Pass-Through Business Alternative Income Tax Offered by State of New Jersey
Earlier this year, New Jersey passed the Pass-Through Business Alternative Income Tax (“BAIT”) Act, effective for tax years beginning on or after January 1, 2020. The new tax act is considered a “work around” for the loss of itemized deductions related to state income taxes paid. Prior to the TCJA that went into effect in 2018, a taxpayer could take a federal itemized deduction for taxes paid to New Jersey. Now, taxes paid to New Jersey are limited to $10,000 on a taxpayer’s federal return. New Jersey passed a law that permits a pass-through entity (partnerships, LLCs taxed as a partnership and S-Corporations) to pay taxes based on the income of the company. Thus, the taxes become a business deduction for federal tax purposes therefore lowering the federal tax liability.
The BAIT Act creates a great opportunity to save federal taxes in 2020 and potentially future years depending on federal tax laws. This New Jersey tax election must be made each year by all owners of the pass-through entity or by an officer designated under the law or the entity’s organizational documents. The annual election must be made on or before the original due date of the entity’s return required by the Division of Taxation. The pass-through entity’s return is due on the 15h day of the third month after the close of the tax year, in general March 15. Estimated tax payments are due on April 15, June 15, and September 15 of the tax year and on or before January 15 of the succeeding tax year. A cash basis taxpayer may be required to make the 4th quarter estimate by December 31 of the year the taxpayer expects to take the tax deduction on the federal return.
The tax paid at the entity level will pass through to the owners and each individual will receive a NJ tax credit against their gross income tax equal to the member’s tax on the share of distributed proceeds paid by the pass-through entity.
Since 2020 is the first year the BAIT is available, taxpayers will not be penalized under the safe harbor provisions in N.J.S.A. 54A:9-6 for the failure to file or make payments this year.
The tax rates are 5.675% of the first $250,000 of distributive income; 6.52% of distributive income between $250,000 and $1 million; 9.12% of distributive income between $1 million and $5 million; and 10.9% of distributive income above $5 million.