The “Pass Through Business Alternative Income Tax Act” was introduced and approved by the state Senate nearly a year ago before stalling. Now it’s back on lawmakers’ radar.
TRENTON — Legislation intended to give thousands of New Jersey small business owners a way to avoid paying higher taxes because of the federal government’s cap on its deduction for state and local taxes is making a comeback.
The bipartisan bill, known as the “Pass Through Business Alternative Income Tax Act,” was introduced and approved by the state Senate nearly a year ago before stalling in the Assembly this spring. Now it’s back on lawmakers’ radar during the Legislature’s lame-duck session and is poised to reach Gov. Phil Murphy’s desk before the end of the year.
It’s up for a vote before the full Assembly on Monday.
Lawmakers are pushing to get it in place for the 2020 tax year.
The legislation is designed to protect so-called pass through businesses and partnerships that pay taxes through their owners’ personal income returns rather than corporate taxes from the federal government’s $10,000 cap on state and local taxes deduction.
The cap was part of the federal tax overhaul in 2017 and limits how much residents in high-tax states like New Jersey can write off from their state income and local property taxes.
In order to protect pass-through businesses, which were previously able to deduct all their state and local taxes in their owners’ federal returns, the legislation aims to reclassify those businesses’ income tax payments as “elective entity-level tax” rather than personal income. The businesses would still be able to write off the state income tax payment because the federal tax law’s $10,000 cap does not apply to business taxes.
Based on IRS statistics, the proposal is expected to protect some 260,000 individuals and families in New Jersey that reported some $23 billion in income from pass-though businesses and partnerships.
It’s not clear why the bill was held up in spring, although multiple sources familiar with discussions between lawmakers and the Murphy administration indicated that some amendments were requested by Treasury. However, there now appears to be renewed confidence the bill will make it to Murphy before the session ends.
But there are also possible complications from the Internal Revenue Service, which revealed in June it planned to issue “guidance” on how the state and local deduction cap is applied to pass-through entities.
The IRS has already changed its regulations to block New Jersey and other states’ attempts to make a SALT cap workaround for homeowners by authorizing towns, counties and other local governments to create charitable funds that homeowners can contribute to in return for property tax credits equal to 90% of what they gave.
New Jersey, New York and Connecticut have teamed in a lawsuit challenging the IRS rules. They claim the rules were changed specifically to prevent their states from protecting their property owners from the SALT cap.
While the pass-through workaround could generate similar push back from the IRS, state officials expressed confidence their proposal would pass legal muster.
For starters, Connecticut approved a similar workaround for pass-through businesses last year that has not been stopped by the IRS.
Also, because New Jersey previously taxed pass-through businesses in the same way until 1993, lawmakers are confident the workaround would survive IRS scrutiny.
“Essentially, we’re going back to the future with a solution that’s IRS-proof,” state Sen. Paul Sarlo, D-36, of Wood-Ridge, said last year.
Another plus, because the businesses’ tax rates would remain the same as the personal income tax rates, there would be no loss of revenue for the state if the workaround is enacted.
While technically revenue neutral, supporters have said it would likely save business owners at least $400 million in federal taxes that they would likely spend in New Jersey, generating more economic activity, jobs and tax revenues for the state.
“It’s revenue neutral for New Jersey, but they’ll ultimately gain from it,” said Bill Love, a Medford accountant who has called on the state to adopt the business workaround. “Adding that much money to the economy creates a multiplier effect, so it’s really going to increase New Jersey’s revenues.”
He said missing out on 2019′s tax year was a blown opportunity so implementing it for 2020 becomes all the more critical.