As states such as New Jersey continue to enact SALT Deduction limitation workarounds, it is essential for businesses to consider opportunities as part of year-end tax planning. Businesses that meet all three conditions should prioritize planning today.
Effective for tax years beginning 2020, the New Jersey Business Alternative Income Tax (“BAIT”), is an elective entity-level tax on pass-through businesses. The BAIT provides a workaround to the Federal limitation for the state tax deductions.
While there are a number of implications businesses should consider, the following businesses that meet these three conditions should assess the New Jersey BAIT as part of their year-end tax planning:
- Flow-through entities (i.e. partnerships, LLCs, and S corporations)
- Partners/Shareholders (of flow-through entities) that are predominantly New Jersey residents
- Businesses with significant New Jersey presence
The TCJA imposed a $10,000 limitation on the amount of state and local tax (“SALT”) that individuals (or pass-through business owners) may deduct for federal income tax. Some states, including New Jersey, responded by enacting various workaround bills in an effort to mitigate the impact of the limitation on their state residents.
Businesses that meet all three conditions should prioritize planning today in preparing for year-end tax planning. As there are many technicalities with the legislation, it is important for businesses to analyze whether making the election would yield in a lower tax burden. Proactive analysis and planning is vital as not all businesses may benefit from the election, with potentially unfavorable consequences.
Mechanics of the BAIT Election
By passing through a net amount of income reduced by the SALT deduction, the owner is able to fully deduct their New Jersey taxes for federal purposes.
Consider the following simplified example:
S corporation (S) has net income of $1,000,000 in 2020, and one individual shareholder (A). Absent the election, S would pass through to A $1,000,000 of net income and A would pay NJ income tax of approximately $60,000. Most of this payment, or $50,000, would not be deductible at the Federal level because of the SALT limit. Alternatively, if S elects the BAIT to pay tax at the entity level, it would hypothetically be able to deduct the full $60,000 for federal purposes. Assuming a 37% tax rate for federal purposes, this could be equated as much as $22,200 of tax savings [1].
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The potential benefits along with the risks need to be weighed in determining the right course of action. Some of these considerations may include:
- IRS Challenges: The treatment of the election for Federal income tax purposes is uncertain, and it is possible BAIT will be challenged by the IRS, with loss of the SALT deduction. (This could result in amended returns, interest, and/or penalties.) Please note that the presidential and congressional election results (i.e. a potential change in administration) could result in significant changes in the tax law, including the reinstatement of the SALT deduction.
- Non-Resident Credits: Non-New Jersey resident partners/owners of an entity that elects to pay the New Jersey entity-level tax may not receive a credit in their home states (e.g. New York) for the New Jersey entity tax paid, resulting in double state income taxation.
- Duplicate Estimate Payment Requirements: The bill does not alter existing non-resident withholding requirements for those pass-through entities that elect to pay the BAIT. Therefore, overlapping payment requirements may be necessary if individual non-resident taxpayers are subject to both regimes. (This is only for estimated payments, not the actual tax itself).
- Other Considerations: Business owners should keep in mind that the election to pay tax at the entity-level is subject to the facts and circumstances of each business.
Withum’s SALT team can discuss and help you analyze if the BAIT election makes sense for your business. Although we are still in the process of understanding all of the nuances of the tax and awaiting the State to draft guidance on the new law, it is important for businesses to consider any planning in respect to the BAIT election for the 2020 tax returns. With quarterly estimates for business owners coming due on September 15, the time to plan is now.
Authors: Jason Rosenberg, CPA, CGMA, EA, MST | [email protected], Jim Bartek, CPA | [email protected], and Barry Horowitz, CPA, MST | [email protected]
State and Local Tax Updates
[1] The simplified calculation uses various assumptions and rounded tax rates for illustration purposes. Reach out to Withum SALT to explore specifics in modeling any potential tax savings.
