When Governor Murphy signed the Pass-Through Business Alternative Income Tax (“BAIT”) into law, it allowed pass-through entities to elect to pay tax on behalf of the owner’s share of distributive proceeds. The owner may then claim a refundable tax credit on their return for the amount of tax paid by the pass-through entity on their share of distributive proceeds. Pass-through entities (“PTEs”) are S Corporations, multi-member LLCs, and partnerships. Single-member LLCs and Sole Proprietorships do not qualify for the NJ BAIT election.
The NJ BAIT beneficially allows business owners to deduct the state tax liability connected with their pass-through income on their federal pass-through entity tax return. This was seen as a true workaround for the State and Local Taxes (“SALT”) limitation. On November 9, 2020, the Internal Revenue Service (“IRS”) substantiated this by its issuance of Notice 2020-75, indicating that certain entity-level taxes imposed on pass-through entities are not subject to the $10,000 SALT limitation of their owners. To receive the benefits of the BAIT, a PTE must make an annual election to be taxed under the entity-level regime.
Along with all the good this did, it created even more confusion for Practitioners and Taxpayers alike. For instance, the NJ BAIT tax was computed on Federal Distributive Proceeds and did not follow New Jersey Gross Income Tax law. Another issue occurs if you have an interest in a lower tier entity via another LLC and it made the NJ BAIT payment. The payment only flows as a refundable tax payment to the higher entity level. The higher tier entity would then need to make an election and pay in the BAIT tax in order for its shareholders/partners to receive the same benefit. The end result is that the shareholders/partners of the upper-level entity are unable to utilize the NJ BAIT credit and must wait for a refund from the state.
For 2021, the New Jersey Division of Taxation has modified their interpretation of “distributive proceeds” to mirror the reporting of partnership income and S corporation income for New Jersey Gross Income Tax purposes. The pass-through entity will complete its Members Directory using each member’s NJK-1 New Jersey sourced income amounts. In addition, for tax year 2021, an S corporation has the option to use three-factor formula (Sales, Payroll & Property) on NJ-NR-A for purposes of the BAIT. They also added an option to apply an overpayment to the following tax year. Under the previous rules, any overpayment needed to be refunded.
Effective for NJ BAIT filings starting on January 1, 2022, Governor Murphy signed a clean-up bill (S-4068/A-6110/6185) into law on January 18, 2022. There are some notable changes to the NJ BAIT law which are outlined below:
- Nonresident Withholding – NJ Partnerships will no longer require nonresident partners to pay in withholding, if the nonresident partner can reasonably expect to have this refunded due to the NJ BAIT Credit. This eliminates the burden of having the partnership basically pay in the same tax twice for a nonresident partner.
- PTE Tax Overpayments – Overpayments of the BAIT are now allowed to be credited to the subsequent tax year. Under the old law, the overpayment was required to be refunded. This will ease the unnecessary burden and risk of penalty, where a taxpayer may potentially be waiting for a refund needed in order to pay an estimate timely. This will take effect on the 2021 PTE-100 by allowing an overpayment to be applied to 2022. Caution – the PTE must remember to make a 2022 NJ BAIT election and file the return in order to utilize the overpayment applied from 2021 to 2022.
- NJ BAIT Tax Base – For resident partners, the base for calculating the NJ BAIT will include income from all sources as opposed to only NJ sources under the old rules. This seems logical as NJ residents are taxed on their entire share of partnership income from all sources. The base for calculating NJ BAIT for nonresident partners will continue to be based only on their distributive share of NJ source income. It should be noted that the new NJ BAIT Tax Base rules only apply to Partnerships and not S Corporations. As a result, the NJ BAIT Tax Base for resident and nonresident shareholders will be based on their pro-rata share of their NJ source income.
- NJ BAIT Apportionment Factor – For tax year 2021, S Corporations will have the option of using the single sales factor or the three-factor formula (Sales, Payroll & Property) to calculate NJ source income for resident and nonresident shareholders. For 2022, you are required to use the 3-tier factor to calculate the NJ BAIT tax base.
- PTE Credits for Tiered Partnerships – For Tiered Partnerships, the PTE credit is now allowed to be allocated to partners of the PTE that own the upper-tier partnership. The same rules apply to S Corporations that are partners in a partnership. In addition, gross income taxpayers can apply overpayments from the PTE credits against estimated tax payments. This will avoid double paying of taxes on the same source of income.
- Changes in Graduated Rates – Under prior law, the 10.9% rate was calculated for income of over $5 million. Under the new law, the 10.9% rate will apply to income more than $1 million.
- Trusts and Estates – Trusts and Estates cannot participate in the NJ BAIT directly. However, the credit allowed to any Trust or Estate pursuant to this section may be allocated to beneficiaries or be used against the tax liability of the estate or trust. For example, if the NJ BAIT credit flows to a Trust from an S Corporation and the Trust distributes its income to its beneficiaries, then the NJ BAIT credit will also distribute to the beneficiaries.
Questions? Please reach out to a Prager Metis tax advisor for more information: https://pragermetis.com/services/tax/