New Jersey Governor Phil Murphy recently signed legislation that makes significant revisions to the state’s corporate and gross income tax, including:
- Adds a bright-ine nexus threshold for New Jersey Corporation Business Tax
- Treats GILTI as dividend income and disallows deductions related to FDII and GILTI.
- Modifies the interest deduction rules.
- Adopts the Finnigan rule for purposes of the sales factor on combined reports.
- Allows prior year net operating loss (NOL) carryovers to be utilized against combined group income and makes other changes impacting NOLs.
- Reduces the available deduction for public companies related to increases in deferred taxes as a result of unitary reporting.
- Subjects captive real estate investment trusts, captive investment companies and captive regulated investment companies to combined reporting requirements.
The majority of the changes impact the New Jersey Corporation Business Tax (“CBT”), but there are also revisions to the apportionment calculations for partnerships and S corporations that affect New Jersey individual gross income tax and other tax and administrative impacts.
Effective for tax years ending on and after July 31, 2023, New Jersey has adopted a threshold that establishes New Jersey CBT nexus if a taxpayer has in excess of $100,000 in New Jersey gross receipts or 200 or more transactions.
The New Jersey CBT nexus threshold now mirrors the economic nexus threshold New Jersey imposes for sales tax purposes. It’s important to note that the new bright-line nexus standard for New Jersey CBT is in addition to the other ways a corporation may have nexus (such as physical presence) with New Jersey. It should also be noted that the protections afforded by P.L. 86-272 will still apply to the New Jersey CBT but not the New Jersey minimum tax.
GILTI and FDII treatment
Effective for tax years ending on and after July 31, 2023, amounts required to be included in federal taxable income under (i.e., GILTI income) are considered dividends and are subject to New Jersey’s 100% dividends received deduction (DRD). The result is an effective 95% deduction after the 5% expense disallowance. Additionally, for tax years ending on and after July 31, 2023, the deductions allowed for GILTI and FDII under IRC § 250 are no longer allowed.
Timing of deduction of New Jersey qualified research expenditures
Taxpayers may deduct the full value of New Jersey qualified research expenditures in the same year as the New Jersey Research and Development Tax Credit. As a result, the New Jersey legislation decouples from the federal treatment for privilege periods beginning on and after January 1, 2022.
For federal purposes, prior to the enactment of the TCJA in 2017, taxpayers were allowed the option to deduct R&E expenses currently or treat these expenses as deferred and to be capitalized or amortized over their life. The TCJA revised this treatment and requires that for amounts paid or incurred in tax years beginning in 2022 and after, all taxpayers are required to capitalize and amortize R&E expenses over a 5-year period for domestic expenses and 15 years for foreign expenses.
Interest expense limitations
Under prior law, for periods beginning after December 31, 2017 and ending before July 31, 2022, the IRC Section 163(j) interest deduction limitation applies on a pro-rata basis to related, as well as unrelated parties, regardless of whether the related parties were subject to the interest expense add-back.
Under the new legislation, for periods ending on and after July 31, 2022, the IRC Section 163(j) interest deduction limitation will be applied to a combined group (for New Jersey purposes) as though the combined group files a federal consolidated return.
As a result, the New Jersey Section 163(j) business interest limitation and interest deduction should mirror the federal consolidated return. If a New Jersey combined group does not include all the affiliates in a federal consolidated group, then the combined group, and those affiliates, will be treated as having filed a federal consolidated return.
Repeal of interest and intangible addbacks
The interest and intangible add-backs for amounts paid to related members have been repealed for tax years ending after July 31, 2023.
Adoption of Finnigan Rule for combined reports
All combined groups are required to use the Finnigan Method for sourcing receipts. A combined group is treated as one taxpayer for purposes of sourcing the unitary receipts of the combined group.
Therefore, for purposes of calculating the numerator and denominator of the New Jersey allocation factor of the combined group, effective for tax years ending on and after July 31, 2023, the combined group (as one taxpayer) is required to include in the numerator New Jersey sourced receipts of all members of the combined group (regardless of whether a member of the group has nexus with New Jersey).
Under the prior rule (i.e., Joyce), only members with New Jersey nexus were required to include New Jersey receipts in the numerator of the New Jersey allocation factor.
