Executive summary
New Jersey requires single-sales factor and customer-based sourcing for pass-through entities
As part of the comprehensive tax bill enacted by New Jersey earlier in the year, New Jersey adopted numerous significant changes to its corporate, international and pass-through tax regime. Since July, New Jersey has issued more than a dozen new and updated technical bulletins and other guidance detailing the changes contained in the tax reform. Although most of the changes impacted corporate taxpayers, New Jersey has recently issued guidance regarding the transition to customer-based sourcing and single-sales factor for non-corporate taxpayers.
New Jersey moves to single-sales factor and market sourcing for pass-throughs
The amended New Jersey tax regime for non-corporate taxpayers
New Jersey is one of several states that have historically applied different tax regimes to its corporate and non-corporate taxpayers. Specifically, while New Jersey has moved to single-sales factor and customer-based sourcing for corporate taxpayers as part of the New Jersey Corporation Business Tax (CBT), it has retained its application of the three-factor formula (property, payroll and receipts) and a cost of performance type approach (based on office location) for partnerships and certain other nonresident taxpayers. The guidance for that treatment was primarily provided through forms and instructions. In addition, New Jersey generally applies different apportionment and sourcing rules for other tax regimes for similar taxpayers, including nonresident partner withholding and the New Jersey Business Alternative Income Tax (the 'BAIT’ - the state’s version of an elective pass-through entity tax). The CBT provisions are already applicable to New Jersey S corporations.
The recently enacted legislation provides that the CBT provisions relating to single-sales factor and customer-based sourcing are applicable to the trade or business income of partnerships, S corporations, and other nonresident individuals when income earned from New Jersey sourcing 'cannot readily or accurately be ascertained' under the current tax regime. Accordingly, New Jersey has expressed its intent to broadly apply the CBT provisions, and its recently issued Technical Bulletin TB-112, Gross Income Tax Allocation and Uniformity with Corporation Business Tax Sourcing for Receipts Business Income, provides guidance regarding the application of the revised tax regime. A high-level summary of the guidance addressed in TB-112 follows below:
- The application of single-sales factor is now the 'default method for sourcing and must generally be used’ for applicable trade or business income. This language appears to negate any potential determination of whether the current tax regime would not ‘readily or accurately’ determine New Jersey-sourced income.
- New Jersey will apply the CBT special sourcing rules, including the application of the investor-based sourcing rules for asset management service providers, as well as the special rules applicable to advertising and transportation service providers.
- Income other than business income such as salaries and wages is not subject to the CBT sourcing rules. New Jersey indicated that guaranteed payments would fall under the CBT sourcing rules.
- New Jersey will also apply CBT concepts, such as whether a receipt is integrated in a trade or business (for example, for intangible income), the operation or non-operational income test and the unitary business principles.
- The new provisions will generally apply to the BAIT.
- New Jersey will entertain request for alternative apportionment (known as 'Section 8 Relief’).
- New Jersey will provide limited penalty and interest relief since the legislation was retroactive to Jan. 1, 2023.
Takeaways
New Jersey’s adoption of corporate concepts to pass-through entities as part of its latest corporate tax reform is the first significant change to New Jersey’s tax regime impacting pass-through entities and their owners with respect to trade or business income. These changes are generally expected to have a beneficial effect on most New Jersey based businesses and a negative impact on non-New Jersey businesses. The adoption of industry-based sourcing is also expected to be a major change to asset-management and other industries operating as pass-through entities.
For a discussion of prior guidance regarding nexus and Public Law 86-272, please see our article, New Jersey adopts new P.L. 86-272 guidance on internet activities. For questions about the state’s comprehensive tax reform or about the application of the numerous revised guidance documents, please speak to a New Jersey state and local tax adviser.
