New Jersey and California Modify Pass-Through Entity Tax Rules to Expand Benefits
March 1, 2022
By: Jeff Glickman, SALT Partner
At a glance
- The main takeaway: New Jersey and California amended their pass-through entity (PTE) taxes with the goal to expand benefits and address previous shortcomings.
- Assess the impact: The new amendments made to PTE taxes will expand the applicability of a PTE tax election and increase the net potential tax benefits available to owners of an electing PTE.
- Take the next step: Aprio’s State and Local Tax (SALT) Team can help you navigate PTE taxes and the impact making an election can have on your business and its owners.
Schedule a free consultation today to learn more!
The full story:
Recently, New Jersey and California enacted legislative amendments to their pass-through entity (PTE) taxes to fix perceived shortcomings and to provide expanded benefits. Below is a summary of certain notable amendments from each bill.
On January 18, 2022, New Jersey Governor Phil Murphy signed into law S.4068, which made several amendments to the state’s PTE tax, referred to as the Business Alternative Income Tax (BAIT). The changes described below became effective January 1, 2022.
- The amount of income subject to the BAIT was originally determined based on the New Jersey source income of the PTE. Under the new legislation, the PTE income subject to BAIT will be expanded to include the entire distributive share of PTE income from all sources in respect to a resident owner.
- Each owner of a PTE is allowed a tax credit equal to such member’s direct share of BAIT paid by the PTE. Previously, the credit amount was based on each owner’s pro-rata share of the BAIT.
- PTEs that overpay the BAIT will now be allowed to apply the overpayment to the entity’s estimated tax payments for the following year.
- If a PTE has an owner that is itself a PTE, the amended law allows the BAIT credit to flow through to owners of the upper-tier PTE. This was not permitted under the original version of the BAIT.
- The new law eliminates the requirement for a partnership to remit non-resident withholding taxes for any nonresident “that reasonably expects to be refunded the payment on account of” a BAIT credit.
On February 9, 2022, California Governor Gavin Newsome signed SB 113, which made several amendments to the state’s PTE tax. Except as specifically noted below, the amendments are applicable for tax years beginning on or after January 1, 2021, and before January 1, 2026.
- One of the issues in the original version of the PTE tax that received the most vocal criticism was the fact that the PTE tax credit was not able to reduce an owner’s individual tax liability below the state’s tentative minimum tax, which significantly restricted use of the credit. The amended law lifts that restriction, thus allowing more of the credit to be used in a given tax year.
- Guaranteed payments are now included in the computation of income subject to the PTE tax.
- The amended law removes the restriction that did not allow a PTE with a partnership as an owner to make a PTE tax election.
- The legislation now allows certain owners of a limited liability company that is disregarded for federal income tax purposes to consent to have their share of PTE income included in the PTE tax computation.
- For tax years beginning on or after January 1, 2022, and before January 1, 2026, the PTE tax credit must be applied after the credit for taxes paid to other states.
The general impact of the amendments made in New Jersey and California is to expand the applicability of the PTE tax election and to increase the net potential tax benefits that may be available for owners of an electing PTE.
The bottom line
There are currently 22 states with PTE taxes that are in effect for tax years beginning on or before 2022, and 4 additional states are currently considering PTE taxes in their legislative sessions. Administrative guidance is constantly being updated to explain how these taxes work. Aprio’s SALT Team continues to track the developments in this area, and we can advise PTEs and their owners on the impact of making an election in one or more states. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.
This article was featured in the February 2022 SALT Newsletter.
Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.
About the Author
Jeff Glickman is the partner-in-charge of Aprio, LLP’s State and Local Tax (SALT) practice. He has over 18 years of SALT consulting experience, advising domestic and international companies in all industries on minimizing their multistate liabilities and risks. He puts cash back into his clients’ businesses by identifying their eligibility for and assisting them in claiming various tax credits, including jobs/investment, retraining, and film/entertainment tax credits. Jeff also maintains a multistate administrative tax dispute and negotiations practice, including obtaining private letter rulings, preparing and negotiating voluntary disclosure agreements, pursuing refund claims, and assisting clients during audits.