NOL limitation and ordering rule
The New Jersey legislation conforms to the federal rules for carryforward purposes and limits a New Jersey taxpayer’s annual net operating loss (“NOL”) deduction to 80% of taxable income after July 31, 2023.
The legislation also allows the use of the dividend exclusion before the use of an NOL deduction. Under prior law, NOLs were required to be deducted before the dividend exclusion.
This revision is beneficial to taxpayers since a dividend exclusion is lost if not used in the tax year received. Excess NOLs may be carried forward.
Revisions to the PNOL sharing rules for combined groups
For periods ending on, and after, July 31, 2023, the remaining balance of the prior net operating loss (PNOL) conversion carryover deduction (as a result of the 2019 New Jersey tax reform) can now offset net income of the combined group for which the corporation is a member. Under prior law, a PNOL conversion carryover deduction could only be used to offset net income of the corporation that generated the PNOL, and it could not be shared.
Adjustment of NOLs upon audit
For tax years ending on, and after, July 31, 2022, both the Director of the New Jersey Division of Taxation and the taxpayer have the authority to adjust NOLs closed for purposes of the statute of limitations on assessments in order to determine the correct tax liability in tax years that remain open to assessment.
For these tax years, but not for previous years, this decision nullifies a 2021 tax court ruling in R.O.P. Aviation v. Div. of Taxation, that precluded the Division of Taxation from adjusting the net operating losses from closed years.
Change in duration of managerial member
For tax years ending on, and after, July 31, 2023, the legislation changes the term that a member is required to serve as a managerial member from 10 privilege periods to six privilege periods (the current privilege period plus the five succeeding privilege periods).
Revisions to the special rule for public corporations with increases in deferred tax liability resulting from combined reporting
The net deferred tax liability (“NDTL”) deduction can still be taken for privilege periods beginning on, and after, January 1, 2023. However, the allowable deduction amount will be calculated differently under the new legislation.
The deduction will be taken over a minimum of 27 group privilege periods but there is no requirement that the periods be consecutive. If an entity cannot use the deduction in a particular group privilege period because of the income limitation, the balance will be carried forward for use in a future period but the total amount used in a given period cannot exceed the allowable deduction percentage for that period.
There are two deduction periods: one for group privilege periods beginning on, or after, January 1, 2023 but before January 1, 2030, and another for group privilege periods beginning on, or after, January 1, 2030. For the first deduction period (group privilege periods beginning on, or after, January 1, 2023 but before January 1, 2030), the deduction is limited to 1% of the total NDTL deduction per period for the first seven group privilege periods. For the second deduction period (group privilege periods beginning on, or after, January 1, 2030), the deduction is limited to 5% of any remaining NDTL deduction per period until fully used.
The 1% and 5% amounts are calculated once at the beginning of each deduction period.
Non-US corporations claiming treaty protection (other than world-wide group members)
For periods ending on, or after, July 31, 2022, a non-US corporation that is incorporated or formed in a foreign nation with a comprehensive tax treaty with the United States does not include any item of income (or loss) excluded or exempted from federal taxable income under the terms of the treaty in entire net income. Deductions, exclusions, or eliminations are not permitted for any excluded income (loss). The receipts attributable to such excluded items are also excluded from the allocation factor.
Income of non-US corporations that are not members of a world-wide group combined return
For periods ending on, or after, July 31, 2022, a non-US corporation that is not a member of a world-wide group combined return must include its effectively connected income on its New Jersey return that was reported for federal purposes that is not protected by a tax treaty. Such non-US corporation does not have to add back world-wide income that was not included for federal purposes.
For a non-US corporation that did not file a federal return, the corporation only reports its non-treaty protected US source income that would be effectively connected income had the corporation been conducting a business effectively connected to the US. Only the receipts and expenses attributable to such income (loss) amounts are included. For allocation factor purposes, only receipts attributable to effectively connected income of that non-US corporation would be included. This means that any receipts not attributable to effectively connected income are excluded from the allocation factor.
