New Jersey Enacts Pass-Through Entity Tax Election to Combat $10,000 SALT Cap

In an effort to mitigate the effect of the $10,000 federal cap on individuals’ itemized deductions for state income taxes, New Jersey Governor Phil Murphy signed into law SB3246 on January 13, 2020, the “Pass-Through Business Alternative Income Tax Act.” With this legislation, New Jersey joins Connecticut, Louisiana, Oklahoma, Rhode Island and Wisconsin in enacting some type of entity-level tax on pass-through entities (PTEs). 

For tax years starting on or after January 1, 2020, PTEs may elect to pay an entity-level income tax based on the sum of the distributive shares of the partners’ income. The tax is based on the sum of each partners’ distributive proceeds. The partners can claim a refundable credit for their pro rata share of the tax paid on their personal return. The term “distributive proceeds” is defined as the PTE’s various classes of income subject to NJ’s Gross Income Tax derived from or connected with sources within the state of New Jersey and upon which tax is imposed and due. For a nonresident partner, this means New Jersey source income.

The Election

The election is made at the entity level. It is available to partnerships, S corporations, and limited liability companies (LLCs) with at least two members. In order to make the election, at least one of the partners must have a liability for NJ Gross Income Tax on their distributive share of such entity’s income. Thus, the election is not currently available for the following:

1. Single-member LLCs (unless treated as an S corporation);
2. PTEs with only corporate partners; or
3. Entities that do not have income. 

Each member of the entity must consent, or consent is made by any officer, manager or member of the entity who is authorized to make such an election. The election is made on or before the due date of the entity’s return and on an annual basis. 

Taxpayer Credits

If a PTE makes the election, partners are allowed a refundable credit against their gross income tax. The credit is equal to the partner’s pro rata share of the tax paid by the PTE. The credit is taken after the application of all other credits. In addition to the credit for taxes paid by the PTE to New Jersey, resident taxpayers are also allowed a credit against their NJ tax otherwise due for amounts that are paid by the PTE to other states and determined to be substantially similar to the New Jersey PTE tax.

Illustration

A New Jersey resident is a 50% partner in a partnership that owns rental real estate in New Jersey and that makes the pass-through tax election. The total of the partners’ distributive proceeds is $200,000. The PTE tax related to this entity is $200,000 * 5.675% = $11,350. The New Jersey resident will receive a credit of their proportionate share (50%) = $5,675. Therefore, as a New Jersey resident, the partner calculates New Jersey income tax on their entire distributive share: $100,000 * 5.675% (assuming their NJ tax rate mirrors the PTE rate) = $5,675. This results in a net tax due of $0.