NJ Business Alternative Income Tax (BAIT) Now Improved

Good News in New Jersey: Business Alternative Income Tax (BAIT) Now Improved
Taxpayer concerns result in modification of prior law

The concerns of passthrough businesses are now being heard in New Jersey. Following the passage of the federal Tax Cuts and Job Act (TCJA) of 2017, passthrough entity (PTE) owners faced a $10,000 state and local tax deduction cap on 2018-2025 federal income tax returns, which resulted in much higher federal taxes for many taxpayers. New Jersey worked swiftly to enact an entity-level tax to work-around the federal deduction cap beginning in 2020.

As the New Jersey Division of Taxation rolled out its interpretation and guidance of the Business Alternative Income Tax (BAIT), serious concerns surfaced.

Small and mid-size businesses, along with professional tax organizations, let their concerns be known - and they were heard. A “clean-up bill” was introduced by the Senate in November 2021. It quickly passed both Houses and was signed into law on January 18, 2022.

Effective January 1, 2022, the bill clarifies the following:

• PTE owners will receive their “direct share” of the BAIT paid, rather than their pro-rata share”
• New Jersey source income will be the basis to calculate the BAIT, rather than federal taxable income, and three-factor income allocation will be permitted for all PTEs
• Tax brackets were expanded to include the 10.9% bracket for distributable proceeds attributable to the PTE more than $1 million, which will be more generous and align BAIT with the New Jersey gross income tax
• BAIT credit can “flow through” to the ultimate owners in tiered entity structures, which should eliminate estimated payments at each level and prevent the credits from being trapped in an “S” corporation
• Nonresident withholding will not be required on PTEs where nonresident owners “reasonably expect” an overpayment because of the BAIT credit, and
• Overpaid BAIT estimated payments by a PTE will be allowed to be applied to a successive year, or refunded

Revised law effective for 2022 tax years - and some department guidance for 2021
Although the “clean-up bill” takes effect for tax years beginning on or after January 1, 2022, a few days after the bill was signed, the New Jersey Division of Taxation posted important updates to the 2021 BAIT return and instructions:

• The interpretation of “distributive proceeds” were modified to mirror the reporting of income for New Jersey Gross Income Tax purposes.
• S corporations are being given the option to use three-factor for purposes of the BAIT.
• Credit carryforward option was added to the 2021 form, provided the 2022 BAIT election is filed before applying an overpayment to 2022.

Final thoughts
Was the Division of Taxation already working to resolve poor interpretations from the original legislation, or was the Division anticipating the “clean-up bill” to pass? Either way, PTE owners should rejoice that they don’t have to wait another year for these much-needed changes.

Article prepared by Jeanettee Hassis - contact us at info@herbein.com.