayer will not have to compute NOLs without taking into account the DRD.
- The legislation adopts mandatory unitary combined reporting for the Corporation Business Tax effective for periods beginning on or after January 1, 2019. A combined group is a group of companies with common ownership (50 percent using Internal Revenue Code section 318 rules) that are engaged in a unitary business where one company is subject to tax in New Jersey.
- A “unitary business” is defined as a single economic enterprise that is made up of separate parts of a company or several companies under common control that are sufficiently interdependent, integrated and interrelated through their activities so as to provide a synergy and mutual benefit that produces a sharing or exchange of value among the companies or divisions of the economic enterprise.
- A combined group shall include income of all members and if not incorporated in the U.S., income should be computed using a profit/loss statement adjusted for U.S. accounting principles and currencies. In addition, intercompany dividends shall be excluded from entire net income of the combined group.
- The managerial member of a combined group can elect to report income on a world-wide basis or affiliated group basis; otherwise, the default will be a water’s edge election which would include any domestic entity unless 80 percent of its property and payroll are based outside the U.S., foreign entities if 20 percent of their property and payroll is based in the U.S., or any member of a combined group that earns more than 20 percent of its income directly or indirectly from intangible property or related service activities that are deductible against the income of the other members of the group.
- The election for reporting lasts for 5 years with the ability to ask permission of the Division of Taxation to deviate from the election.
- Under combined reporting, intercompany transactions should be deferred in the same way as provided under federal income tax principals with recognition of the income restored when: the object of the transaction is resold to a third party; resold to an entity that is part of the group for use outside the unitary business; used outside the unitary group; or the buyer and seller are no longer in the same combined group.
- Under the new law, a converted prior NOL can only be used by the entity which generated it.
- If a member of a combined group has an NOL from another prior combined group that is from the same tax year as when the new regime went into effect, the NOL can be used to offset other group member’s income. For NOLs generated when a member was not part of the combined group, only it or members of its previous group can use the NOL.
- There are no similar limitations on the use of tax credits within the combined group.
- Alternative Minimum Assessment (“AMA”) credits of a member can be used to reduce the net deferred tax liability of the group, which means the net increase, if any, in deferred tax liabilities minus the net increase, if any, in deferred tax assets of the combined group, as computed in accordance with generally accepted accounting principles, that is the result of the transition from filing separate returns to filing a mandatory unitary combined return. The remaining balance of AMA credits can offset up to 50 percent of the tax owed by the combined group, with any remainder available for carryforward until fully utilized.
- An expense attributable to income of another member which cannot be constitutionally taxed is disallowed as a deduction to the payor.
- It appears as though the Joyce approach is incorporated for determining the sales factor numerator, which provides that receipts of members that are subject to the Corporation Business Tax are included in the numerator, but not receipts of non-taxable members.
- If a partnership is doing business in New Jersey and is unitary with a member of a combined group, the partnership brings the entire group into New Jersey for purposes of being subject to the Corporation Business Tax and income from the partnership is apportioned using the flow-through method of apportionment.
- The legislation also provides a unique deduction to help publicly-traded companies deal with the financial statement and reporting impacts of combined reporting. If the changes from combined reporting and the new legislation result in a reduction to deferred tax assets or an increase to deferred tax liability, there shall be a deduction available to the taxpayer beginning in January 1 of the fifth year after enactment (combined reporting is set to take effect in 2019). The deduction is available for 10 years (1/10th each year) and equals the amount of the reduction to deferred tax assets or increase to deferred tax liability, divided by the applicable Corporation Business Tax rate (usually 9 percent), and finally, divided by the allocation factor of the unitary group.
- The shift to combined reporting also entails a process for dealing with prior year NOLs. Prior year NOL carryforwards will be converted to current year post-apportionment NOLs by multiplying them against the base year (prior year) allocation factor. A converted NOL cannot be carried forward for additional periods beyond the original 20 years. The converted NOLs are taken as a deduction against allocated net income prior to NOLs computed under the new combined reporting and post-apportionment regime.
- NOLs computed under the combined reporting regime will be calculated on a post-apportionment basis.
- The Corporation Business Tax’s prior rules regarding NOL carryforwards surviving mergers and acquisitions and only being available to the entity which sustained the loss shall not be applicable for NOLs computed under the new combined reporting regime.
- The privilege period for the combined group shall be the same as that for the federal consolidated period if two members use the same tax year in a consolidated return, otherwise the applicable privilege period for the group should be that of the managerial member.
- S Corporations can elect out of the combined group.
- In the insurance context, the combined reporting rules only apply to combinable captive insurance companies. Other insurance companies would not be subject to these requirements and would pay the Insurance Premiums Tax.
- The bill also links the research and development (“R&D”) credit in the Corporation Business Tax to current Internal Revenue Code definitions and not those of 1992. In addition, the new law clarifies that R&D credits cannot be refundable and that no provision of the Internal Revenue Code eliminating the credit shall apply for purposes of the Corporation Business Tax.
- The law also adopts market sourcing for services for periods beginning on or after January 1, 2019. Services shall be sourced to the location where the benefit of the service is received. If the benefit is received in more than one state, reasonable approximation may be used. For individuals, the default sourcing rule is the billing address; for others it could be the location from where the order is placed or the billing address.
- The legislation also clarifies the sourcing rule for services of registered securities or commodities brokers and dealers, in addition to the services of asset managers, to be sourced based on the location of the customer.
- Finally, the legislation also provides various hold-harmless provisions to account for these major tax changes. The law provides that there shall be no penalties on underpayments from the changes coming from tax years beginning on or after January 1, 2017. However, the additional payments must be made by either the second next estimated payment subsequent to the enactment of the new law, by December 31, 2018 for tax years beginning on or after January 1, 2017, or by the first estimated payment due after January 1, 2019 for tax years beginning on or after January 1, 2018.
- There should also be no underpayment penalties from the first year of the switch to combined reporting and any overpayment by a member of the combined group from the prior tax year will be credited as an overpayment of the tax owed by the combined group or toward future estimated payments of the group.
- Following the U.S. Supreme Court’s recent holding in Wayfair v. South Dakota, the legislature was quick to enact its own remote seller sales tax nexus law.
- A-4261 establishes a bright-line for sales tax nexus of: $100,000 in taxable sales or 200 or more separate transactions.
- The law also imposes sales tax collection and reporting requirements on a “marketplace facilitator,” which is defined to mean any person or business who provides a forum to a retailer to advertise, promote and list the retailer’s products and who also collects receipts from the customer and remits payment to the retailer.
- The sales tax nexus legislation is effective beginning on October 1, 2018.
- Governor Murphy is expected to sign this legislation as part of the state’s budget and tax overhaul.
We will continue to keep you updated if there are any further tax changes on the horizon. The concepts involved in these changes are complex and will surely result in additional controversies and ultimately litigation. It is important for you to be aware of these changes and the different legal issues and interpretations that are implicated.