New Jersey Taxes — They Are a-Changing…
By Jaime Reichardt, J.D., LLM - Tax, Sills Cummis & Gross P.C. –
July 25, 2018
After weeks of negotiation and discussion regarding competing tax proposals in Trenton, a budget deal with significant tax reforms was struck 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. Below is a summary of some of the major business tax changes set to take effect in New Jersey broken down by category:
- A-3438 provides for a 90-day tax amnesty period to run through no later than Jan. 15, 2019.
- Under the new amnesty, any taxpayer with liabilities for returns due on or after Feb. 1, 2009, can pay the tax, plus half the interest due as of Nov. 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-percent 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 (CBT)
- A-4202 imposes a surtax under the CBT at the following rates: for tax years beginning on or after Jan.y 1, 2018, through Dec. 31, 2019, 2.5 percent on taxpayers with New Jersey allocated income that exceeds $1 million; for tax years beginning on or after Jan. 1, 2020, through Dec. 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 legislation adopts mandatory unitary combined reporting for the corporation business tax effective for periods beginning on or after Jan. 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.
- 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 five years with the ability to ask permission of the Division of Taxation to deviate from the election.
- The Joyce approach is incorporated for determining the sales factor numerator, which provides that receipts of members that are subject to the CBT 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 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 Jan. 1 of the fifth year after enactment (combined reporting is set to take effect in 2019). The deduction is available for 10 years (1/10 each year) and equals the amount of the reduction to deferred tax assets or increase to deferred tax liability, divided by the applicable CBT (usually 9 percent) and, finally, divided by the allocation factor of the unitary group.
- The legislation also provides for a host of transition issues in the adoption of combined reporting, including the utilization of net operating losses and tax credits by members of the combined group.
- The law adopts market sourcing for services for periods beginning on or after Jan. 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.
- The bill decouples the CBT 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 Jan. 1, 2017.
- For tax years beginning on or after Jan. 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 CBT purposes beginning on or after Jan. 1, 2018.
- For tax years beginning on or after Jan. 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 CBT is modified for tax years beginning after Dec. 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 Jan.y 1, 2017, through Dec. 31, 2017, should be apportioned using a three-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 Jan. 1, 2018, shall be apportioned under regular CBT 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 Jan. 1, 2017, a net operating loss (“NOL”) includes the dividend exclusion. The bill also provides the same treatment for an NOL carryforward. Accordingly, taxpayer will not have to compute NOLs without taking into account the DRD.
- The law also incorporates a mechanism for dealing with NOLs generated prior to the shift to combined reporting. NOL carryforwards will be converted to current year post-apportionment NOLs by multiplying them against the base year (2018) 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 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 CBT.
- 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 Jan. 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 Dec. 31, 2018, for tax years beginning on or after Jan. 1, 2017, or by the first estimated payment due after Jan. 1, 2019, for tax years beginning on or after Jan. 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 Oct. 1, 2018.
- Governor Murphy is expected to sign this legislation as part of the state’s tax overhaul, though there could be minor changes to the bill’s specific language.
The summary above only covers a portion of the major CBT changes. These reforms are complex and will surely result in uncertainty in tax planning and financial reporting, additional controversies and ultimately litigation. Furthermore, there is already talk of a “clean-up” bill in Trenton to address some of the new law’s ambiguities and confusion pertaining to various effective dates provided for in the legislation.
Jaime S. Reichardt
Jaime Reichardt, J.D., LLM - Tax, is chair of the Sills Cummis & Gross state and local tax practice. He helps companies not only identify potential compliance issues and tax reporting exposures, but also assists with identifying and securing pro-active refunds, tax credits or abatements, and other incentive opportunities. Mr. Reichardt speaks frequently on topics related to state and local income and business activity taxes, nexus, income sourcing, sales tax nexus, product taxability and sourcing, as well as tax credits and incentives developments.
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