Definitions of world-wide basis and world-wide group
Under the legislation, a definition was added for “world-wide basis” and “world-wide group” for purposes of combined reporting. A world-wide group includes all members of the combined group regardless of where they are located or formed. The world-wide basis includes all of the income and attributes of such members regardless of whether they file federal returns. The members must include all income regardless of any exemption or exclusion provided by a tax treaty. In the case of a member that is a non-US corporation, the member is allowed to take deductions that are allowed for a US corporation.
Inclusion of certain captive entities in the combined group
The new legislation requires real estate investment trusts (“REITs”), investment companies, and regulated investment companies (“RICs”) that meet statutorily enumerated definitions of a “captive” to be included as members of the combined group and taxed as C corporations, which means disallowing the benefits provided to those entities, including the special apportionment treatment and deductions that would be allowed under the Internal Revenue Code only for those classes of entities.
It's important to note that REITs, investment companies, and RICs in which at least 50% of the shares, by vote or value, are owned or controlled, directly or indirectly, by a state or federally chartered bank, savings bank, or savings and loan association with assets that do not exceed $15 billion or that otherwise do not meet the definition of a captive REIT, investment company, or RIC are still excluded from the combined group and are not subject to these changes.
Due date of tax returns
The legislation makes a technical change in the tax return due date by providing that the return due date and a return on extension are due the 15th day of the month following the month in which the federal tax return is due (for tax years ending on, and after, July 31, 2023) rather than providing that the due date is 30 days after the federal return is due (which previously applied to tax years ending on, and after, July 31, 2020 and before July 31, 2023).
Increase in installment payment safe harbor amounts
The legislation increases the installment payment safe harbor from $500 to $1,500. Additionally, the law sets forth the safe harbor amount for combined groups by applying the $1,500 amount by taxable member in the aggregate. As an example, if a combined group had three taxable members, the safe harbor amount would equal $4,500.
Installment payment underpayment date change
The legislation also changes the underpayment date to coincide with the same month as the due date of the New Jersey CBT returns to the 15th day of the fifth month after the close of the fiscal or calendar accounting year (i.e., the 15th day of the month following the month of the original due date of the federal return). The legislation also provides that a taxpayer may petition the Director of the Division of Taxation to have such penalties or interest waived due to undue hardship, good cause shown, or other reasons as may be provided for waiving penalties and interest in the State Tax Uniform Procedure Law.
Penalties and interest related to the New Jersey legislation
For CBT and GIT taxpayers impacted by the statutory amendments, no penalties or interest will accrue for underpayment of tax as a result of the provisions of this legislation applying to privilege periods ending on, and after, July 31, 2023 (that began on January 1, 2023 in the case of Gross Income Tax taxpayers), but ending before January 1, 2024, that create an additional tax liability as a result of the statutory amendments. However, the additional estimated payments shall be made by the later of the second next estimated payment due date subsequent to the enactment the legislation or the second estimated payment due date after January 1, 2024
The New Jersey legislation also prospectively mandates that the sourcing rules for business receipts (not individual taxpayer’s compensation) for Gross Income Tax (“GIT”) purposes will follow the New Jersey CBT sourcing rules.
Therefore, if a taxpayer that is subject to the GIT engages in a trade or business (regardless of business form) or is a partner in a partnership or shareholder of an S corporation that conducts business operations partly inside and partly outside New Jersey, and the portion of the New Jersey income cannot readily or accurately be ascertained, the income must be sourced in a manner consistent with the provisions under the CBT rules.
The result is that for GIT purposes business receipts (other than the individual taxpayer’s compensation as an employee) are sourced using a single sales factor formula (instead of the historic three-factor formula) and service receipts are sourced using market sourcing rules (instead of cost of performance rules).
The New Jersey legislation is a major step towards providing tax relief to companies doing business in the state.
The New Jersey Division of Taxation has issued a Technical Bulletin (TB-107) that explains the many changes and provisions of the bill. In addition, the Division released three technical advice memoranda on July 25, 2023 – TAM-2011-6(R) which addresses foreign corporations subject to tax, TAM 2011-13(R) which addresses adding back related member interest expense for periods ending prior to July 31, 2023, and TAM 2011-22(R) which addresses international affiliate transactions involving intangibles and intellectual property for periods ending prior to July 31, 2023.
Please contact your Mazars professional for additional information.
The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.