Purpose of The NJ Pass-Through Business Alternative Income Tax Act
As New Jersey taxpayers are well aware, the Tax Cuts & Jobs Act limited the individual state and local tax (SALT) deduction to $10,000 a year. This limitation can be particularly onerous on residents of high tax states such as ours. New Jersey created the “Pass-Through Business Alternative Income Tax”, which became effective for tax years beginning on or after January 1, 2020, in order to mitigate the effects of this limitation.
Partnerships and S Corporations are pass-through entities (PTEs) which do not directly pay income tax. The tax on any profit earned by PTEs is paid by the partners or shareholders on their personal returns. The new law, if elected by a PTE, will shift the NJ income tax burden from the individual to the entity level. The idea is that by taxing the entity directly, the tax payments will no longer be subject to the SALT deduction limitations which are imposed on individuals. The law provides for a refundable gross income tax credit for individual partners or shareholders equal to their pro rata share of the tax paid by the entity.
IRS Provides Clarification Supporting Key Aspects of the NJ Law
The IRS issued Notice 2020-75 which clarified its position on key aspects of the NJ law as well as similar laws enacted by other states. Prior to issuance of this notice, there were questions surrounding whether PTEs would be able to deduct any state income tax paid at the entity level, particularly when these payments are elective and not mandatory. There were also questions surrounding whether entity-level payments made under these laws would need to be taken into account when applying the SALT deduction on the owner’s return. The IRS has now stated that proposed regulations will be released which will allow the PTE to deduct these state and local income taxes in arriving at the income or loss which will pass through to the owners. The amount of state tax paid by the PTE will not need to be separately stated on the owner’s K-1, and will not be taken into account in determining the owner’s individual SALT limitation. This is welcome news for NJ business owners and should be considered in conjunction with year-end planning decisions.
Cullari Carrico LLC remains committed to assisting our clients, friends and communities and has a dedicated tax team in place that can assist with any questions you may have. We invite you to contact us if you would like assistance in developing tax strategies for minimizing your overall tax burden during these difficult times.