New Jersey Legislation Implements Major Tax Changes, Including Market-Based Sourcing for Partnerships
New Jersey Gov. Phil Murphy signed into law A5323 on July 3, 2023, which includes wide-ranging provisions that will considerably impact businesses. The legislation includes significant changes to the state’s Business Tax reform that was originally enacted in 2018, which brought about unitary-combined filing and market-based sourcing for corporations beginning in 2019.
One of the most noteworthy changes of A5323 is that partnerships and sole proprietors are required to retroactively use the same apportionment and sourcing rules as corporations. This results in the elimination of a 3-factor apportionment formula, thereby adopting a single sales factor (SSF) formula, in addition to market-based sourcing (MBS) for service providers. As SSF/MBS is effective January 1, 2023, the provision includes estimated tax penalty and interest relief for qualifying taxpayers.
The implementation of MBS may affect pass-through owners who reside in low or no-income tax states. These owners may have used various tax planning strategies to minimize state tax, such as shifting some income into a partnership “management company,” coupled with the state’s cost of performance sourcing, resulting in untaxed state income. Now, such strategies may need to be rethought.
Changes to Corporate Business Tax (CBT)
The preponderance of A5323 includes provisions affecting New Jersey CBT, including these key provisions:
- Nexus Factor-Presence Test: Although New Jersey has historically asserted broad economic nexus rules, the legislation enacts a bright-line economic nexus standard. This new bright-line test adopts a Wayfair nexus rule, subjecting a corporation to tax if it derives receipts in excess of $100,000 or has more than 200 separate transactions.
- New Corporate Business Tax Due Date: Revises the due date of the New Jersey return to the 15th day of the month immediately following the month of the original/extended federal corporate return filing due date.
- Net Operating Losses:
- Net Operating Losses (NOLs) can be adjusted either by the taxpayer or by the Division on assessment as used in tax years that remain open under the statute of limitations, even if the NOLs derived from tax years which the statute of limitations have closed.
- Allows a taxpayer to take a dividends received deduction (DRD) before applying NOL carryovers. New Jersey’s previous NOL ordering rules were unfavorable, as it would result in dividend income absorbing NOL carryover.
- Allows for the sharing of prior net operating loss conversion carryovers or “PNOLs.”
- Under A5323, New Jersey conforms to the 80% limitation on utilization of NOLs under IRC Section 172.
- GILTI: Under the legislation, GILTI is treated as dividend income, so the legislation provides for 95% GILTI exclusion under IRC 951A. As such, the 50% GILTI deduction under IRC 250 is disallowed. This will be a favorable change for businesses with significant GILTI income.
- IRC 163(j) Interest Deduction Limitation: For purposes of the IRC 163(j) interest limitation, if a New Jersey combined group includes affiliates not included in the federal consolidated return, A5323 would now compute the interest limitation based on the members included on a New Jersey combined return as though they had filed a federal consolidated return. This provision is consistent with previously released guidance from the Division.
- Joyce to Finnigan Apportionment: All types of combined reporting groups are now required to use “Finnigan” rules for computing the sales factor. Under Finnigan, all New Jersey sourced receipts of combined group members are includable in the receipts factor numerator, regardless of whether the member has New Jersey nexus. This is unlikely to have any impact on businesses deriving service receipts, as typically, they would otherwise be subject to economic nexus.
- Income Excluded Pursuant to a Tax Treaty: Consistent with prior New Jersey guidance and case law, for taxpayers filing on a separate company, water’s-edge, or affiliated group basis, income that is protected by a treaty is not required to be included as income for New Jersey CBT purposes.
- Water’s Edge Group Members: The water’s edge definition has been modified to remove the requirement that members (wherever organized) with New Jersey nexus are included in the water’s edge combined return. Now, foreign affiliates includable under a water’s edge filing are included only to the extent of ECI, subject to treaty limitations.
It should be noted that the provisions are set to take effect in varying tax years, with some provisions being retroactive. Some of the best news coming from A5323 is what the legislation doesn’t include. As the Legislature did not extend the 2.5% CBT surtax, the surtax is now scheduled to sunset at the end of 2023.
Let’s Talk
Much of A5323 is filled with distinct CBT provisions that will impact businesses that are specific to their facts and circumstances. However, businesses with NOL carryforwards, GILTI income, file NJ combined returns, have foreign affiliates, or are subject to IRC 163(j) interest limitations will want to consider reviewing any potential implications and their current state filing positions.
One of the most notable changes lumped into the “CBT Legislation” is a non-CBT provision, which includes partnerships and sole proprietors adopting single sales/market-based sourcing. New Jersey adopted market-based sourcing for corporations as of 2019, and the state is doubling down to further expand the use of these rules. The adoption of a single-sales factor and market-based sourcing follows the ongoing trend we’ve seen for the last decade, as states continue to look to “export” the tax to out-of-state businesses by relying solely on a sales factor for apportionment and sourcing based on the location of the customer.
As businesses analyze the potential impact of the legislation, they should also monitor for any subsequent guidance from the Division of Taxation.