Highlights of New Jersey Business Tax Changes
By Debra M. Simon, CPA, MST
The New Jersey Legislature passed substantial retroactive changes in its tax laws on July 2, 2002, in P.L. 2002, Chapter 40. The changes were necessitated by a constitutional mandate to balance the state’s budget. Most of the passages were targeted at corporations and business entities that were believed to be deriving benefits from business operations in New Jersey but not contributing to the tax rolls. Some changes specifically target nonresident corporate and individual members of partnerships, limited liability companies, and limited liability partnerships. Other changes were necessitated by the state’s projected loss in revenue as a result of federal legislation passed earlier this year. Provisions within the tax act are generally effective for tax years beginning on or after January 1, 2002.
New Concepts in N.J. Taxation
Some of the changes in this legislation represent new concepts in N.J. taxation. New concepts affecting entities filing partnership returns include a fee, called the K-1 tax, to be paid by the entity for each partner or member of record. Another of these concepts is a partnership-level tax on nonresident partners or members that have source income in New Jersey.
A new concept in N.J. corporate taxation is a throwout rule that changes the apportionment of multistate income. Perhaps the most talked-about change in the legislation is the Alternative Minimum Assessment (AMA), which expands New Jersey’s nexus beyond the protection of P.L. 86-272, even as the assessment is crafted so as not to be a direct income tax.
Every entity filing a partnership return for federal income tax purposes (partnership, limited liability company, or limited liability partnership) is considered a partnership within the provisions of the new law.
Every partnership having any income derived from N.J. sources (at an entity level) and having more than two owners must file a minimum fee of $150 per partner, which is capped at $250,000. Each entity required to make a payment under this provision is also required to make an installment payment of its filing fee for the succeeding return equal to 50% of the amount due for the succeeding return period.
Every tax partnership (other than qualified investment partnerships or partnerships listed on a U.S. national stock exchange) is required to make a payment of tax on or before the 15th day of the fourth month succeeding the close of the partnership year. The tax represents withholding on the net income of nonresident partners. The amount is equal to the net income multiplied by an allocation factor, which is based on the allocation fractions of the partnership as multiplied by the applicable rate. For nonresident noncorporate partners, the rate is .0637%. For corporate partners, the rate is .09%. The amount of tax paid by a partnership under this provision is to be credited to the respective accounts of the partners in proportion to the partners’ shares of allocated net income.
Professional Services Corporations
Each professional corporation or similar corporation for profit organized for the purpose of rendering professional services and having more than two licensed professionals must pay a fee similar to, but greater than, the K-1 tax. The entity must pay $150 per licensed professional, capped at $250,000, regardless of whether that licensed professional is an owner or a shareholder. This tax is based on the average number of licensed employees for the given year. Entities liable for payments under this provision must also make 50% installment payments for the succeeding year. The payments are due when the return is required to be filed.
S corporation tax rates were in the process of being phased out; however, that phase-out has been delayed. The rate will remain at 1.33% through tax year 2005, will be reduced to .067% for 2006, and will be eliminated thereafter. S corporations with entire net incomes of $100,000 or less are no longer subject to the tax.
The new legislation increased the minimum corporate tax to $500 for the 2002 tax year and thereafter. Corporations that are members of affiliated groups with a total payroll of $5 million or more are liable for a $2,000 per-entity minimum tax. Small businesses that are C corporations and have net income less than or equal to $50,000 will be taxed at a reduced rate of 6.5%.
Utilization of carryforward net operating losses against current income is suspended for 2002 and 2003. Instead of those losses expiring after seven years, however, the carryover period is extended to nine years.
The AMA is perhaps the provision with the most impact. It is imposed at graduated rates on either “N.J. gross receipts” or “N.J. gross profits,” at the election of the taxpayer. The election, once made, is binding for a five-year period. The graduated rate tables differ depending upon the elected method. N.J. gross receipts are receipts from sales of tangible personal property to N.J. destinations, services performed in New Jersey, rentals of property situated in New Jersey, royalties for the use of patents and copyrights in New Jersey, and all other business receipts earned within New Jersey. N.J. gross profits are N.J. gross receipts, less returns and allowances, and less cost of goods sold. Payments are due if the calculated AMA exceeds the Corporate Business Tax (CBT). Payments of AMA (excess of AMA over CBT) may be credited against future corporate business taxes, without expiration of the carryforward. The disposition of an AMA carryforward in the event of a corporate reorganization is not clear. A single corporation cannot have an AMA liability of more than $5 million. There is a cap of $20 million on the AMA of affiliated groups of five or more taxpayers.
Another provision expected to have significant impact is the throwout rule affecting the apportionment of sales for multistate corporations. Previously, New Jersey required an entity to have a bona fide out-of-state office in order to apportion sales. If that requirement was met, then the entity was allowed to apportion based on a formula of N.J. sales in the numerator and total sales in the denominator. The requirement for an out-of-state place of business stands, but in addition, under the throwout rule, sales that are not subject to income taxes within a state, U.S. territory, or foreign entity, are ignored for purposes of the denominator.
The deduction of interest and intangible expenses, paid directly or indirectly and accrued or paid to affiliates, is disallowed. The deduction may, however, be permitted if the taxpayer provides evidence that the affiliate was a conduit for an unrelated third party. Such payments to related members within a foreign nation under a comprehensive tax treaty with the United States are not disallowed. Related-party interest deductions are generally disallowed, but may be allowed in certain nonavoidance situations.
Depreciation claimed as a result of the recent bonus depreciation allowed by the federal government under the Job Creation and Worker Assistance Act of 2002 must be added back for the calculation of entire net income.
Deductions for foreign taxes paid to any foreign country, state, province, territory, or subdivision thereof are disallowed.
Combined reporting may be required at the discretion of the director of the Division of Taxation, and will be due within 60 days of the request.
Other corporate provisions include an expansion of eligibility for the jobs credit, limitations on the dividends-received deduction, and limitations on the deduction for research and experimentation costs.
The new legislation also changes the requirements for estimated payments of corporations; the fourth-quarter estimates for 2002 are based upon the 2002 tax. For years beginning on or after January 1, 2003, corporations with gross receipts of $50 million or more must accelerate their estimates by doubling the second-quarter estimate to 50% of the estimated liability (in most cases, eliminating the need for a fourth-quarter payment).
The implications of these new tax changes clearly expand beyond residents of New Jersey. In order to enforce the act, the director’s authority and discretion are enhanced. Temporary regulations are currently in effect until permanent regulations can be promulgated according to usual policy.
There are many gray areas, and hopefully the regulations will offer answers to the following questions: When is the measurement date for the licensed professional fee of the professional corporations? What nexus issues and legal challenges will arise with respect to the Alternative Minimum Assessment? What will be the reality of the 60-day demand for combined returns at the discretion of the director? How will the director interpret his role within the new legislation?
A full text of the legislation is available from the New Jersey State Legislature’s website at www.njleg.state.nj.us. The N.J. Division of Taxation has published information in a question-and-answer format, available from the division’s website, www.state.nj.us/treasury.
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