On Jan. 13, 2020, New Jersey Gov. Phil Murphy signed into law Senate Bill 3246, establishing an elective entity-level tax on pass-through entities. If the election is made, the entity’s members can receive a refundable gross income tax and corporation business tax credit. The measure had passed unanimously in both the state senate and general assembly in mid-December 2019.
For tax years beginning on or after Jan. 1, 2020, the tax is based on the sum of each member’s share of distributive proceeds attributable to the pass-through entity as follows:
- 5.675% of the sum of proceeds not over $250,000
- $14,187.50 plus 6.52% of the proceeds over $250,000, but not over $1,000,000
- $63,087.50 plus 9.12% of the proceeds over $1,000,000, but not over $5,000,000
- $427,887.50, plus 10.9% of the excess over $5,000,000
Pass-through entities include S Corporations, partnerships, and limited liability companies. The state income tax credit would equal each member's taxed share. The law allows for corporate tax credits to offset the elective taxes paid by a pass-through business owned by a corporation. According to the legislation, the election must be made annually on or before the due date of the entity’s return and cannot be made retroactively. Revocation of an election must be made on or before the due date of the entity’s return.
The new election applies to tax years for pass-through entities beginning on or after Jan. 1, 2020. The New Jersey law is similar to those enacted in five other states: Connecticut, Louisiana, Oklahoma, Rhode Island and Wisconsin. Connecticut’s version of the tax is mandatory, and not elective.
The bill is intended to provide a workaround to the federal $10,000 limitation on the state and local tax deduction. The federal deduction for the new state tax would be claimed at the entity level, but the members would receive a state credit. Importantly, taxpayers should analyze whether making the election and paying the entity-level tax will result in a lower overall tax burden. Not all pass-through entity members may benefit from the election and there may be other tax considerations that make the election undesirable. Taxpayers are encouraged to contact their state and local adviser to determine if paying the entity-level tax is a favorable option and to consider whether this provision, and those similar provisions enacted in other states, will withstand IRS scrutiny.