New Jersey Joins Other States in Recognizing Federal “S” Corporation Elections
It’s not unusual for the State of New Jersey to buck a trend. As New Jersey drivers know, after Oregon lifted its own ban, New Jersey now remains the only state in America where it’s illegal to pump your own gas. So too was the case if a taxpayer corporation wanted to designate itself as a “small business corporation,” or an “S” corporation.
For federal income tax purposes, certain eligible domestic business corporations that meet certain criteria, including types of shareholders and types of stock may elect to be treated as “S” corporations by filing Form 2553 with the Internal Revenue Service. This allows the corporation to receive favorable “pass-through” tax treatment and avoid double taxation of income by being taxed at only the shareholder level. S corporations must then file their income tax returns on Form 1120-S.
Almost every state and jurisdiction that imposes a corporate income tax follows federal tax law and recognizes the federal S election as choosing the same treatment at the state level. Said differently, once a federal Form 2553 is properly filed and effected, no separate S corporation election is required. That was not the case with New Jersey. Until recently, New Jersey was one of the few states requiring separate elections.
However, effective December 22, 2022, New Jersey no longer requires eligible taxpayers to affirmatively elect S corporation treatment. To accomplish the change, New Jersey amended the definition of “New Jersey S Corporation” to include taxpayers that have made a valid election to be an S corporation for federal income tax purposes. Therefore, if a taxpayer is treated as an S corporation for federal tax purposes, then the taxpayer is automatically treated as a S corporation for New Jersey CBT and Gross Income Tax purposes. Any entity that has federal S corporation status for tax periods on or after December 22, 2022, may automatically file their state returns on Form CBT – 100S (for New Jersey S Corporations). To be treated as a New Jersey S corporation for any periods beginning before December 22, 2022, the New Jersey corporation must still make a retroactive election for those dates.
This should simplify New Jersey tax compliance and help avoid a “hybrid” situation with pass-through treatment at the federal level and double-taxation at the state level. However, New Jersey does still require proof of federal S corporation status. Moreover, the New Jersey Division of Revenue and Enterprise Services requires newly formed S corporations to submit shareholder consents to such tax treatment. Note that such treatment opens up New Jersey nonresident shareholders to taxes in New Jersey on any income generated by the corporation, as it is “passed through” directly to the shareholder (versus only on any distributions in a standard corporate tax scheme). If a nonresident shareholder does not consent to New Jersey jurisdiction, then the corporation itself must consent to the assumption of any tax liabilities on the shareholder’s behalf when filing the New Jersey Corporation Business Tax Return on Form CBT‑100S.
A New Jersey corporation with a valid federal S election can elect to be a hybrid corporation (where it is a federal S corporation but New Jersey C corporation) under N.J.S.A. 54:10A-5.22.d. If 100% of the shareholders consent to this decision, the entity may make the C Corporation Tax Status Election. All of the above is also true for qualified S corporation subsidiaries.
The language of the legislation can be found here: https://legiscan.com/NJ/bill/A4295/2022.
For our Pennsylvania clients, as mentioned above, a federal S corporation election automatically confers the same treatment at the Pennsylvania state level. However, as with New Jersey (since December 22, 2022), a Pennsylvania corporation with federal S corporation status that does not desire to be a Pennsylvania S corporation may file a special election on PA state Form REV-976 to be specifically excluded. The REV-976 election must be filed on or before the due date of the PA Corporate Net Income Tax Report for the first tax period in which the election is to be in effect. The election must also be signed by all shareholders of the corporation and cannot be revoked for a period of five years. The same is true for qualified S corporation subsidiaries.
About the Author
Yuri Mitchell concentrates his practice in the representation of businesses and individuals in a variety of tax and corporate matters. His clients rely on him for his understanding of the legal and financial landscape in the areas of entity choice and formation, mergers and acquisitions, restructurings, and the associated tax impact of a particular transaction. Learn more.