Submitted by Edward J. Sadowski, CPA, MST with Withum
On January 13, 2020, Governor Phil Murphy signed into law Senate Bill 3246 (S. 3246 or bill) establishing the "business alternative income tax" (BAIT), an elective New Jersey business tax regime for pass-through entities (PTEs). Staffing firms are left wondering if electing to pay the BAIT is the right choice. Here we summarize how the NJ BAIT works, as well as its pros and cons for companies in the industry.
The new law allows pass-through entities such as S corporations and LLCs to elect to pay NJ income tax at the entity level, as a business tax, and to pass through a net amount of Federal taxable income to the owners of the business along with a gross amount of NJ taxable income a NJ tax credit to prevent double taxation in NJ. By passing through a gross amount of NJ taxable income and a credit, the owner is not required to separately pay NJ income tax that could be subject to the SALT limit. Absent this election, the business would pass through a gross amount of Federal and NJ taxable income to the owner, the owner would pay NJ income tax, and the owner’s tax payment would be subject to the SALT limit. The BAIT applies to PTE tax years beginning on or after January 1, 2020. A detailed article regarding the BAIT tax and its mechanics can be found here. https://www.withum.com/resources/new-jersey-businesses-should-consider-salt-deduction-limitation/
Below are some key considerations to take into accounting in determining whether your firm may want to elect to pay the BAIT:
What makes the NJ BAIT election attractive to staffing firms?
What aspects of the NJ BAIT election may be unattractive to staffing firms?
- The BAIT can be most advantageous where a significant portion of the receipts are sourced to New Jersey and the entity’s owners are New Jersey residents. In that case, the residents get a significant advantage with the entity claiming the federal tax deduction for state taxes paid. In this manner, a federal benefit is recognized for the NJ income tax paid rather than having the federal itemized deduction on Schedule A capped at $10,000. In addition, NJ residents partners/shareholders do not have to worry about whether they will be able to claim offsetting credits in home states other than New Jersey.
- Partnerships, LLC’s and consenting New Jersey S-Corporations can make the BAIT election.
- Single member LLC’s and sole proprietorships may not elect the BAIT.
• Non-resident credits: The partner or shareholder’s resident state, if not NJ, may not allow a resident credit on their individual returns for taxes paid at the entity level in New Jersey.
• Cash flow: Duplicate BAIT estimated payments are required as are non-resident withholding payments.
• Cash basis taxpayers must make BAIT payments by year-end to get the federal tax deduction.
• S-Corporation revenue sourcing methodology for those who elect BAIT may be Cost of Performance as opposed to market sourcing.
The IRS recently released Notice 2020-75. In the Notice, the IRS has announced that it intends to issue proposed regs to clarify that State and local income taxes imposed on and paid by a partnership or an S corporation on its income are allowed as a deduction by the partnership or S corporation in computing its non-separately stated taxable income or loss for the taxable year of payment. For more information on the impact of this on NJ BAIT, see Withum’s recent update.
Business owners should keep in mind that the election to pay tax at the entity-level is subject to the facts and circumstances of each business. It should also be noted that the results of the presidential election could make BAIT moot if the SALT cap of $10,000 were to be reversed at some point in the future.
Withum can discuss and help you analyze if the BAIT election makes sense for your business. It is important for businesses to consider any planning in respect to the BAIT election for their 2020 tax returns.